From the given case,

Identify the Operating Exposure of Banbury Impex if there is any changes in foreign currency exchange rate.

Banbury Impex (India)' As November 2010 came to a close, CEO Aadesh Lapura of Banbury Impex Private Limited, a textile company in India, sat in his office in solitude looking over his company's financial statements. It looked like 2010 would close with a small growth in sales and a small drop in profits. Although Banbury's profits were positive, the prospects of about 1.5% return on sales were simply not good enough moving for- ward. He now had two problems: negotiating a short-term prospective sale to a Turkish company, and increasing his overall profitability, which was a larger, long-term problem. Lapura concluded that overall profitability thereof-was a result of two price forces. The first was the rapid rise in the price of cotton. A major cost driver in the textiles industry, cotton prices had risen dramatically in 2010. The second issue was clearly the rising value of the Indian rupee (INR) against the U.S. dollar (USD). Banbury's sales were all invoiced in U.S. dollars, and the dollar was falling. Profit margins were down, and he needed to move quickly. Banbury's sales were nearly all exported, mainly to the Middle East (50%), South America (30%), and Europe (10%). Banbury's products included a range of blended woven fabrics made from viscose, cotton, and wool. The company operated two weaving units based in India. The company's sales growth had been slow over the past five years, averaging about 2.5% per year. However, man- agement had been satisfied with 5% margins in 2006 and 2007 in a highly competitive business environment. Cash flows had remained relatively predictable as Lapura had managed foreign exchange risks by using forward contracts. Choosing to invoice all international sales in USD helped provide further stability in mitigating raw material costs, as international cotton prices were priced in USD. All things considered, Banbury's profit projections for 2011 looked disastrously low. -or lack Banbury Fabrics Founded in 1997, Banbury Impex Private Ltd. was a family-owned enterprise that manufactured and exported apparel fabrics. The company expected sales close to INR 24.28 crores or USD 5.4 million (a crore, cr, is a unit in the Indian numbering system equal to 10 million) in 2010 as illustrated in Exhibit A. Sales were flat, operating income was declining, and, to be honest-prospects were bleak. The Indian Textile Industry The Indian textile industry has been a major contributor to Indian GDP over the past several years. After dismantling the quota regime in 2005, the government had hoped for textile exports to hit USD 50 billion by 2012, but as of 2010, they had reached only USD 22 billion. The industry was both capital and labor intensive, as well as highly regulated. Companies operated on small margins in a highly competitive marketplace, and the global recession of 2008-2009 had battered the Indian industry even further. The Indian textile industry faced a number of challenges including rising raw material and labor costs, competition Copyright 2010 Thunderbird, School of Global Management. All rights reserved. This case was prepared by Kyle Mineo, MBA '10; Saurabh Goyal, MBA '10; and im Erion, MBA '10, under the direction of Professor Michael Moffett for the purpose of classroom discussion only, and not to indicate either effective or ineffective management. from China and other Asian countries, and appreciation of the rupee. Rising Raw Material and Labor Costs. The chief raw materials used in textiles were cotton and other natural and poly-based yarns. Erratic monsoons, coupled with increased exports of cotton in recent years, had caused the price of cotton to rise dramatically. During the past 12 months, cotton prices had increased more than 75%. A variety of government programs and restrictions had also contributed to a growing scarcity of skilled labor in the textile industry. Competition from China and Other Asian Countries. India and China account for the majority of global textile production. Due to low labor costs and strong government support and infrastructure, China had been able to stay ahead in competing with the BRIC (Brazil, Russia, India, and China) countries. As a consequence, Chinese textile products were priced more competitively in the global mar- ket, and prevented Indian companies from pushing through any price increases. Indian companies were now suffering falling margins and losing orders to other countries. Much of the Indian low-value market had already shifted to Bangladesh, as costs there were 50% lower than in India. Appreciation of the Rupee. The rupee had grown increasingly volatile in recent years against the dollar, and over the past two years, appreciated by nearly 20%. This appreciation had made countries like Bangladesh and Vietnam more competitive on the global front, In early November, the rupee had risen to INR44/USD, the strongest in more than three years. It now hovered at INR45/USD. Further strengthening of the rupee against the dollar would most likely put many Indian textile companies out of business. The Curious Case of High Cotton Prices. The cotton market had been nothing short of "crazy" recently. The monsoons in India had prompted many farmers to plant more cotton to meet the heightened demand. But, despite increased production, cotton prices had skyrocketed in the past year, reaching $1.50/lb, as illustrated in Exhibit B. The increased demand from China and the reduced inventories in the United