Final Report

Table of Contents Industry Overview .....................................................................................................................3 Indian pharmaceutical industry ..............................................................................................7 Company Profile ......................................................................................................................
10 Need and problem of the study ................................................................................................18 Scope of the study....................................................................................................................18 Objectives of the study.............................................................................................................19 Research Methodology ............................................................................................................19 Working Capital Management .................................................................................................20 Introduction ..........................................................................................................................20 Methods of Estimating Working Capital Requirement........................................................21 Approaches for Determining Financing Mix of Working Capital .......................................23 Procedure for working capital finance .................................................................................24 Credit monitoring arrangement (CMA) ...............................................................................25 Drawing power of the borrower ...........................................................................................27 Form of Assistance...............................................................................................................31 Factoring/Forfeiting..........................................................................................................32 Bank Guarantee ................................................................................................................35 Letter of Credit .................................................................................................................36 Loan ..................................................................................................................................38 Overdraft...........................................................................................................................38 Cash Credit .......................................................................................................................39 Bills purchased or discounted...........................................................................................39 Working Capital Term Loans ...........................................................................................41 Packing Credit ..................................................................................................................42 Trade credit.......................................................................................................................43 Analysis of Working Capital Financing at PDL ......................................................................47 Brief history of foreign exchange markets...............................................................................50 Foreign Exchange Risk Management ......................................................................................50 Derivative products..................................................................................................................51 Currency Forwards...............................................................................................................51
Submitted By- Harsh Gupta University Business School Page 1
Currency Futures ..................................................................................................................52 Currency Options .................................................................................................................57 Analysis of Foreign Exchange Risk Management at PDL ......................................................62 References................................................................................................................................64
Submitted By- Harsh Gupta
University Business School
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Industry Overview:
Pharmaceutical markets: The global pharmaceuticals market can be classified into two categories: regulated and unregulated/semi regulated. The regulated markets are primarily governed by stringent government regulations such as intellectual property protection, including product patent recognition. As a result, regulated markets have greater stability for both volumes and prices while a drug is under patent protection. On the other hand, unregulated/semi-regulated markets have lower entry barriers in terms of regulatory requirements; hence they are highly competitive, with industry players primarily competing on the basis of price. Patented vs. Generic Drugs Patented or Branded drugs: Pharmaceutical companies which hold patents for their products are given the right to exclude others from using their invented products for any commercial purpose. Pharmaceutical patent holders are allowed a certain exclusive marketing period mainly to earn the corresponding revenue on a product to recover the time and resources they spent in inventing such product. Generic drugs: Generic pharmaceutical drugs are pharmaceutical products that are not protected by patents. These are drugs marketed by different companies but containing the same active ingredients. Intellectual Property Rights as applied to Pharmaceuticals: Among the various ways in which pharmaceutical products can receive patent protection, two are enumerated below: Product Patents Pharmaceutical product patents in a majority of jurisdictions protect a specific molecular structure, compound, combination, composition, product, formulation, dosage form, kit or the like and prevent others from making, using, offering for sale or selling a pharmaceutical product that represents the patented molecular structure, compound, combination, composition, product, formulation, dosage form, kit or the like without permission. The United States, Canada and the United Kingdom are some developed markets that recognize product patents. Process Patents The method of making the product itself is protected by process patents. However, if an individual is able to create the same product through a different and non-infringing process referred to as designing around the process patent holder cannot prevent the products reproduction. U.S. Regulation of Generics Products: The U.S., the world's largest pharmaceuticals market, recognizes both product and process patents. Strong patent protection, advanced medical infrastructure, high per capita gross domestic product, the availability of health insurance and an aging population are all contributory factors to the large market for pharmaceutical products in the U.S.
The U.S. is a highly regulated and developed market, with high barriers to entry and strict quality standards for pharmaceutical products. The USFDA is the most powerful national regulatory body, driving the regulatory framework in which the pharmaceutical industry operates globally. Set out below are the main FDA applications and processes relevant to the generic drugs market. DMFs A DMF is a submission to the USFDA that may be used to provide confidential, detailed information about facilities, processes or articles used in the manufacturing, processing, packaging and storing of one or more human drugs. It usually refers to the raw material or active ingredient which is used in manufacturing the finished drug (the bulk drug). Information in the DMF may be used to support an Investigational New Drug Application ("INDA"), a New Drug Application ("NDA"), an Abbreviated New Drug Application ("ANDA"), another DMF or amendments or supplements for any of these filings. ANDAs An ANDA contains data which, when submitted to the USFDA's Center for Drug Evaluation and Research, Office of Generic Drugs, is reviewed and is the ultimate basis of approval for any generic drug product for sale. Once approved an applicant may manufacture and market the generic drug product in the US, provided that all issues related to patent protection and exclusivity have been resolved. European Union Regulation Member countries of the EU have an approval regime that is similar to the USFDAs ANDA filing, which involves the manufacturer of the drug formulation filing a dossier which incorporates the API DMF. Based on the dossier filed, the EDQM issues a CoS. It may be possible for the API manufacturer to file one DMF for use in all EU jurisdictions. If not, the API manufacturer is required to file a DMF in each jurisdiction in which the generic manufacturer will be filing a dossier. Global pharmaceutical industry: The global pharmaceutical market grew by 4.8% to reach USD 773 billion in 2008 from USD 715 billion in 2007. The CAGR for the period 2001-2007 was 10.5%. The two largest markets, the US and Europe, which contributed almost 72.3% to the global market in 2008, achieved growth rates of 1.4% and 5.8% respectively. The European market is expected to grow with a CAGR of 2-5% for 20082013. On the other hand, emerging markets like Asia, Africa and Latin America, collectively grew at a CAGR of 12-14% from 2003-2008, and are expected to continue growing at a higher rate over the coming years.
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The recent trends pertaining to the global pharmaceutical markets are:
1. Decreased R&D productivity: During the eight year period between 2000 and 2008, while the total R&D spend of pharmaceutical companies has increased from USD 53 billion to USD 129 billion, the number of drugs approved has declined as can be seen from the number of New Molecular Entities (NMEs) approved. This decreased R&D productivity is due to the increased failure rate in trials and higher cost of developing new drugs due to stricter regulatory requirements.
2. Current global financial crisis: The crisis has severely affected the liquidity of small biotech companies; with 44% of the U.S. biotech companies having less than a years operating cash and 26% having less than six months of operating cash. Further, the consumer spend on healthcare has declined, reflected by a drop in the number of prescriptions in the U.S. by 2% for the first time in a decade in 2008-09.
3. Increasing penetration of generics: Penetration of generics in U.S., in terms of their share in total prescriptions, has increased from 47% in 1999 to 63% in 2007. Going forward, this is expected to increase further driven by impending patent expiries and measures by governments to reduce healthcare costs.
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4. Fewer and smaller blockbusters : Decreased number of blockbuster approvals to replace the existing ones going off patent and reduced sales potential of recently launched drugs will further decelerate the market growth. The sales of blockbuster drugs have grown only 9% in 2007 compared to 24% in 2004. Pharmaceutical companies are tackling the pressure by focusing on new technologies, participating in emerging markets and enhancing efficiency. The companies are focusing on new technologies like biologics. Other new technologies which are increasingly becoming areas of interest are the ones required for complex chemistries, such as lower-temperature technology that can suppress side reactions and increase reaction selectivity, chemical decontamination technology for cytotoxics and research in nanotechnology.
Emerging markets are expected to be the key engines of growth for the global pharmaceutical market. While there has been a slowdown in the developed pharmaceutical market, emerging markets which form 17.8% of the global pharmaceutical market, continue to drive growth contributing 49% of the total growth in 2009. Emerging markets outperformed developed markets in terms of growth with a CAGR (2003-2008) of 12-13% whereas CAGR for developed economies stayed around 6-8% for the same period.
Pharmaceutical companies are focusing on restructuring and implementing cost containment initiatives. Almost all of them have announced cost reduction programs over the past few years. They are increasingly using acquisitions as a key strategy for sustained growth and adopting a networked operating model to boost efficiencies, gain access to technologies and to emerging markets. Through networked model, pharmaceutical companies have been increasingly becoming reliant on using third parties to improve efficiencies through in-licensing, out-licensing, collaborations and outsourcing.
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Indian pharmaceutical industry:

The Indian pharmaceutical industry can be classified based on products manufactured as bulk actives and formulations. Based on the markets catered, these can be further classified into domestic and exports. Further, exports can be made to regulated or developed markets like US, Europe, Japan etc and semi-regulated/non-regulated or emerging markets like Asia, Africa and Latin America. Bulk actives are otherwise known as Active Pharmaceutical Ingredients (APIs) or bulk drugs. They comprise medicinally active ingredients that are converted into formulations or dosage forms. Formulations involve developing a preparation of the drug (from APIs and other ingredients) which is both stable and acceptable to the patient. This usually involves incorporating the drug into a tablet, capsules, injectibles, syrups, etc. Strong GDP growth (8.5% in 2007-08, 9.4% in 2006-07 and 9.0% in 2005-06) and significant cost advantages have resulted in the Indian pharmaceutical industry growing significantly by 19.8% from around USD 6.9 billion in 2002-03 to around USD 17.0 billion in 2007-08. Indian participation in the international pharmaceutical market has increased and with more products going generic in developed economies, Indian formulations and bulk drug exports have grown significantly. Also, increasing cost pressures on innovators has resulted in significant growth in contract research business. Driven by the above factors Indian pharmaceutical exports have grown at a CAGR of 27.0% in the last six years to reach USD 8.6 billion in 2007-08. According to the Ministry of Commerce, Report of the Task Force, December 2008, currently, the Indian pharmaceutical industry is one of the worlds largest and most developed, ranking fourth in volume terms and 13th in value terms. In the API segment, India ranks third in the world producing about 500 different APIs. India has emerged as the country with the largest number of USFDA approved plants outside US. According to the Department of Industrial Policy & Promotion, the drugs and pharmaceuticals sector has attracted foreign direct investment (FDI) worth 121.8 million during the period April-October, 2009. The cumulative FDI inflows in this sector from April 2000 to October 2009 have been USD 1.58 billion. The Indian pharmaceutical industry is expected to grow at a CAGR of 14.2% to around USD 50 billion in 2015-16. Exports are expected to grow at a CAGR of 16.2% while the domestic market is expected to grow by 12.5%. API manufacturers in India supply APIs to domestic formulation companies, which cater to domestic and/or export markets, and also export APIs directly to regulated and/or semi regulated/unregulated markets abroad. Domestic Formulations The domestic formulations industry grew at a CAGR of 14.3% from around USD 4.3 billion in 2002-03 to USD 8.4 billion in 2007-08. The Indian market expanded much faster than the global pharmaceutical market as a whole. It is expected to reach USD 21.5 billion in 2015-16. The break-up of key therapeutic categories for 2007-08 is as under:
Anti-infectives is the most important segment in the domestic pharmaceutical market and accounts for about 18% of the total market turnover of USD 8.4 billion in 2007-08. Next in line and accounting for 1/10th each are cardiovascular preparations, cold remedies, pain killers and respiratory solutions. By contrast, the market for treating diseases such as diabetes and obesity, or so-called lifestyle drugs such as anti-depressants, anti-wrinkle drugs etc., are of less significance at present, but are expected to grow in the future. The growth drivers for the domestic pharmaceuticals industry are Increasing per capita income Better pricing power on account of consolidation Growth in population Change in the Indian demographics Health insurance and change in patent laws
Indian Formulation Exports The global market for generics is expected to grow significantly on account of number of blockbuster drugs going off patent over the coming years. It is estimated that patents of products worth USD 235 billion are expected to expire over the coming years, thereby resulting in a number of new drugs entering the global market. In countries like Japan, which are facing the problem of rising healthcare costs resulting from ageing population, the government has modified its laws for generic medication and has thus enabled more companies to file DMFs and formulation dossiers in the country.
The global generics market grew from around USD 27 billion in 2001 to around USD 75 billion in 2007 on account of large scale patent expiry. This leaves a large opportunity for country like India where the companies are focused on higher revenue generation by sales to regulated markets.
The Indian formulations export industry is expected to reach around USD 12-13 billion by 2015 due to significant growth in the generics industry and higher market share of Indian players (8.7% in 2015-16 from 5.3% in 2007-08) in the international market. The growth drivers for the formulations export industry are Patent expiries Increasing share in ANDA filing Inorganic growth by acquisitions abroad Bulk Drug Exports The global API industry has grown substantially over past few years due to the growth in generics industry. Global bulk drug demand increased at a CAGR of 10.9% from 2001-2006 to reach USD 84 billion in 2006. It was estimated to have reached USD 90 billion in 2007. Most of the companies that purchase bulk drugs are generics manufacturers.
Indias bulk drug/API exports account for 21% of Indias pharmaceutical industry, which, in contrast to many developed countries is significantly higher as bulk drugs are mainly manufactured for internal consumption. Bulk drugs exports grew robustly at a 28.4% CAGR between 2002-03 and 2007-08 to reach an estimated USD 4.2 billion, mainly on account of Growth in the international generics industry Increasing share of the Indian companies in DMF filings Contract manufacturing opportunity The Indian bulk drugs exports is expected to reach USD 12.6 billion in 2015-16 largely driven by significant increase in sales to the regulated markets.
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Company Profile:
Parabolic drugs ltd was founded in 1996 by Promoters Mr. Pranav Gupta and Mr. Vineet Gupta, who are professionally qualified first generation entrepreneurs. It is engaged in the manufacturing, including contract manufacturing of APIs and API intermediates for the domestic market as well as for exports to international markets, including regulated markets. APIs, also known as bulk drugs or bulk actives are the principal ingredient used in making finished dosages in the form of capsules, tablets, liquid, or other forms of dosage, with the addition of other APIs or inactive ingredients. It currently produces the Semi Synthetic Penicillin (SSP) and Cephalosporin range of antibiotics in oral and sterile form, along with their intermediates and also non antibiotic segment. Its product portfolio presently comprises 44 APIs and seven API intermediates which are marketed domestically and exported. PDL supplies their products to approximately 51 countries, including regulated markets and have filed 18 dossiers with the relevant regulatory authorities to increase penetration in the regulated markets. This includes 8 DMFs filed with the USFDA, one DMF filed with the Bureau of Pharmaceutical Sciences, Canada and nine Certificates of Suitability (CoS) with EDQM. Some of the Highlights of the Company are as follows: Fiscal 1996 1998 1999 2003 2004 2005 Key events, milestones and achievements Incorporated and received certificate for commencement of business Commencement of commercial production of oral Semi Synthetic Penicillin APIs at Derabassi Initiated contract manufacturing services Entered into export market through direct and third party exports Set up of our regulatory affairs department for the filings of our dossiers Commenced commercial production from Unit II at Panchkula and capacity enhanced by 360 TPA Launch of our first Cephalosporin oral API (Cefixime Trihydrate) Our Company was awarded WHO-GMP certificate for Amoxicillin Trihydrate and Flucloxacillin Sodium vide certificate no.09 & 10 dated October 11, 2004 Commercial operation of new Cephalosporin API plant for Cefuroxime Axetil Raised funding from Alden (formerly Minivet Limited) and Exquisite Commercial operation of a new plant CoS received from the EDQM for Amoxycillin and Flucloxacillin allowing exports to the European Union Commercial operation of new multipurpose block I for Cephalosporins API 3 process patents filed with the Indian Patent Office 8 dossiers filed in US, Canada and European Union Raised funding from BTS Launch of Sterile Cephalosporin APIs Commissioning of R&D center at Barwala Received an ISO 14001:2004 Management System Certificate from Det Norske
2006 2007
2009
2010
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Veritas
Vision and Mission of the Company: By reading on Vision and Mission of the company any one can get a clear idea about the companys high ambition and passion to achieve robust growth along with being responsible for the the Society.
Strengths and strategies: Competitive Strengths Robust chemistry capabilities Diversified customer base Wide product range in the antibiotics segment Facilities designed to serve regulated markets and manufacture multiple products Dynamic and professional management with healthcare domain knowledge and experience
Robust chemistry capabilities We are a research driven company with our R&D efforts focused on developing noninfringing processes and achieving process improvements and production cost efficiencies. We have an established R&D facility which comprises chemical and analytical research laboratories at Sundhran, Derabassi, and a team of 85 scientists including 16 Ph.Ds, as at April 15, 2010. We have also set up an additional R&D centre at Barwala in fiscal 2010. Our R&D department has successfully launched various sterile and oral SSPs and Cephalosporins in the past.
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Diversified customer base As at March 31, 2009, we catered to 487 customers worldwide, including some of the leading generic companies in the world. Our sales to top five customers, which amounted to 57.59% of total sales by value in fiscal 2007 reduced to 34.84% in fiscal 2009. We are constantly striving to increase our customer base and reduce dependence on any particular customer. The total number of our customers, including domestic and international customers, has increased from 244 in fiscal 2007 to 487 during fiscal 2009. For further information, see Managements Discussion and Analysis of Financial Condition and Results of Operations and Financial Statements on pages 218 and 156, respectively. Wide product range in the antibiotics segment We manufacture a wide range of products in the antibiotics segment encompassing oral as well as sterile forms of SSPs and Cephalosporins. In addition, we manufacture a range of API intermediates which are in turn used to manufacture APIs. Our current product portfolio comprises 44 APIs and seven API intermediates which are marketed domestically and exported. We continuously focus on developing new products within our existing segments, including niche products developed with specific applications or taking customer specifications in view. For instance, we presently produce niche Penicillin APIs such as Bacampicillin, Sultamycillin, and Pivampicillin at our Panchkula facility. Facilities designed to serve regulated markets and manufacture multiple products Our manufacturing facilities are designed to manufacture a variety of APIs and API intermediates using a combination of processes. Our facility at Sundhran, Derabassi is WHOGMP and ISO-14001 certified. Our Panchkula facility supplies 6-APA for the U.S. markets conforming to the regulations prescribed by the USFDA and our custom synthesis site at Barwala has also been set up in compliance with USFDA standards. We have also received CoS for supplying Amoxicillin, Flucloxacillin Sodium and Cefuroxime Axetil for the European markets. Such facilities allow us to market our products in regulated markets on registration and approval of the products with the relevant authorities. Our proposed facility at Chachrauli, Derabassi is also being set up in compliance with USFDA standards. Our flexible manufacturing infrastructure enables us to expand our product range and change our product mix in response to changes in customer demand and to serve customer requirements ranging from laboratory scale research to commercial production. Dynamic and professional management with healthcare domain knowledge and experience Our Promoter and Managing Director, Mr. Pranav Gupta, and our other Promoter and Wholetime Director, Mr. Vineet Gupta, are professionally qualified first generation entrepreneurs with international experience. Mr. Pranav Gupta holds a bachelors degree in mechanical engineering from Thapar Engineering College, Patiala and a masters degree in business administration from Kansas, USA. Before promoting our Company, Mr. Pranav Gupta worked with the Ford Motor Company, USA. Mr. Pranav Gupta is involved in managing our day to day operations. Mr. Vineet Gupta holds a bachelors degree in mechanical engineering from IIT, Delhi and has been instrumental in driving our expansion
into international markets. Other members of our management team include our Directors Dr. Ram Kumar and Dr. Deepali Gupta, who are qualified doctors with several years of experience, and are members of various healthcare and scientific organizations. Mr. Arun Mathur, a non-executive Director on our Board, has a bachelors degree in chemical engineering from IIT, Kanpur and has nearly 35 years of experience in reputed pharmaceutical companies such as Ranbaxy Laboratories Limited (Ranbaxy) (as director of operations), Matrix Laboratories Limited (as global manufacturing head), Lupin Pharmaceuticals and Beximco Pharmaceuticals Limited. We believe that the healthcare domain knowledge and experience of our Promoters and senior and middle management provide us with a competitive advantage as we seek to expand in our existing markets and enter new geographic markets. Key Business Strategies Our vision is to be a partner-of-choice to leading globally oriented pharmaceutical innovators, specialty and generic players in the development, custom-synthesis and commercial manufacturing of Active Pharmaceutical Ingredients (APIs) and intermediates. Key Business Strategies Leverage our existing capabilities to expand in the CRAMS segment Increase our penetration into international markets with a focus on regulated markets Diversify our product portfolio and expand into the non-antibiotic segment Leverage our existing capabilities to expand in the CRAMS segment Within the CRAMS segment we intend to focus on custom synthesis, clinical trial manufacturing and commercial manufacturing for innovator companies. Over the years we have added several products to our portfolio by developing, scaling up and commercially manufacturing APIs. We intend to leverage the capabilities that we have developed in contract manufacturing for generic companies and innovators to expand in the CRAMS segment and become an outsourcing partner of choice for global innovator companies. Increase our penetration into international markets with a focus on regulated markets We seek to leverage our R&D capabilities to expand into international markets, including regulated markets where our strategy is primarily to become the preferred supplier of APIs and API intermediates to pharmaceutical companies. We intend to increase the number of dossier filings in the regulated markets and develop long term manufacturing relationships with customers. We already have relationships with some of the leading generic companies in the world and we seek to strengthen our relationship further with these companies. Our custom synthesis site at Barwala is set up in compliance with USFDA standards and the proposed manufacturing facility at Chachrauli, Derabassi is also sought to be set up in compliance with USFDA standards. Diversify our product portfolio and expand into the non-antibiotic segment We intend to further expand our product portfolio to manufacture APIs in the non-antibiotic segment including lifestyle segments such as anti-hypertensive, gastro-intestinal, psychiatric,
pain management, respiratory, retro-viral, dermatological and anti-diabetic segments. We intend to enter these therapeutic segments with a focus to offer a wider product portfolio to our existing customer base. We are in the process of setting up a new facility at Chachrauli, Derabassi, to manufacture such products, for which we propose to invest a portion of the Net Proceeds of the Fresh Issue. PRODUCT PORTFOLIO
INFRASTRUCTURE
Facilities
PDL I Derabassi
Punjab ,India Commercial Operations since : FY 98 Segment: Cephalosporins- API and Intermediates- 8 Plants
Approvals / Certifications:
PDL II Panchkula
Haryana ,India Commercial Operations since : FY 2005 Segment: SSPs - API and Intermediates 2 Plants 6 APA Supplied for US Markets as per USFDA Standards
PDL IV Chachrauli
Punjab, India Commercial Operations since: FY 2012 Segment: Non Antibiotics - API and Intermediates Proposed Facilities being set up in accordance with US FDA Standards
R&D Centre Barwala

Haryana, India Commercial Operations since : FY 2010 Segment: Non-Antibiotic Custom synthesis including HPAI, Pilot manufacturing plant, and R&D Centre
Recognized By:
Shareholding Pattern of Parabolic Drugs Ltd: Public Limited Company, promoter holding - 38.69% Public Issue of Rs. 200 Cr fully subscribed and listed on both NSE & BSE stock exchange on 1st July 2010. Two series of private equity participation by reputed FIIs with 18.09% holding.
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Shareholding Pattern of Parabolic Drugs Ltd.