States had driven the price up. Although most market analysts continued to argue that cotton prices were abnormally high- and must fall sooner rather than later, they remained high and only seemed to go higher, even as the soothsayers predicted their fall. What frightened Lapura even more, were the market analysts who were now arguing that cotton prices had moved to a higher level-permanently. Lapura was considering the use of cotton futures, a practice some of his competitors were already using. A recent check of futures prices had provided him some data on what prices he may be able to lock in now for cotton in the coming year, in U.S. cents per pound: 113.09 (March 2011); 102.06 (July 2011); 95.03 (October 2011). Although futures would eliminate the risk of further increases in cot- ton prices, he was still afraid he would be locking in the price at the top. drive U.S. dollar, euro, and yen values down even further against the rupee. Currency of Invoice As an Indian textile exporter, Lapura had never had a choice about the currency of invoice-it would be the U.S. dollar. But maybe times had changed? The dollar had been falling against the rupee for some time now (as seen in Exhibit C), and as a result, the rupees generated from export sales were less and less. The problem was that, as an exporter from what the world called an "emerging mar- ket, his hard currency choices were the U.S. dollar, the European euro, and the Japanese yen. And the rupee had been strengthening against all of them! But what might the future bring? All three hard curren- cies were at record low rates of return-nominal interest rate yields-and not expected to change much in the imme- diate future. They were under careful watch by their cen- tral banks, with all three central banks pumping liquidity into the respective monetary systems following the credit crisis of 2008-2009. The most immediate likelihood was the rise of inflation in all three markets. Unfortunately, that would not help, as a rise in inflation would probably only The Turkish Sale Lapura's immediate problem was a $250,000 textile sale he had made to a Turkish customer. The contract allowed him to change the currency of invoice from the Turkish lira to the dollar or euro if he wished, but he had to decide by close of business day. Expected settlement on the invoice was January 30, 2011. But regardless of which currency he chose (the rupee not being one of the choices), he still had to decide how to hedge it. Lapura had collected a variety of forward rates from his local bank for the dollar, euro, and Turkish lira, as listed in Exhibit D. He eyed the dollar quotes the closest. The forwards would lock him into a rupee rate, which was slightly better than the current spot rate. Of course if the forwards were considered indicators of likely rate move- ment, they did indicate what he had long hoped for-a rise in the dollar. He had also considered some form of money market hedge-borrowing Turkish lira against the receivable. Although he had been selling in Turkey for over five years, he had never borrowed there, and only had one bank relationship in Ankara. If he provided sales history to the Turkish bank, he may be able to use his $250,000 receivable as collateral. Domestic loan rates in Turkey for companies with similar credit quality were about 14% according to his bankers. But his bankers also told him that as a small foreign business, the Turkish market would charge him an addi- tional 300 basis point credit spread. But if he did indeed get the money sooner rather than later, domestic Indian deposit rates were averaging a healthy 10.4%. Currency options had recently become a hedging alterna- tive in India. The National Stock Exchange of India in Mumbai had opened a currency options market in October 2010. EXHIBIT D Forward Rate Quotes 90 days Spot 45.8300 60.9611 Currency Cross Indian rupees per U.S. dollar Indian rupees per euro Japanese yen per rupee Indian rupees per Turkish lira Turkish lira per U.S. dollar Symbols USD/INR EUR/INR INR/JPY TRY/INR USD/TRY Bank Quotes on Forward Rates 30 days 60 days 46.12 46.70 61.70 61.90 1.81 1.81 30.96 30.95 1.49 1.48 46.11 62.20 1.80 1.8250 30.7192 1.4793 30.87 1.48 EXHIBIT E Currency Option Quotes on the USD Put Premium (Rupee/USD) Strike Rate (Rupee/USD) 44.00 0.005 Call Premium (Rupee/USD) 1.890 0.440 45.25 0.035 Quotes for 60-day maturity, USD 1000 per contract Source: National Stock Exchange of India, nseindia.com With no experience with options, Lapura wondered if an option would provide better protection than a forward con- tract. The options market, at least for now, was limited to INR/USD options. Although Mr. Lapura could see the upside potential that an options contract might provide, he wondered how much the contract would hurt his slim margins if he had to exercise his contract. Put and call option quotes on the dollar, considered by Mr. Lapura, are listed in Exhibit E. growth, many analysts are forecasting a stronger Indian rupee versus USD exchange rate into the foreseeable future. Competition was fierce. Lapura wondered how much longer his Indian operations - the livelihood of the family-would be profitable. Out of Time Aadesh Lapura picked up his notes and knew it was time to call a family meeting. Times were tough and the family's livelihood was being threatened. Two things needed to be sorted out and quickly. With the last major sale of 2010 on the books-the Turkish sale-he knew he needed to pro- tect the value of this sale from currency losses. Secondly, he needed to find a sustainable path to protecting