Promoter's Share Holding
40%
39%
FII's DII's
16% 5%
Management of the Company:
Other Non-Institution's Shareholding
Mr. Inder Bir Singh Passi, 70 years, is our Chairman and an independent Director. He graduated with a masters degree in mathematics from Punjab University, and completed his Ph.D. from the University of Exeter, UK. Since 2005, he has been Professor Emeritus at Punjab University, Chandigarh. He was the editor of the Journal of Indian Mathematical Society during 1985-89, and of the Journal of Group Theory during 1998-2001. Mr. Pranav Gupta, 43 years, is our Managing Director and one of our Promoters. He holds a bachelors degree in technology (mechanical engineering) from Thapar Engineering College, Patiala and holds a masters degree in business administration from the University of Kansas, USA. Before relocating to India in 1994, he worked with the Ford Motor Company, USA as a financial analyst in the area of strategic finance, investment banking and planning. He has over 18 years of experience in the pharmaceutical industry. Mr. Vineet Gupta, 41 years, is our whole-time Director and is also one of our Promoters. He holds a bachelors degree in technology (mechanical engineering) from the Indian Institute of Technology, New Delhi. He is also one of the promoters and a director of Jamboree and a member on the board of the AIESEC Alumni Association. Dr. Ram Kumar, 64 years, is our independent Director. Dr. Kumar holds a bachelors degree in medicine and a masters degree in surgery and is an eye specialist. He also holds
memberships in scientific societies including the Indian Medical Association and the North Zone Ophthalmological Society. He has authored various books in the field of medical science and has published articles in various newspapers. He is experienced in the field of medical science specializing in ophthalmology. Mr. Pardeep Diwan, 48 years, is our independent Director. Mr. Diwan holds a bachelors degree in commerce from Punjab University, Chandigarh, and is a fellow of the Institute of Chartered Accountants of India. He has over 15 years of experience in the field of audit, income tax and company law. Mr. Arun Kumar Mathur, 61 years, is our non-executive Director. He graduated with a bachelors degree in chemical engineering from Indian Institute of Technology, Kanpur. He has over 35 years of experience in reputed pharmaceutical companies like Lupin, Ranbaxy Laboratories Limited as director - operations, Beximco Pharmaceuticals Limited and Matrix Laboratories Limited as global manufacturing head. Mr. Koppisetty Srinivas, 46 years, is our Nominee Director, appointed by BTS. He graduated with a bachelors degree in engineering and a masters degree in business administration from Andhra University, Hyderabad. He has over 18 years of experience in the private equity industry and about four years experience in the airlines industry. Mr. Srinivas is the vice chairman and managing partner of BTS Investment Advisors Private Limited, a part of the BTS group of Switzerland. Financial Performance of the Company: Parabolic sales:
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Share Price of the Company over the Years:
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Need and problem of the study

The study will help in maximizing the firms efficiency by evaluating the various working capital financing instruments which are offered by various financial institutions and along with this risk minimization arising out of foreign trade.
Scope of the study

The study will broadly cover: Working Capital Financing To study the existing arrangement of working capital financing through various instruments and analyzing the pros and cons of each of the instruments along with the various export financing instruments like Pre shipment finance and post shipment finance. Detailing the bank arrangements of PDL for such facilities. Foreign exchange risk management- Understanding instruments, derivatives, exchange rate movements, strategies to risk management
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Objectives of the study

The study has the following objectives: To study the existing Working Capital financing arrangement at Parabolic Drugs Ltd. To evaluate the various alternatives available to the company for financing of working capital. Analysing the pros and cons of various instruments available for currency hedging. To study how the risk in foreign trade can be minimized.
Research Methodology
Sources of Data: The study will be conducted by collecting secondary data from various souces like annual reports of the company, journals, articles published by experts etc. and primary dat will not be used for this study. Tools used in the study: MS-EXCEL
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Working Capital Management:

Introduction:
For running an industry or a Concern, two types of capital are required viz., fixed capital and working capital. Fixed Capital is utilized for acquiring the fixed assets such as land, building, plant & machinery, etc., and to meet capital expenditure connected with the setting to keep the wheels moving up of the industry or Concern. But by themselves, these fixed assets would not produce / earn anything. They have to be run for production. This requires enough liquid sources, viz., working capital. Working Capital represents the money that is required for purchase / stocking of raw materials, payment of salary, wages, power charges etc, and also for financing the gap between the supply of goods and the receipt of payment thereafter. In other words, Working Capital Finance is the fund required to meet the cost involved during the working capital cycle or operating cycle. Basic Definitions and Concepts: Working capital, sometimes called gross working capital, simply refers to current assets used in operations. Net working capital is defined as current assets minus current liabilities. A positive position means that a company is able to support its day-to-day operations. i.e. to serve both maturing short-term debt and upcoming operational expenses.
Net operating working capital (NOWC) is defined as operating current assets minus operating current liabilities. Generally, NOWC is equal to cash, accounts receivable, and inventories, less accounts payable and accruals. Marketable securities and other short-term investments are generally not considered to be operating current assets, hence they are generally excluded when NOWC is calculated. Permanent or Fixed Working Capital At any time, there is always a minimum level of current assets which is constantly and continuously required by a business unit to carry on its operations. This minimum amount of current assets referred to as fixed or permanent working capital. Temporary or Variable Working Capital Any amount over and above the permanent level of working capital is variable, temporary or fluctuating working capital.
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Working Capital Management: Working capital management involves two basic questions: What is the appropriate amount of working capital, both in total and for each specific account? How should working capital be financed?
Methods of Estimating Working Capital Requirement:

Working capital requirement can be determined mainly by using the following methods: Percentage on Sales Method: It is a simple method of determining the level of working capital and its components. In this method, working capital is determined as a percentage of present or forecast sales. This percentage is determined on the basis of past experience. If over the years, relationship between sales and working capital is found to be stable, then this relationship may be taken as a base for determining the working capital for future. This method is simple, easy and useful in forecasting working capital. Operating Cycle or Working Capital Cycle Method: It is the time period involved in the conversion of raw material into finished goods or services including the credit period involved for selling products/services. For example: Suppose a business buy raw material on credit and takes 73 days to convert this raw material into finished goods. It pays back its creditors in 30 days. Assume goods are sold as they are manufactured. It receives payment from its debtors after 24 days of credit sales. Now this revenue will be used to buy fresh raw material. So here the Operating Cycle for the Company is: Operating Cycle=73 days +24 days -30 days =67 days
Here, Inventory Conversion Period = Inventory/Sales per day=73 Days Payables Deferral Period= Receivables/Sales per day=30 Days And Receivables Collection Period= Payables/Purchases per day=24 Days
Each of the above stage is expressed in terms of days of relevant activity. Each requires a level of investment to support it. The sum of these stage wise investments will be total amount of working capital of the firm. Total Working Capital Needed= Cost of goods sold/No. of operating cycles in the year Cash Forecasting Method: Under this method, an estimate is made of cash receipts and payments for the next period. Estimated cash receipts are added to the amount of working capital which exists at the beginning of the year and estimated cash payments are then deducted from this amount. The difference will be the amount of working capital. Regression Analysis Method: The regression analysis method is a very useful statistical technique of forecasting working capital requirement. In the sphere of working capital management it helps in making projections after establishing the average relationship in the past years between sales and the working capital and its components .The analysis can be carried out through the graphic portrayals (scatter diagram) or through mathematical formulae. The relationship between sales and working capital may be simple and direct indicating complete linearity between the two or may be complex in differing degrees involving simple linear regression, or simple curvilinear regression and multiple, regression situations. This method is suitable for simple as well as complex situations.
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Approaches for Determining Financing Mix of Working Capital:

Most businesses experience seasonal and/or cyclical fluctuations. For example, construction firms have peaks in the spring and summer, retailers peak around Christmas, and the manufacturers who supply both construction companies and retailers follow similar patterns. Similarly, virtually all businesses must build up working capital (WC) when the economy is strong, but they then sell off inventories and reduce receivables when the economy slacks off. Still, WC rarely drops to zerocompanies have some permanent WC, which is the WC on hand at the low point of the cycle. Then, as sales increase during the upswing, WC must be increased, and the additional WC is defined as temporary WC. The manner in which the permanent and temporary WC is financed is called the firms financing Mix of Working Capital. Maturity Matching, or Self-Liquidating, Approach: The maturity matching, or self-liquidating, approach calls for matching asset and liability maturities as shown in Figure. This strategy minimizes the risk that the firm will be unable to pay off its maturing obligations. To illustrate, suppose a company borrows on a 1year basis and uses the funds obtained to build and equip a plant. Cash flows from the plant (profits plus depreciation) would not be sufficient to pay off the loan at the end of only 1 year, so the loan would have to be renewed. If for some reason the lender refused to renew the loan, then the company would have problems. Had the plant been financed with long-term debt, however, the required loan payments would have been better matched with cash flows from profits and depreciation, and the problem of renewal would not have arisen. At the limit, a firm could attempt to match exactly the maturity structure of its assets and liabilities. Inventory expected to be sold in 30 days could be financed with a 30-day bank loan; a machine expected to last for 5 years could be financed with a 5-year loan; a 20-year building could be financed with a 20-year mortgage bond; and so forth. In practice, firms dont actually finance each specific asset with a type of capital that has a maturity equal to the assets life. However, academic studies do show that most firms tend to finance shortterm assets from short-term sources and long-term assets from long-term sources.
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Aggressive Approach: Figure illustrates the situation for a relatively aggressive firm that finances all of its fixed assets with long-term capital and part of its permanent WC with short-term debt. This is highly aggressive, extremely non-conservative position, and the firm would be very much subject to dangers from rising interest rates as well as to loan renewal problems. However, short-term debt is often cheaper than long-term debt, and some firms are willing to sacrifice safety for the chance of higher profits.
Conservative Approach: Figure has the dashed line above the line designating permanent WC, indicating that longterm sources are being used to finance all permanent operating asset requirements and also to meet some of the seasonal needs. In this situation, the firm uses a small amount of short-term debt to meet its peak requirements, but it also meets a part of its seasonal needs by storing liquidity in the form of marketable securities. The humps above the dashed line represent short-term financing, while the troughs below the dashed line represent short-term investing.
Procedure for working capital finance:

Credit sanctions process: The revised credit process is introduced with a view of reducing the time lag in the sanction of credit besides clearly delineating the areas of responsibilities of various functionaries. As per this the revised process is divide into two components: Pre sanctioning Post sanctioning The post sanctioning is the follow of the payment. In case the payment defaults then the account will go into NPA in stages and the bank is then said to scrutinize the said account. Pre sanction process:
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In the pre sanctioning it is the only time that the bank can take due assessment and precautions to make sure that the investments are done for the benefit of the bank. Obtain loan application When a customer required loan he is required to complete application form and submit the same to the bank also the borrower has to be submit the required information along with the application form.
The information, which is generally required to be submitted by the borrower along with the loan application, is under: Audited balance sheets and profit and loss accounts for the previous three year (in case borrower already in the business). Estimated balance sheet for current year. Projected balance sheet for next year. Profile for promoters/directors, senior management personnel of the company. In case the amount of loan required by borrower is 50 lacs and above he should submit the CMA Report.
Credit monitoring arrangement (CMA):