the busi- ness over the long term. With India's continued economic Banbury Impex (India)' As November 2010 came to a close, CEO Aadesh Lapura of Banbury Impex Private Limited, a textile company in India, sat in his office in solitude looking over his company's financial statements. It looked like 2010 would close with a small growth in sales and a small drop in profits. Although Banbury's profits were positive, the prospects of about 1.5% return on sales were simply not good enough moving for- ward. He now had two problems: negotiating a short-term prospective sale to a Turkish company, and increasing his overall profitability, which was a larger, long-term problem. Lapura concluded that overall profitability thereof-was a result of two price forces. The first was the rapid rise in the price of cotton. A major cost driver in the textiles industry, cotton prices had risen dramatically in 2010. The second issue was clearly the rising value of the Indian rupee (INR) against the U.S. dollar (USD). Banbury's sales were all invoiced in U.S. dollars, and the dollar was falling. Profit margins were down, and he needed to move quickly. Banbury's sales were nearly all exported, mainly to the Middle East (50%), South America (30%), and Europe (10%). Banbury's products included a range of blended woven fabrics made from viscose, cotton, and wool. The company operated two weaving units based in India. The company's sales growth had been slow over the past five years, averaging about 2.5% per year. However, man- agement had been satisfied with 5% margins in 2006 and 2007 in a highly competitive business environment. Cash flows had remained relatively predictable as Lapura had managed foreign exchange risks by using forward contracts. Choosing to invoice all international sales in USD helped provide further stability in mitigating raw material costs, as international cotton prices were priced in USD. All things considered, Banbury's profit projections for 2011 looked disastrously low. -or lack Banbury Fabrics Founded in 1997, Banbury Impex Private Ltd. was a family-owned enterprise that manufactured and exported apparel fabrics. The company expected sales close to INR 24.28 crores or USD 5.4 million (a crore, cr, is a unit in the Indian numbering system equal to 10 million) in 2010 as illustrated in Exhibit A. Sales were flat, operating income was declining, and, to be honest-prospects were bleak. The Indian Textile Industry The Indian textile industry has been a major contributor to Indian GDP over the past several years. After dismantling the quota regime in 2005, the government had hoped for textile exports to hit USD 50 billion by 2012, but as of 2010, they had reached only USD 22 billion. The industry was both capital and labor intensive, as well as highly regulated. Companies operated on small margins in a highly competitive marketplace, and the global recession of 2008-2009 had battered the Indian industry even further. The Indian textile industry faced a number of challenges including rising raw material and labor costs, competition Copyright 2010 Thunderbird, School of Global Management. All rights reserved. This case was prepared by Kyle Mineo, MBA '10; Saurabh Goyal, MBA '10; and im Erion, MBA '10, under the direction of Professor Michael Moffett for the purpose of classroom discussion only, and not to indicate either effective or ineffective management. from China and other Asian countries, and appreciation of the rupee. Rising Raw Material and Labor Costs. The chief raw materials used in textiles were cotton and other natural and poly-based yarns. Erratic monsoons, coupled with increased exports of cotton in recent years, had caused the price of cotton to rise dramatically. During the past 12 months, cotton prices had increased more than 75%. A variety of government programs and restrictions had also contributed to a growing scarcity of skilled labor in the textile industry. Competition from China and Other Asian Countries. India and China account for the majority of global textile production. Due to low labor costs and strong government support and infrastructure, China had been able to stay ahead in competing with the BRIC (Brazil, Russia, India, and China) countries. As a consequence, Chinese textile products were priced more competitively in the global mar- ket, and prevented Indian companies from pushing through any price increases. Indian companies were now suffering falling margins and losing orders to other countries. Much of the Indian low-value market had already shifted to Bangladesh, as costs there were 50% lower than in India. Appreciation of the Rupee. The rupee had grown increasingly volatile in recent years against the dollar, and over the past two years, appreciated by nearly 20%. This appreciation had made countries like Bangladesh and Vietnam more competitive on the global front, In early November, the rupee had risen to INR44/USD, the strongest in more than three years. It now hovered at INR45/USD. Further strengthening of the rupee against the dollar would most likely put many Indian textile companies out of business. The Curious Case of High Cotton Prices. The cotton market had been nothing short of "crazy" recently. The monsoons in India had prompted many farmers to plant more cotton to meet the heightened demand. But, despite increased production, cotton prices had skyrocketed in the past year, reaching $1.50/lb, as illustrated in Exhibit B. The increased demand from China and the reduced inventories in the United States had driven the price up. Although most market analysts continued