Consequent upon the withdrawal of requirement of prior authorization under the erstwhile credit authorization scheme (CAS) and introduction of a system of post sanction scrutiny under credit monitoring arrangement (CMA) the database forms have been recognized as CMA database. The revised forms for CMA database as drawn up by the sub-committee of committee of directions have come into use from 1st April 1991. The revised sets of forms have been separately prescribed for industrial borrowers and traders/merchant exporters. The details of forms are as under: Post sanctions process: Form 1: Particulars of the existing/proposed limit from the banking system. Form 2: Operating statement. It contains data relating to gross sales, net sales, cost of raw material, power and fuel, etc. It gives the operating profit and the net profit figures.
Form 3: Analysis of balance sheet. It is complete analysis of various items of last years balance sheet; current years estimate and following years projection are given in this form. Form 4: Comparative statement of current asset and liabilities. Details of various items of current asset and current liabilities are given. The figures in this form must tally with those in form III. Form 5: Computation of maximum permissible bank finance for working capital. The calculation of MPBF is done in this form to obtain the fund based credit limits to be granted to the borrower. Form 6: Fund flow statement It provides the details of fund flow from long term sources and uses to indicate whether they are sufficient to meet the borrowers long term requirements. Credit rating: The Bank evaluates the financial strength of the applicant on the basis of CMA, Balance Sheet, Profit and loss Statement and other documents submitted to bank along with the various risk associated with the applicants business. On the basis of this evaluation Bank gives rating to the applicant as the measure of its financial strength and sanctions loan accordingly. The various risk faced by any company may be broadly classified as follows: Industry Risk: It covers the industry characteristic, compensation, financial data etc. Company/ business risk: It considers the market position, operating efficiency of the company etc. Project risk: It includes the project cost, project implementation risk, post project implementation etc. Management risk: It covers the track record of the company, their attitude towards risk, propensity for group transaction, corporate governance etc. Financial risk: financial risk includes the quality of financial statements, ability of the company to raise capital, cash flow adequacy etc. Grade Degree of safety with Comments regard to servicing debt obligations Very High The fundamentally strong debt servicing capacity of such companies is most unlikely to be adversely affected by changes in circumstances. Adverse business conditions are unlikely to affect debt servicing capacity. Such companies differ in safety from those in Grade only marginally.
Grade I (AAA)
Grade (AA+)
II High
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Grade (AA)
III Adequate Average
Changes in circumstances are more likely to affect debt servicing capacity than for higher grades. Debt servicing capacity could weaken in view of changing circumstances. While such companies are less susceptible to default than those in lower grades, uncertainties faced by them could adversely affect debt servicing capacity. Uncertainty faced by issuer could lead to inadequate capacity to make timely debt repayments. Debt servicing capacity is highly vulnerable to adverse changes in circumstances. Adverse business or economic conditions are likely to lead to lack of ability or willingness to service debt obligations. Timely payment of debt would continue only if favourable circumstances continue. Debt servicing capacity in default and returns from this may be realized only on reorganization or liquidation.
Grade IV (A) Grade (BBB) Grade (BB+) Grade (BB) Grade (B) Grade (CC)
V Below Average
VI Inadequate VII Low VIII High Risk
IX Substantial Risk Default
Grade X (C)
Drawing power of the borrower:

The drawing power that a borrower enjoys at any one point depends on each components of working capital. The bank for each component, which the borrower must hold as his contribution to finance working capital, prescribes margins. The drawing power of the borrower can be best explained with the following illustration: Suppose a borrower has Rs 100.00 lacs as working capital limit sanctioned to him by a bank. The security provided by the borrower to the bank is the hypothecation of inventory. Suppose, the borrower needs to hold an inventory level of say 130 lacs in order to enjoy Rs 100 lacs as his working capital limit. The actual level of inventory with the borrower at a point is say 110 lacs. The inventory margin prescribed by the bank is say 25 %.
Inventory level (Required) Drawing power of borrower Inventory level (Actual) Margin prescribed by bank
Rs 130 lacs Rs 100 lacs Rs 110 lacs 25 %