to argue that cotton prices were abnormally high- and must fall sooner rather than later, they remained high and only seemed to go higher, even as the soothsayers predicted their fall. What frightened Lapura even more, were the market analysts who were now arguing that cotton prices had moved to a higher level-permanently. Lapura was considering the use of cotton futures, a practice some of his competitors were already using. A recent check of futures prices had provided him some data on what prices he may be able to lock in now for cotton in the coming year, in U.S. cents per pound: 113.09 (March 2011); 102.06 (July 2011); 95.03 (October 2011). Although futures would eliminate the risk of further increases in cot- ton prices, he was still afraid he would be locking in the price at the top. drive U.S. dollar, euro, and yen values down even further against the rupee. Currency of Invoice As an Indian textile exporter, Lapura had never had a choice about the currency of invoice-it would be the U.S. dollar. But maybe times had changed? The dollar had been falling against the rupee for some time now (as seen in Exhibit C), and as a result, the rupees generated from export sales were less and less. The problem was that, as an exporter from what the world called an "emerging mar- ket, his hard currency choices were the U.S. dollar, the European euro, and the Japanese yen. And the rupee had been strengthening against all of them! But what might the future bring? All three hard curren- cies were at record low rates of return-nominal interest rate yields-and not expected to change much in the imme- diate future. They were under careful watch by their cen- tral banks, with all three central banks pumping liquidity into the respective monetary systems following the credit crisis of 2008-2009. The most immediate likelihood was the rise of inflation in all three markets. Unfortunately, that would not help, as a rise in inflation would probably only The Turkish Sale Lapura's immediate problem was a $250,000 textile sale he had made to a Turkish customer. The contract allowed him to change the currency of invoice from the Turkish lira to the dollar or euro if he wished, but he had to decide by close of business day. Expected settlement on the invoice was January 30, 2011. But regardless of which currency he chose (the rupee not being one of the choices), he still had to decide how to hedge it. Lapura had collected a variety of forward rates from his local bank for the dollar, euro, and Turkish lira, as listed in Exhibit D. He eyed the dollar quotes the closest. The forwards would lock him into a rupee rate, which was slightly better than the current spot rate. Of course if the forwards were considered indicators of likely rate move- ment, they did indicate what he had long hoped for-a rise in the dollar. He had also considered some form of money market hedge-borrowing Turkish lira against the receivable. Although he had been selling in Turkey for over five years, he had never borrowed there, and only had one bank relationship in Ankara. If he provided sales history to the Turkish bank, he may be able to use his $250,000 receivable as collateral. Domestic loan rates in Turkey for companies with similar credit quality were about 14% according to his bankers. But his bankers also told him that as a small foreign business, the Turkish market would charge him an addi- tional 300 basis point credit spread. But if he did indeed get the money sooner rather than later, domestic Indian deposit rates were averaging a healthy 10.4%. Currency options had recently become a hedging alterna- tive in India. The National Stock Exchange of India in Mumbai had opened a currency options market in October 2010. EXHIBIT D Forward Rate Quotes 90 days Spot 45.8300 60.9611 Currency Cross Indian rupees per U.S. dollar Indian rupees per euro Japanese yen per rupee Indian rupees per Turkish lira Turkish lira per U.S. dollar Symbols USD/INR EUR/INR INR/JPY TRY/INR USD/TRY Bank Quotes on Forward Rates 30 days 60 days 46.12 46.70 61.70 61.90 1.81 1.81 30.96 30.95 1.49 1.48 46.11 62.20 1.80 1.8250 30.7192 1.4793 30.87 1.48 EXHIBIT E Currency Option Quotes on the USD Put Premium (Rupee/USD) Strike Rate (Rupee/USD) 44.00 0.005 Call Premium (Rupee/USD) 1.890 0.440 45.25 0.035 Quotes for 60-day maturity, USD 1000 per contract Source: National Stock Exchange of India, nseindia.com With no experience with options, Lapura wondered if an option would provide better protection than a forward con- tract. The options market, at least for now, was limited to INR/USD options. Although Mr. Lapura could see the upside potential that an options contract might provide, he wondered how much the contract would hurt his slim margins if he had to exercise his contract. Put and call option quotes on the dollar, considered by Mr. Lapura, are listed in Exhibit E. growth, many analysts are forecasting a stronger Indian rupee versus USD exchange rate into the foreseeable future. Competition was fierce. Lapura wondered how much longer his Indian operations - the livelihood of the family-would be profitable. Out of Time Aadesh Lapura picked up his notes and knew it was time to call a family meeting. Times were tough and the family's livelihood was being threatened. Two things needed to be sorted out and quickly. With the last major sale of 2010 on the books-the Turkish sale-he knew he needed to pro- tect the value of this sale from currency losses. Secondly, he needed to find a sustainable path to protecting the busi- ness over the long term. With India's continued economic