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Drawing power of borrower
110-(0.25 110) = Rs 82.5 lacs
Therefore with this inventory level, the borrower enjoys only Rs 82.5 lacs as his working capital limit as against Rs 100 lacs. Suppose, the borrower holds Rs 150 lacs of inventory: Inventory level (required) Drawing power of borrower Inventory level (actual) Margin prescribed by bank Drawing power of borrower Rs 150 lacs Rs 100 lacs Rs 150 lacs 25% 150 (0.25 150) = Rs. 112.2 lacs
Therefore, in this case the borrower would still enjoy Rs 100 lacs as his working capital limits as against Rs 112.5 lacs. Therefore, the lower of the two is always considered as the working capital limit or the drawing power of the borrower sanctioned by the bank. Security: Banks need some security from the borrowers against the credit facilities extended to them to avoid any kind of losses. securities can be created in various ways. Banks provide credit on the basis of the following modes of security from the borrowers. Hypothecation: under this mode of security, the banks provide credit to borrowers against the security of movable property, usually inventory of goods. The goods hypothecated, however, continue to be in possession of the owner of the goods i.e. the borrower. The rights of the banks depend upon the terms of the contract between borrowers and the lender. Although the bank does not have the physical possession of the goods, it has the legal right to sell the goods to realize the outstanding loans. Hypothecation facility is normally not available to new borrowers. Mortgage: It is the transfer f a legal / equitable interest in specific immovable property for securing the payment of debt. It is the conveyance of interest in the mortgaged property. This interest terminated as soon as the debt is paid. Mortgages are taken as an additional security for working capital credit by banks. Pledge: The goods which are offered as security are transferred to the physical possession of the lender. An essential prerequisite of pledge is that the goods are in the custody of the bank. Pledge creates some kind of liability for the bank in the sense that Reasonable care means care, which a prudent person would take to protect his property. In case of non-payment by the borrower, the bank has the right to sell the goods. Lien: The term lien refers to the right of a party to retained goods belonging to other party until a debt due to him is paid. Lien can be of two types viz. Particular lien i.e. A right to
retain goods until a claim pertaining to these goods are fully paid, and General lien, Which is applied till all dues of the claimant are paid. Banks usually enjoyed general lien. Assessment of Working Capital: There are number of ways to asses the working capital requirement of a Company some of the methods which banks usually use are as follows: Turnover method Cash budget system Committee recommendations Turnover method: This Method of Working Capital Assessment was proposed by The Nayak Committee. This Method is mainly used for assessment of working capital needs of SMALL TRADING COMPANIES as it is not appropriate for big manufacturing and trading companies. The amount of financing in this method is normally for the financing of less than Rs. 25.0 lacs. For Example: Working Capital Requirement = 25% of Turnover Promoter Contribution (Margin) = 5% of Turnover Then, Bank Finance = 20% of Turnover Cash budget system: This Method of Working Capital Assessment is mainly used for assessment of working capital needs of service sector companies Like BPO, KPO, Software companies etc. This method eliminates traditional requirement of Stock and Debtors for assessment. Under this Method, Bank Finance in the form of Working Capital= Cash Inflow Cash Outflow.
Committee recommendations: Bank follows certain norms in granting working capital finance to companies. These norms have been greatly influenced by the reconditions of various committees appointed by the RBI
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from time to time. The norms of working capital finance followed by banks are mainly based on the recommendation of Tandon committee and chore committee. Tandon Committee: The Tandon committee suggested the following three methods of determining the permissible level of bank borrowings: Maximum Permissible Bank Finance (Tandon Committee Recommendation):
For Example:
Raw Material Finished Goods Receivables Adv. to Suppliers - Rs. 15.0 cr. Credit Payable - Rs. 30.0 cr. Rs. 56.0 cr. Rs. 45.0 cr. Rs. 80.0 cr. Rs. 15.0 cr Rs. 30.0 cr.
(Minimum requirement of Raw Material and Finished Goods is Rs. 15.0 cr. and 10.0 cr. respectively) According to Method 1:
According to Method 2:
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According to Method 3:
Chore Committee Recommendation: The committee suggested placing the second method of lending as explain in the Tandon committee report. Supervision and follow up: Sanction credit limit of working capital requirement after proper assessment of proposal is alone not sufficient. Close supervision and follow up are equally essential for safety of bank credit and to ensure utilization of fund lend. A timely action is possible only close supervision and followed up by using following techniques. Monthly stock statement Inspection of stock Scrutiny of operation in the account Quarterly/half quarterly statements. Under information system Annual audited report
Form of Assistance:
After deciding the amount of overall assistance to be extended to the company, the bank can disburse the amount in any of the following forms: Non-Fund Based Lending Fund Based Lending
Structured Product:
Factoring/Forfeiting:
Factoring involves an outright sale of the receivables of a firm by another firm specializing in the management of trade credit, called the factor. Under a typical factoring arrangement a factor collects the accounts on the due dates, effects payments to its client firm on these days (irrespective of whether or not it has received payment or not) and also assumes the credit risks associated with the collection of the accounts. For rendering these services, the factor charges a fee which is usually expressed as a percentage of the total value of the receivables factored. Factoring is thus an alternative to in-house management of receivables. The complete package of factoring services includes (1) sales ledger administration; (2) finance; and (3) risks control. Sales ledger administration: For a service fee, the factor provides its client firm professional expertise in accounting and maintenance of sales ledger and for collection of receivables. Finance: The factor advances up to a reasonable percentage of outstanding receivables that have been purchased, say, about 80 percent immediately, and the balance minus commission on maturity. Thus, the factor acts as a source of short-term funds. Risk Control: The factor having developed a high level of expertise in credit appraisal, reduces the risk of loss through bad debts. Depending upon the inherent requirements of the clients, the terms of factoring contract vary, but broadly speaking, factoring service can be classified as Non-recourse factoring Recourse factoring In non recourse factoring, the factor assumes the risk of the debts going bad. The factor cannot call upon its client-firm whose debts it has purchased to make good the loss in case of default in payment due to financial distress. However, the factor can insist on payment from its client if a part of the receivables turns bad for any reason other than financial insolvency.
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In recourse factoring, the factoring firm can insist upon the firm whose receivables were purchased to make good any of the receivables that prove to be bad and unrealizable. However, the risk of bad debts is not transferred to the factor. Cost: Factoring involves two types of costs. Factoring commission Interest on funds advances. Factoring commission represents the compensation to the factor for the administrative services provided and the credit risk borne. The commission charged is usually 2-4 per cent of the face value of the receivables factored, the rate depending upon the various forms of service and whether it is with or without recourse. The factor also charges interest on advances drawn by the firm against uncollected and nondue receivables. In the Ul(, it is the practice to advance up to 80 per cent of the value of such outstanding at a rate of interest which is 2-4 per cent above the base rate. This works out to near the interest rate for bank overdrafts. The cost of factoring varies, from 15.2 to 16.20 per cent (Singh, 1988), 15.6 to 16.0 percent (SBI Monthly Review, 1989), and the margins in which the factors will have to operate would be extremely narrow. The strategy of factors, therefore, must be to carve out a niche in the services segment namely, receivables management and generate revenues by way of commission rather than concentrate on lending and financing activities where the margins are low. Advantages Firms resorting to factoring also have the added attraction of ready source of shortterm funds. This form of finance improves the cash flow and is invaluable as it leads to a higher level of activity resulting in increased profitability. By offloading the sales accounting and administration, the management has more time for planning, running and improving the business, and exploiting opportunities, the reduction in overheads brought about by the factors administration of the sales ledger and the improved cash flows because of the quicker payments by the customers result in interest savings and contributes towards cost savings. Factoring receivables is an ideal financial solution for new and emerging firms without strong financials. This is because credit worthiness is evaluated based on the financial strength of the customer (debtor). Hence these companies can leverage on the financial strength of their customers. Credit rating is not mandatory. But the factoring companies usually carry out credit risk analysis before entering into the agreement.
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Disadvantages Factoring could prove to be costlier to in-house management of receivables, especially for large firms which have access to similar sources of funds as the factors themselves and which on account of their size have well organized credit and receivable management. Factoring is perceived as an expensive form of financing and also as finance of the last resort. This tends to have a deleterious effect on the creditworthiness of the company in the market. Commercial Paper and Its Features: Commercial paper can be defined as a short term, unsecured promissory notes which are issued at discount to face value by well known companies that are financially strong and enjoy a high credit rating. Here are some of the features of commercial paper They are negotiable by endorsement and delivery and hence they are flexible as well as liquid instruments. Commercial paper can be issued with varying maturities as required by the issuing company. They are unsecured instruments as they are not backed by any assets of the company which is issuing the commercial paper. They can be sold either directly by the issuing company to the investors or else issuer can sell it to the dealer who in turn will sell it into the market. It helps the highly rated company in the sense they can get cheaper funds from commercial paper rather than borrowing from the banks. However use of commercial paper is limited to only blue chip companies and from the point of view of investors though commercial paper provides higher returns for him they are unsecured and hence investor should invest in commercial paper according to his risk -return profile. Use of commercial paper Commercial paper is classified according to the channels through which it is sold, the sellers operating money or the quality of the issuer. It may be sold through an agent, who in turn resells it to customers at a higher price it usually removed a commission on the total amount of driving operation. Paper can be classified as top quality and medium quality. The first quality is delivered by the most reliable of all customers, while the average quality of issuers is less reliable. In some cases, the issue is accompanied by a line of credit or a credit card, prepared by the issuer to ensure buyers that in case of difficulties with payment, may support the paper in a loan agreement with the bank. This sometimes requires lower quality companies when they sell paper, and increase the real interest rate.
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Advantages of commercial papers: It is quick and cost effective way of raising working capital. Best way to the company to take the advantage of short term interest fluctuations in the market It provides the exit option to the investors to quit the investment. They are cheaper than a bank loan. As commercial papers are required to be rated, good rating reduces the cost of capital for the company. It is unsecured and thus does not create any liens on assets of the company. It has a wide range of maturity It is exempt from federal SEC and State securities registration requirements. Disadvantages of commercial papers: It is available only to a few selected blue chip and profitable companies. By issuing commercial paper, the credit available from the banks may get reduced. Issue of commercial paper is very closely regulated by the RBI guidelines. Non-Fund Based Lending In case of Non-Fund Based Lending, the lending bank does not commit any physical outflow of funds. As such, the funds position of the lending bank remains intact. The Non-Fund Based Lending can be made by the banks in two forms. Bank Guarantee Letter of Credit
Bank Guarantee:
Suppose Company A is the selling company and Company B is the purchasing company. Company A does not know Company B and as such is concerned whether Company B will make the payment or not. In such circumstances, D who is the Bank of Company B, opens the Bank Guarantee in favour of Company A in which it undertakes to make the payment to Company A if Company B fails to honour its commitment to make the payment in future. As such, interests of Company A are protected as it is assured to get the payment, either from Company B or from its Bank D. As such, Bank Guarantee is the mode which will be found typically in the sellers market. As far as Bank D is concerned, while issuing the guarantee in favour of Company A, it does not commit any outflow of funds. As such, it is a Non-Fund Based Lending for Bank D. If on due date, Bank D is required to make the payment to Company A due to failure on account of Company B to make the payment, this Non-Fund Based Lending becomes the Fund Based Lending for Bank D which can be recovered by Bank D from Company B. For issuing the Bank Guarantee, Bank D charges the Bank Guarantee Commission from Company B which gets decided on the basis of two factorswhat is the amount of Bank Guarantee and what is the period of validity of Bank Guarantee. In case of this conventional for of Bank Guarantee, both company A as well as Company B get benefited as it is able to make the credit purchases from Company A without knowing Company A. As such, Bank Guarantee transactions will be applicable in case of credit transactions.
In some cases, interests of purchasing company are also to be protected. Suppose that Company A which manufactures capital goods takes some advance from the purchasing Company B. If Company A fails to fulfil its part of contract to supply the capital goods to Company B, their needs to be to be some protection available to Company B. In such circumstances, Bank C which is the banker of Company A opens a Bank Guarantee in Favour of Company B in which it undertakes that if Company A fails to fulfil its part of the contract, it will reimburse any losses incurred by Company B due to this non fulfilment of contractual obligations. Such Bank Guarantee is technically referred to as performance Bank Guarantee and it ideally found in the buyers market.
Letter of Credit:
In case the exporter and the importer are unknown to each other. Under these circumstances, exporter is worried about getting the payment from the importer and importer is worried as to whether he will get the goods or not. In this case, the importer applies to his bank in his country to open a letter of credit in favour of the exporter whereby the importers bank undertakes to pay the exporter or accept the bills or drafts drawn by the exporter on the exporter fulfilling the terms and conditions specified in the letter of credit. Basic Types of Letters of Credit There are three basic features of letters of credit, each of which has two options. These are described below. Each letter of credit has a combination of each of the three features. SIGHT OR TERM/USANCE Letters of credit can permit the beneficiary to be paid immediately upon presentation of specified documents (sight letter of credit), or at a future date as established in the sales contract (term/usance letter of credit). REVOCABLE OR IRREVOCABLE Letters of credit can be revocable. This means that they can be cancelled or amended at any time by the issuing bank without notice to the beneficiary. However, drawings negotiated before notice of cancellation or amendment must be honoured by the issuing bank. An irrevocable letter of credit cannot be cancelled without the consent of the beneficiary. UNCONFIRMED OR CONFIRMED An unconfirmed letter of credit carries the obligation of the issuing bank to honour all drawings, provided that the terms and conditions of the letter of credit have been complied with. A confirmed letter of credit also carries the obligation of another bank which is normally located in the beneficiarys country, thereby giving the beneficiary the comfort of dealing with a bank known to him. Benefits of a letter of credit: To The Exporter/Seller
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Letters of credit open doors to international trade by providing a secure mechanism for payment upon fulfillment of contractual obligations. A bank is substituted for the buyer as the source of payment for goods or services exported. The issuing bank undertakes to make payment, provided all the terms and conditions stipulated in the letter of credit are complied with. Financing opportunities, such as pre-shipment finance secured by a letter of credit and/or discounting of accepted drafts drawn under letters of credit, are available in many countries. Bank expertise is made available to help complete trade transactions successfully. Payment for the goods shipped can be remitted to your own bank or a bank of your choice. To the Importer/Buyer Payment will only be made to the seller when the terms and conditions of the letter of credit are complied with. The importer can control the shipping dates for the goods being purchased. Cash resources are not tied up. Uniform Customs and Practice for Documentary Credits (UCP) The Uniform Customs and Practice for Documentary Credits is an internationally agreed upon set of rules for all parties involved in all types of letter of credit transactions. The rules, which were adopted by the International Chamber of Commerce in Vienna in 1933, have been revised several times and are used by banks in practically all countries. The Uniform Customs and Practice for Documentary Credits, currently applicable, is a set of rules which, when not in contravention of local laws, are binding on the parties who have adopted them. The authority of UCP lies in its universal acceptance which is acknowledged by a statement on the letter of credit itself. All Scotia bank Documentary Letters of Credit are issued subject to UCP. Copies of the Uniform Customs and Practice for Documentary Credits are available upon request from your nearest Scotia bank office. Pitfalls of Letters of Credit: Letters of credit make it possible to do business worldwide. They are important and helpful tools, but you should be careful when using letters of credit. As a seller, make sure you: Carefully review all requirements for the letter of credit before moving forward with a deal Understand all the documents required Can get all the documents required for the letter of credit Understand the time limits associated with the letter of credit, and whether they are reasonable
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Know how quickly your service providers (shippers, etc) will produce documents for you Can get the documents to the bank on time Make all documents required by the letter of credit match the letter of credit application exactly Fund Based Lending In case of Fund Based Lending, the lending bank commits the physical outflow of funds. As such, the funds position of the lending bank gets affected. The Fund Based Lending can be made by the banks in the following forms: Pre Shipment Post Shipment
Loan:
In this case, the entire amount of assistance is disbursed at one time only, either in cash or by transfer to the companys account. It is a single advance. The loan may be repaid in instalments, the interests will be charged on outstanding balance.
Overdraft:
In this case, the company is allowed to withdraw in excess of the balance standing in its Bank account. However, a fixed limit is stipulated by the Bank beyond which the company will not be able to overdraw the account. Legally, overdraft is a demand assistance given by the bank i.e. bank can ask for the repayment at any point of time. However in practice, it is in the form of continuous types of assistance due to annual renewal of the limit. Interest is payable on the actual amount drawn and is calculated on daily product basis. An overdraft is particularly useful when you have regular sales and purchases coming out of your account which could leave you in bad cash flow situations. They are a good backup to ensure you can pay your bills even when you have not yet received your invoice payments. An overdraft is not supposed to be a permanent source of finance, and if your business is relying on using it, you should get your finances checked out. Advantages of Overdrafts Flexible An overdraft is there when you need it, and costs nothing (apart from possibly a small fee) when you do not. It allows you to make essential payments whilst chasing up your own payments, and helps to maintain cash flow. You only need to borrow what you need at the time. Quick Overdrafts are easy and quick to arrange, providing a good cash flow backup with the minimum of fuss. Disadvantages of Overdrafts
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Cost Overdrafts carry interest and fees; often at much higher rates than loans. This makes them very expensive for long term borrowing. You also face large charges if you go over the agreed overdraft limit. Recall Unless specified in the terms and conditions, the bank can recall the entire overdraft at any time. This may happen if you fail to make other payments, or if you have broken terms and conditions; though sometimes the banks simply change their policies. Security Overdrafts may need to be secured against your business assets, which put them at risk if you cannot meet repayments.
Cash Credit:
In practice, the operations in cash credit facility are similar to those of overdraft facility except the fact that the company need not have a formal current account. Here also a fixed limit is stipulated beyond which the company is not able to withdraw the amount. Legally, cash credit is a demand facility, but in practice, it is on continuous basis. The interests is payable on actual amount drawn and is calculated on daily product basis.
Bills purchased or discounted:
This form of assistance is comparatively of recent origin. This facility enables the company to get the immediate payment against the credit bills raised by the company. The bank holds the bill as a security till the payment is made by the customer. The entire amount of bill is not paid to the company. The Company gets only the present worth of the amount of bill, the difference between the face value of the bill and the amount of assistance being in the form of discount charges. On maturity, bank collects the full amount of bill from the customer. While granting this facility to the company, the bank inevitably satisfies itself about the credit worthiness of the customer. A fixed limit is stipulated in case of the company, beyond which the bills are not purchased or discounted by the bank. Types of Bills: There are various types of bills. They can be classified on the basis of when they are due for payment, whether the documents of title of goods accompany such bills or not, the type of activity they finance, etc. Some of these bills are: Demand Bill This is payable immediately at sight or on presentment to the drawee. A bill on which no time of payment or due date is specified is also termed as a demand bill. Usance Bill this is also called time bill. The term usance refers to the time period recognized by custom or usage for payment of bills. Documentary Bills are the B/Es that are accompanied by documents that confirm that a trade has taken place between the buyer and the seller of goods. These documents include the invoices and other documents of title such as railway receipts, lorry receipts and bills of lading issued by custom officials. Documentary bills can be further classified as: Documents against acceptance (D/A) bills. Documents against payment (D/P) bills.
D/ A Bills In this case, the documentary evidence accompanying the bill of exchange is deliverable against acceptance by the drawee. This means the documentary bill becomes a clean bill after delivery of the documents D/P Bills In case a bill is a documents against payment bill and has been accepted by the drawee, the documents of title will be held by the bank or the finance company till the maturity of the B/E. Clean Bills These bills are not accompanied by any documents that show that a trade has taken place between the buyer and the seller. Because of this, the interest rate charged on such bills is higher than the rate charged on documentary bills. Advantages: The advantages of bill discounting to investors and banks and finance companies are as follows: It is a short-term source of finance. Bills discounting being in the nature of a transaction is outside the purview of Section 370 of the Indian Companies Act 1956, that restricts the amount of loans that can be given by group companies; Since it is not a lending, no tax at source is deducted while making the payment charges which is very convenient, not only from cash flow point of view, but also from the point of view of companies that do not envisage tax liabilities It gives flexibility not only in the quantum of investments but also in the duration of investments. No extra security is to be offered: Banks generally do not ask for any other security while making payment against the bill Sources of Short-term Finance. However, if a customer is interested, banks also grant him limit for discounting of bills. This limit is known as limit against discounted bills. Usually banks ask for certain security while extending this limit. Such limit is obtained when drawing of bills of exchange is almost a regular feature in business. Nature of liability for repayment: Repayment of money advanced against discounted bill is the responsibility of the drawee of bills of exchange. Banks therefore approach the drawee, who is generally the acceptor of the bill, for payment after the due date on the bill. In case the drawee does not pay or refuses to pay, the drawer or the person who got payment after discounting the bill is held responsible for payment. Disadvantages of Bill discounting: Payment of interest in advance: While discounting a bill, bank deducts the discount and balance is credited in customers account. This discount is equal to the amount of interest for the remaining period of payment against the bill. Thus, a person receiving money through discounting of bill has to offer advance interest on the amount of the bill. Facility is subjected to the creditworthiness of parties involved. Banks generally extend this facility after being satisfied with the creditworthiness of different parties
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involved. In case of doubt, the bank may ask for some security. Thus, it is not a very easily available facility. It gives additional burden in case of non-payment. Bills not paid upon maturity are to be certified by Notary Public and a certain amount in the form of noting charges is paid. Thus, it becomes an additional burden.
Illustration: The innovative finance Ltd, discounts the bills of its clients at the rate specified below: 1) L / C backed bills 22 per cent per annum 2) Clean bill 24 per cent per annum Required: Compute the effective rate of interest implicit in the two types of bills assuming usance period of (a) 90 days for the L/C based bill and (b) 60 days for the clean bill and value of the bill, Rs 10,000 Solution: Effective rate of Interest on L / C based bill: Value of the bill, Rs 10,000 Discount charge, Rs 550 {Rs 10,000 x 0.22 x 90 / 360} Amount received by the client, Rs 9,450 (Rs 10,000 Rs 550) Quarterly effective interest rate, 5.82 percent (Rs 550 / Rs 9,450 x 100) Annualized effective rate of interest, [(1.0582)4 1] x 100, 25.39 per cent Effective rate of interest on clean Bill: Value of bill, Rs 10,000 Discount charge ( Rs 10,000 x 0.24 x 60/ 360), Rs 400 Amount received by the client (Rs 10,000 R 400), Rs 9,600 Quarterly rate of interest (Rs 400 / Rs 9,600 x 1000, 4.17 percent Effective rate of interest per annum, [(1.0417)4 1] x100 = 17.75 percent
Working Capital Term Loans:
To meet the working capital needs of the company, banks may grant the working capital term loans for a period of 3 to 7 years, payable in yearly or half yearly instalments. These loans can be either backed by securities or not. The Common Types of Working Capital Loans: There are many different types of Working Capital Loans. To complicate matters, different banks use different terms to describe the same type of loan. To help you better understand and select the right loan, here are some common types of Working Capital Loans. Short-Term Loan:
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Unlike an overdraft, a short-term loan has a fixed repayment period - usually 12 months - and fixed interest rates. You may be asked to put up an asset as collateral for this loan. If your track record and relationship with the bank is good, the lender may even be willing to provide you with the loan without collateral. Confirmed Sales Orders or Accounts Receivable: Loans based on confirmed sales orders or accounts receivable is another way to raise working capital. If you need to fulfill a sizeable order of goods, but do not have the funds to do so, you may apply for a Working Capital Loan based on the value of the contract or order. If there is new opportunity round the corner and you need funds to take advantage of it, you may apply for a Working Capital Loan based on the value of your accounts receivable. Accounts receivable is the amount of money you have billed your customers but have not yet received payment. If your customers are established and reputable, the lender may be willing to help ease your cash flow problems. Loans for Buying & Selling Goods: There are special loan facilities for businesses that buy and sell goods, e.g. importers, manufacturers, exporters, etc. Letters of Credit, Inventory Loans and Trust Receipts are some examples. Advantages: Working Capital Loans are quick sources of cash. They can help your business tide over cyclical downturns. They can be used to provide cash flow during short-term shocks e.g. when your key customer is declared bankrupt. Disadvantages: They can only be used to meet short-term cash needs - they are insufficient for longterm plans or projects that require more capital (cash or asset). You need to monitor your loans closely and make sure you repay them on time to avoid being blacklisted by credit bureaus and lending institutions.
Packing Credit:
This type of assistance may be considered by the bank to take care of specific needs of the company when it receives some export order. Packing credit is a facility given by the bank to enable the company to buy the goods to be exported. If the company holds a confirmed export order placed by the overseas buyer or a letter of credit in its favour, it can approach the bank for packing credit facility. Features: Credit to Purchase Goods for Shipping: Packing credit provides capital for you to purchase any goods you plan on exporting. Sometimes the cost of purchasing the goods you need to ship exceeds your budget, so a packing credit offers you the safety in knowing you will have money available to buy your goods.
Lower Interest Rates: Unlike a bank loan where interest accrues for an overdraft, packing credit offers lower interest rates to exporters. Depending on the nature of your business and the amount you are borrowing, your interest rates will vary. Depending on your area, the percentage will vary, but packing credit is typically lower than other standard bank loans. Covers Cost of Manufacturing: For exporters who have product that must be manufactured out of house, the packing credit covers these costs. Furniture, and other goods not made in the same country as the exporter will have to be shipped to the exporter, which is also covered by most packing credit agreements. Credit Terms Usually More Flexible: Since packing credit is purchased based on the needs of your business, the terms are usually also flexible, depending on your business. Payment plans and overdrafts are often more flexible to allow the exporter to pay back the loan when he or she receives payment for the shipment. During the interim, all financing for the exporter continues.
Trade credit:
Trade credit refers to the credit extended by the suppliers of goods and service in normal course of transaction/business/sale of the firm. According to trade practice, cash is not paid immediately for purchase but after an agreed period of time. There is however, no formal/specific negotiation of trade credit It is an informal arrangement between buyer and seller. There is no legal instrument of acknowledgement of debt, which is granted on an open account basis. Advantages: Trade credit as a source of short-term working capital finance has certain advantages. It is easily available. Moreover it is flexible and spontaneous source of finance. The availability and magnitude of trade credits is related to the size of operation of a firm in relation to sales/purchase. If the credit purchase of goods decline, availability of credit will also decline. Trade credit is also an informal, spontaneous source of finance. Not requiring negotiation and formal agreement, trade credit is free from the restriction associated with formal/negotiated source of finance/credit. Cost: Trade credit does not involve any explicit interest charged. However there is an implicit cost of trade credit. It depends on trade credit offered by suppliers of goods. The smaller the difference between the payment day and the end of the discount period, the larger is the annual interest/cost of trade credit. Banking arrangements: Working capital is made available to the borrower under the following arrangements:
Consortium banking arrangement: RBI till 1997 made it obligatory for availing working capital facilities beyond a limit (Rs 500 million in 1997), through the consortium arrangement. The objective of the arrangement was to jointly meet the financial requirement of big projects by banks and also share the risks involved in it. While it consortium arrangement is no longer obligatory, some borrowers continue to avail working capital finance under this arrangement. The main features of this arrangement are as follows: Bank with maximum share of the working capital limits usually takes the role of lead bank. Lead bank, independently or in consultation with other banks, appraise the working capital requirements of the company. Banks at the consortium meeting agree on the ratio of sharing the assessed limits. Lead bank undertakes the joint documentation on behalf of all member banks. Lead bank organizes collection and dissemination of information regarding conduct of account by borrower. Multiple banking arrangements: Multiple banking is an open arrangement in which no banks will take the lead role. Most borrowers are shifting their banking arrangement to multiple banking arrangements. The major features are: Borrower needs to approach multiple banks to tie up entire requirement of working capital. Banks independently assessed the working capital requirements of the borrower. Banks, independent of each other, do documentation, monitoring and conduct of the account Borrowers deals with all financing banks individually. Syndication: A syndicated credit is an agreement between two or more lenders to provide a borrower credit facility using common loan agreement. It is internationally practiced model for financing credit requirements, wherein banks are free to syndicate the credit limit irrespective of quantum involved. It is similar to a consortium arrangement in terms of dispersal of risk but consist of a fixed repayment period. Bank assessment of working capital Reserve Bank of India had instructed to use strictly and adhere with the second method of lending to banks while lending for working capital. As per this method the borrower should finance 25% of all current assets from owned funds and long term liabilities and the balance be financed by bank. By applying this method of lending one need to calculate the Maximum Permissible Bank Finance (MPBF) for deriving the maximum limit which the bank could extend to the borrower.
Format for calculating the MPBF is as follows:
The Drawing Power (DP) should be equal to or more than the limit applied for. The calculation of same is as follows:
The inventory holding period, time taken in realization of debtors, advance to suppliers and credit availed from suppliers are also taken into consideration. All the above factors are calculated in either days or months. It shows the requirement of working capital in months or days. In bank term it is called Working Capital Cycle of the concern. It is very important factor because it shows blockage of funds and how much time a concern takes to realize the same. It is the measure of capability of concern to manage the liquidity in the system. Bank compare the holding period of borrowing concern current assets with the concern in same business and industry standards. If bank finds major differences than it may instruct to
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borrowing concern, to standardize the same with peers or industry standard, subject to necessary approvals from higher authorities.
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Analysis of Working Capital Financing at PDL:

Working Capital arrangement of Parabolic Drugs Ltd. for the year ending MAR12 is as follows: Working Capital Financing at Parabolic Drugs Ltd. As on MAR'12 *All Figures are in Rs. Crore Amount %age Form Instrument 138.26 27.49 13.13 2.61 22.58 4.49 71.18 14.15 31.42 6.25 20.89 4.15 144.37 28.71 61.04 12.14 502.85 100.00
Cash credit from Banks Export Packing Credit from Banks FCNR Buyers Credit from Banks Vendors Discounting from Banks PCFC Term Loan from banks Bill Discounting from Banks Total
Working Capital Financing at PDL
Bill Discounting from Banks 12% Cash credit from Banks 28% Term Loan from banks 29%
PCFC 4%
Buyers Credit from Banks 14% Vendors Discounting from Banks 6%
Export Packing Credit from Banks FCNR 3% 4%
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Instrument Cash credit from Banks Export Packing Credit from Banks FCNR Buyers Credit from Banks Term Loan from banks Bill Discounting from Banks
Rate of Interest BPLR BPLR-2.5% LIBOR+6.5% LIBOR+(2-5)% BPLR+0.5% 8-11%
Effective Rate As on
We can derive the following conclusions from the above charts: As we can clearly see that most of the finances at the company are being arranged by Term Loan from the banks. This is because of its easy availability from the banks. Approximately 29% finances are being arranged by this very instrument. But we can also see that it is one of the most costly for the company. While another major source of finance for the Company is Cash Credit. It approximately contributes 28% of the total financing of the Company. These loans serve as the permanent working capital of the company. But again the cost of financing through this instrument is too high. The company has Export of approximately 30% of the total revenue. The Govt. of India always tries to promote the export earnings of the country so it has various measures through which an exporter can get the cheap finances. This has resulted in financing through instruments like Buyers Credit from Banks, PCFC (Packing Credit in Foreign Currency) etc. These are the one of the cheapest sources of finance for the company. The Company should try to utilise the maximum finances from these instruments. Apart from these sources the company also arranges finances through Factoring for which no data from the company can be obtained. But some of the details which can be obtained from my project guide through an interview about the Factoring in company are as follows: Factor Name Amount Received at the time of Factoring 80% of the Bill Value 85% of the bill Value Factoring Charges Interest on Overdue Interest Utilised Amount of Factoring 0.25% of Bill Value 15.75% Up to 3 Days 3% p.a. p.a. Beyond 6 Days 6% p.a. 0.15% of Bill Value 14.75% 5% p.a. p.a.
Bibby Financial
India Factoring Ltd.
As we can see from the above data that if the payments from the debtors is even 3 days late from the due date the Cost of financing can go up to the 18.75-19.75% and in worst case it can even touch 21.75% which is too high as far as financing is concerned.
So the Company should try to utilise all the limits given to it from various banks under various heads. Then only in great need of finances it should go for financing. Along with this the Company should go for factoring for only those clients who are credible in making the payments and do not carry any risk of bad debts from their previous records.
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Brief history of foreign exchange markets:

The current currency rate mechanism has evolved over thousands of years of the world community trying with various mechanism of facilitating the trade of goods and services. Initially, the trading of goods and services was by barter system where in goods were exchanged for each other. Such system had its difficulties primarily because of nondivisibility of certain goods, cost in transporting such goods for trading and difficulty in valuing of services. People tried various commodities as the medium of exchange ranging from food items to metals and finally gold coins became the standard means of exchange because of their ease of transportation, divisibility, certainty of quality and universal acceptance. The process of evolution of medium of exchange further progressed into development of paper currency. People would deposit gold/ silver coins with bank and get a paper promising that value of that paper at any point of time would be equal to certain number of gold coins. With time, growth in international trade resulted in evolution of foreign exchange (FX) i.e., value of one currency of one country versus value of currency of other country. Each country has its own currency and whenever there is a cross-border trade, there is need to exchange one brand of money for another, and this exchange of two currencies is called foreign exchange or simply forex (FX). This led to the question of determining relative value of two currencies. In 1870 countries agreed to value their currencies against value of currency of other country using gold as the benchmark for valuation. This mechanism of valuing currency was called as gold standard. During 1944-1971, countries adopted a system called Bretton Woods System. As part of the system, all currencies were pegged to USD at a fixed rate and USD value was pegged to gold. Finally Bretton Woods system was suspended and countries adopted system of free floating or managed float method of valuing the currency. Developed countries gradually moved to a market determined exchange rate and developing countries adopted either a system of pegged currency or a system of managed rate. In pegged system, the value of currency is pegged to another currency or a basket of currencies. In managed float, countries have controls on flow of capital and central bank intervention is a common tool to contain sharp volatility and direction of currency movement.
Foreign Exchange Risk Management:

An organisations act of minimizing the exchange risk arising out of the international trade is called foreign exchange risk management. This risk can be managed through use of Currency Derivative. This process of risk minimisation is also called Currency Hedging. Derivatives Definition: Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate). The underlying asset can be equity, foreign exchange, commodity or any other asset.
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For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying".
Derivative products:
Though derivatives can be classified based on the underlying asset class (such as forex derivatives, equity derivatives, etc), it is more useful to classify them based on cash flow pattern into four generic types of forward, futures, option and swap. I. II. III. IV. Forwards Futures Options Swaps
Currency Forwards:
A forward is a made-to-measure agreement between two parties to buy/sell a specified amount of a currency at a specified rate on a particular date in the future. The depreciation of the receivable currency is hedged against by selling a currency forward. If the risk is that of a currency appreciation (if the firm has to buy that currency in future say for import), it can hedge by buying the currency forward. For Example: If RIL wants to buy crude oil in US dollars six months hence, it can enter into a forward contract to pay INR and buy USD and lock in a fixed exchange rate for INR-USD to be paid after6 months regardless of the actual INR-Dollar rate at the time. Features of Indian Forward Market: With respect to settlement, the market participant could decide to settle it via gross settlement mechanism or net settlement mechanism. Requirement of underlying trade contract: According to RBI guidelines, any resident Indian desiring to book a forward contract should have an underlying trade contract which could establish exposure to foreign currency. The amount and tenor of the contract booked has to be equal to or less than the amount and tenor of foreign exchange exposure as suggested by the underlying trade contract. The market participant is expected to submit the trade contract to bank within 15 days of booking the forward contract. RBI has also made provisions to facilitate booking of forward contracts by small and medium enterprises (SME) without submitting the underlying trade contracts. This exemption is given for entities who qualify as SME as defined by the Rural Planning and Credit Department, Reserve Bank of India vide circular RPCD PLNS.BC.No.63/06.02.031/ 2006-07 dated April 4, 2007. Exchange rate arithmetic - cross rate: For some currency pairs prices are not directly available and are rather derived by crossing the prices of underlying currency pairs. For Example: For deriving prices of EURINR lets assume EURUSD: 1.4351 / 1.4355; USDINR: 44.38 / 44.39. The price of EUR is directly available only in terms of USD. Therefore you need to sell INR to buy USD; and further sell the USD received to buy EUR. We identified
the price of buying 1 unit of USD as 44.39. Therefore price of buying 1.4355 units of USD would be 1.4355 x 44.39 INR i.e. 63.7218 INR. Therefore the price of buying 1 unit of EUR in terms of INR is 63.7218 INR. Advantage/Disadvantage: The main advantage of a forward is that it can be tailored to the specific needs of the firm and an exact hedge can be obtained. On the downside, these contracts are not marketable, they cant be sold to another party when they are no longer required and are binding.
Currency Futures:
A futures contract is similar to the forward contract but is more liquid because it is traded in an organized exchange i.e. the futures market. Depreciation of a currency can be hedged by selling futures and appreciation can be hedged by buying futures. The previous example for a forward contract for RIL applies here also just that RIL will have to go to a USD futures exchange to purchase standardized dollar futures equal to the amount to be hedged as the risk is that of appreciation of the dollar. Features of Currency Futures: Tick value: It is the minimum size of price change. The market price will change only in multiples of the tick. Tick values differ for different currency pairs and different underlying. For e.g. in the case of the USDINR currency futures contract the tick size shall be 0.25 paisa or 0.0025 Rupee. Three Stock Exchange facilitate trading in Currency Futures in India. These are Mcx-Sx, NSE and BSE. One has to have a trading account and has to pay brokerage charges for executing the trade. Futures terminology: Some of the common terms used in the context of currency futures market are given below: Spot price: The price at which the underlying asset trades in the spot market. Futures price: The current price of the specified futures contract. Contract cycle: The period over which a contract trades. The currency futures contracts on the SEBI recognized exchanges have one-month, two-month, and threemonth up to twelve-month expiry cycles. Hence, these exchanges will have 12 contracts outstanding at any given point in time. Value Date/Final Settlement Date: The last business day of the month will be termed as the Value date / Final Settlement date of each contract. Expiry date: Also called Last Trading Day, it is the day on which trading ceases in the contract; and is two working days prior to the final settlement date.
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Contract size: The amount of asset that has to be delivered under one contract also called as lot size. In the case of USDINR it is USD 1000; EURINR it is EUR 1000; GBPINR it is GBP 1000 and in case of JPYINR it is JPY 100,000. Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market. The mark-to-market gains and losses are settled in cash before the start of trading on T+1 day. If mark-to-market obligations are not collected before start of the next days trading, the clearing corporation collects correspondingly higher initial margin to cover the potential for losses over the time elapsed in the collection of margins. Computing payoffs from a portfolio of futures and trade remittances: I. Combined position of futures and underlying export trade remittance: An exporter of garments from India has contracted to export 10,000 pieces of shirt to a large retailer in US. The agreed price was USD 100 per shirt and the payment would be made three months after the shipment. The exporter would take one month to manufacture the shirt. The exporter had used the prevailing spot price of 45 as the budgeted price while signing the export contract. To avoid the FX risk, the exporter sells four month futures at the price of 46. Situation 1: The exporter receives USD well on time and he converts USD to INR in the market at the then prevailing price of 47 and also cancels the futures contract at the same time at the price of 47.20. Calculation of effective currency price for the exporter: The effective price would be summation of effect of change in USDINR price on the underlying trade transaction and the effect of change in future price on the currency futures contract. 1. Underlying trade transaction: Against the budget of 45, the exporter realizes the price of 47 and therefore there is a net positive change of Rs 2. 2. Futures contract: Against the contracted price of 46, the exporter had to settle the contract at 47.2 and therefore resulting in a net negative change of Rs 1.2. 3. Combined effect: The combined effect of change in USDINR spot price and change in future price i.e. (Rs 2) + (- Rs 1.2) = + Rs 0.8.
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4. Effective price: Therefore the effective price was 45 (budgeted price) + 0.8 (effect of hedging and underlying trade transaction) i.e. Rs 45.8. Situation 2: Assume that INR appreciated against USD at time of converting USD to INR the spot was 44 and futures contracts cancellation rate was 44.2. In this situation also the effective currency price for the exporter would still be 45.8. This is because there would be a negative change of Rs 1 on underlying trade transaction and a positive change of Rs 1.8 on futures contract. Therefore the net effect will be summation of 1 and + 1.8 i.e. Rs 0.8. Conclusion: Please notice that because of the futures contract exporter always gets a price of 45.8 irrespective of depreciation or appreciation of INR. However, not using currency futures would have resulted in effective rate of 47 (in the first case when INR depreciated from 45 to 47) and effective rate of 44 (in the second case when INR appreciated from 45 to 44). Thus using currency futures, exporter is able to mitigate the risk of currency movement. II. Combined position of futures and underlying import trade remittance: Let us take an example where an importer hedges only partial amount of total exposure. An importer of pulses buys 1000 tons of chickpea at the price of USD1600 per ton. On the day of finalizing the contract, USDINR spot price was 45. He decides to hedge half of the total exposure using currency futures and contracted a rate of 45.5 for two month contract. In the next two months, INR depreciated to 46.5 at the time of making import payment. The settlement price of futures contract was declared as 46.7. Calculation of effective currency price for the importer: The effective price would be summation of final price at which import remittance was made and payoff from the futures contract. 1. Futures contract: Against the contracted price of 45.5, the importer settled the contract at 46.7, thereby resulting in a net positive change of Rs 1.2. Since importer hedged only half of the total exposure, the net inflow from hedging would be available for half of total exposure. 2. Effective price computation: Therefore the effective price would be 46.5 (final remittance price) for the unhedged part and 45.3 for the balance half which was hedged. The figure of 45.3 is computed by deducting 1.2 (inflow from hedging) from 46.5. Therefore final effective price would be: (46.5 x 0.5) + (45.3 x 0.5) = 45.9 As against the effective price of 45.9, the price would have been 45.3 had the importer decided to hedge the total exposure. Also note that without hedging,
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the effective price would have been 46.5 i.e., the price at which importer made the import remittance. Currency futures contract specification: Contract specification: USDINR, EURINR, GBPINR and JPYINR Currency Derivatives Underlying Foreign currency as base currency and INR as quoting currency Market timing 9:00 AM to 5:00 PM Contract Size USD 1000 (for USDINR), EUR 1000 (for EURINR), GBP 1000 (for GBPINR) and JPY 100,000 (for JPYINR) Tick Size Re. 0.0025 Quotation The contract would be quoted in Rupee terms. However, outstanding position would be in USD, EUR, GBP and JPY terms for USDINR, EURINR,GBPINR and JPYINR contracts respectively Available contracts Maximum of 12 calendar months from current calendar month. New contract will be introduced following the Expiry of current month contract. Settlement date Last working day of the month (subject to holiday calendars) at 12 noon Last trading day (or Expiry day) 12 noon on the day that is two working days prior to the settlement date Settlement Basis Daily mark to market settlement will be on a T +1 basis and final settlement will be cash settled on T+2 basis. Daily settlement Price Daily mark to market settlement price will be announced by the exchange, based on volumeweighted average price in the last half an hour of trading, or a theoretical price if there is no trading in the last half hour. Settlement Cash settled in INR Final Settlement Price The reference rate fixed by RBI on last trading day or expiry day. Final Settlement Day Last working day (excluding Saturdays) of the expiry month. The last working day will be the same as that for Interbank Settlements in Mumbai. The rules for Interbank Settlements, including those for known holidays and subsequently declared holiday would be those as laid down by FEDAI.
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Regulatory guidelines on open position limits: In order to avoid building up of huge open positions, the SEBI has specified the maximum allowable open position limit across all members of the Exchange. Client level USDINR Non bank TM Bank TM
EURINR
GBPINR
JPYINR
6% of total open 15% of total open 15% of total open interest or USD 10 mn, interest or USD 50 mn, interest or USD 100 whichever is higher whichever is higher mn, whichever is higher 6% of total open 15% of total open 15% of total open interest or EUR 5 mn, interest or EUR 25 mn, interest or EUR 50 mn, whichever is higher whichever is higher whichever is higher 6% of total open 15% of total open 15% of total open interest or GBP 5 mn, interest or GBP 25 mn, interest or GBP 50 mn, whichever is higher whichever is higher whichever is higher 6% of total open 15% of total open 15% of total open interest or JPY 200 interest or JPY 1000 interest or JPY 2000 mn, whichever is mn, whichever is mn, whichever is higher higher higher
Settlement Mechanism: All futures contracts are cash settled, i.e. through exchange of cash in Indian Rupees. Currency futures contracts have two types of settlements, the MTM settlement which happens on a continuous basis at the end of each day, and the final settlement which happens on the last trading day of the futures contract. Final settlement for futures: On the last trading day of the futures contracts, after the close of trading hours, the Clearing Corporation marks all positions of a CM to the final settlement price and the resulting profit/loss is settled in cash. Final settlement loss/profit amount is debited/credited to the relevant CM's clearing bank account on T+2 working day following last trading day of the contract (contract expiry day). The final settlement price is the RBI reference rate for the last trading day of the futures contract. All open positions are marked to market on the final settlement price for all the positions which gets settled at contract expiry. Such marked to market profit / loss shall be paid to / received from clearing members. Margin requirements: The different types of margins collected by the Exchanges are as follows: Initial Margin: The initial security deposit paid by a member is considered as his initial margin for the purpose of allowable exposure limits. The Initial Margin requirement is based on a worst case loss of a portfolio of an individual client across various scenarios of price changes. The various scenarios of price changes would be so computed so as to cover a 99% Value at Risk (VaR) over a one-day horizon. The prescribed level of minimum initial margin for different currency pair is given below:
Minimum margin requirement on first day Minimum margin requirement after first day
USDINR 1.75%
EURINR 2.8%
GBPINR 3.2%
JPYINR 4.5%
1%
2%
2%
2.3%
Portfolio Based margin: The Standard Portfolio Analysis of Risk (SPAN) methodology is adopted to take an integrated view of the risk involved in the portfolio of each individual client comprising his positions in futures contracts across different maturities. The client-wise margin is grossed across various clients at the Trading / Clearing Member level. The proprietary positions of the Trading / Clearing Member are treated as that of a client. Calendar Spread Margins: A currency futures position at one maturity which is hedged by an offsetting position at a different maturity is treated as a calendar spread. The calendar spread margin in Rs for different currency pair is given below: 1 month spread 2 month spread 3 month spread 4 or more months spread USDINR 400 500 800 1000 EURINR 700 1000 1500 1500 GBPINR 1500 1800 2000 2000 JPYINR 600 1000 1500 1500
Unique Client Code (UCC): The Exchange ensures that each client is assigned a client code that is unique across all members. The unique client code is assigned with the use of Income Tax Permanent Account Number (PAN) number. Advantage/Disadvantage: Futures require a small initial outlay (a proportion of the value of the future) with which significant amounts of money can be gained or lost with the actual forwards price fluctuations. This provides a sort of leverage. Price transparency. Elimination of Counterparty credit risk. The benefit of standardization, though improves liquidity in futures, leads to imperfect hedge since the amount and settlement dates cannot be customized.
Currency Options:
SEBI and RBI permitted introduction of USDINR options on stock exchange from July 30 2010. Persons resident in India are permitted to participate in the currency options market, subject to the directions contained in the Exchange Traded Currency Options (Reserve Bank) Directions, 2010, [Notification No.FED.01 / ED (HRK)-2010 dated July 30, 2010].
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As of now, these options are available on National Stock Exchange (NSE) and United Stock Exchange (USE). Options Definition: A currency Option is a contract giving the right, not the obligation, to buy or sell a specific quantity of one foreign currency in exchange for another at a fixed price; called the Exercise Price or Strike Price. The right to buy the asset is called call option and the right to sell the asset is called put option. Call Options are used if the risk is an upward trend in price (of the currency), while Put Options are used if the risk is a downward trend. Again taking the example of RIL which needs to purchase crude oil in USD in 6months, if RIL buys a Call option (as the risk is an upward trend in dollar rate), i.e. the right to buy a specified amount of dollars at a fixed rate on a specified date. There are two scenarios. If the exchange rate movement is favourable i.e. the dollar depreciates, then RIL can buy them at the spot rate as they have become cheaper. In the other case, if the dollar appreciates compared to todays spot rate, RIL can exercise the option to purchase it at the agreed strike price. In either case RIL benefits by paying the lower price to purchase the dollar. Features: The price which option buyer pays to option seller to acquire the right is called as option price or option premium. The asset which is bought or sold is also called as an underlying or underlying asset. Buying an option is also called as taking a long position in an option contract and selling is also referred to as taking a short position in an option contract. Style of options: Based on when the buyer is allowed to exercise the option, options are classified into two types: I. European options: European options can be exercised by the buyer of the option only on the expiration date. In India, all the currency options in OTC market are of European type. II. American options: American options can be exercised by the buyer any time on or before the expiration date. Currently American options are not allowed in currencies in India. Moneyness of an option: Moneyness of an option indicates whether the contract would result in a positive cash flow, negative cash flow or zero cash flow for the option buyer at the time of exercising it. Based on these scenarios, moneyness of option can be classified in three types: I. In the money (ITM) option: An option is said to be in the money, if on exercising it, the option buyer gets a positive cash flow. Thus a call option would be in the money, if underlying price is higher than the strike price and
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similarly a put option would be in the money if underlying price is lower than the strike price. II. Out of the money (OTM) option: An option is said to be out of the money, if on exercising it, the option buyer gets a negative cash flow. Thus a call option would be out of the money, if underlying price is lower than the strike price and similarly a put option would be out of the money if underlying price is higher than the strike price.
At the money (ATM) option: An option is said to be at the money if spot price is equal to the strike price. Any movement in spot price of underlying from this stage would either make the option ITM or OTM. Option pricing methodology: There are two common methodologies for pricing options: I. Black and Scholes: This methodology is more analytical, is faster to compute and is mainly used to price European options. II. Binomial pricing: This methodology is more computational, taken more computing power and is mainly used to price American options. Option strategies: There are two types of option strategies which can be used by any option user. I. Vanilla options: These are four basic option positions, which are long call, long put, short call and short put option. II. Combination strategies: Combination strategies mean use of multiple options with same or different strikes and maturities. These are more suitable when market view is moderately bullish/ bearish, range bound or uncertain and the transaction objective is to also reduce the overall payout of options premium. Using Currency Option: Case Analysis An Indian IT company with exports of USD 10mn per year is preparing its revenue budget for next quarter. The companys sales team has given revenue estimate of USD 4mn. The senior management of company is struggling to find a way to prepare the revenue budget in INR as they are uncertain of USDINR exchange rate. They also have an additional uncertainty of volatile economic conditions in USA and which may result in actual revenues to be lower than USD 4mn as estimated by sales team. The company has two choices to convert USD revenue estimate in INR estimate: 1. short USDINR futures for next quarter and use the price to convert USD estimate to INR estimate; 2. buy put option on USDINR for next quarter and use the strike price for converting USD estimate to INR estimate. Assessment of two choices: I. Futures: While futures are low cost choice, it does not allow participation in favourable currency movement. Additionally, use of futures may result in losses if actual revenues in USD are lower than estimate and USDINR
III.
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weakens. In such a scenario, company will lose on futures leg of transaction and will have gain on a lower amount of corresponding spot leg of transaction. II. Put option: It is a costly alternative as company has to pay option premium for buying the option. However, it allows company to take benefit of any favourable price movement in currency. Additionally, put option also allows company to know the maximum possible loss in the event of actual revenue is less than estimated revenue. Solution Using Futures: Assume that the current USDINR spot is 45 and three months futures is 45.6. The premium on a three month put option with strike of 45.6 is Rs 1.5. In future, if on contract expiry the spot is 46, there would be loss of 0.4 (46-45.6) while there would be gain of Rs 1 (46-45) on the corresponding spot leg. There by resulting in a gain of Rs 0.6 per USDINR. Thus on USD 4mn, the effective realization would be Rs 18.24 Crore (USD 4mn X 45.6). However, if amount of futures booked was for USD 4 million while actual sales is lower by 0.5 million, the actual realization on USD 3.5 million would be Rs 15.93 Crore (USD 3.5mn x 45.6) (USD 0.5mn x 0.4). This translates into an effective exchange rate of 45.54, which is lower than 45.6. Solution Using Options: The company chooses to opt for option over futures. It asks its finance team to find out the cost of buying vanilla put option. Finance team reverts back with a cost estimate of 3% for a strike price equal to that of 3 months futures price. Company analyses the option cost and comes to a conclusion that buying vanilla option would certainly lower the revenue estimate by 3%. Senior management decides that it is comfortable in giving up part of the upside, if any, from any favourable currency movement if the cost is lowered. What kind of option strategy could finance team present to its senior management? Finance team could suggest a strategy where in company can buy an ATM or ITM put and reduce its cost by selling an OTM call. The strike price of these options would depend on premiums and the management decision on how much cost they are comfortable with and after what price level they are comfortable to let go off of any favourable currency price movement. Contract design: Standard option contract: SEBI has approved following specification of USDINR options contract: Contract specification: USDINR currency option Underlying USDINR spot Market timing 9 AM to 5 PM Type of option European
Contract Size Tick Size (Rupees) Quotation
Trading Cycle
Expiry Day
USD 1000 0.0025 The premium will be quoted in INR terms. However, outstanding position would be calculated in USD terms Three serial monthly contracts followed by three quarterly contracts of the cycle March/June/September/December. Last working day of the month (subject to holiday calendars) Two working days prior to the last business day of the expiry month at 12 noon. Daily mark to market settlement will be on a T +1 basis and final settlement will be cash settled on T+2 basis. RBI reference rate for last trading date of the contract Cash settled in Indian Rupees Last working day (excluding Saturdays) of the expiry month. The last working day will be the same as that for Interbank Settlements in Mumbai.
Last Trading Day Settlement Basis
Settlement Price Settlement Final Settlement Day
Taxation of Currency Derivatives: Finance Act, 2005 has amended section 43(5) so as to exclude transactions in derivatives carried out in a recognized stock exchange for this purpose. This implies that income or loss on derivative transactions which are carried out in a recognized stock exchange is not taxed as speculative income or loss. Thus, loss on derivative transactions can be set off against any other income during the year. In case the same cannot be set off, it can be carried forward to subsequent assessment year and set off against any other income of the subsequent year. Such losses can be carried forward for a period of 8 assessment years. It may also be noted that securities transaction tax paid on such transactions is eligible as deduction under Income-tax Act, 1961.
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Analysis of Foreign Exchange Risk Management at PDL:

The Company is involved in both the transaction Import as well as Export. These transactions give birth to the Foreign Exchange Risk Management in the company. These arrangements helps the Company to avoid Currency fluctuation risk in the Company. (Rs. in million) 2010-2011 2009-2010 2008-2009 1736.17 1,300.46 1,090.41 2631.11 2,095.31 2,331.21 2592.22 22.85 1.57 0 2.2 12 1.5 3.4 6160.22 65.99 28.18 42.71 2059 15.86 0 0.34 2.03 16.6 0 1.49 5138.93 62.07 25.31 40.77 2276.22 43 0 3.27 1.29 4.44 0.31 2.69 3943.68 46.77 27.65 59.11
Foreign Exchange Transactions Earnings (FOB Value of exports) Outgo (CIF Value of imports and Expenditure in foreign currency) Raw material Capital Goods Salary Consultancy Expenses Travelling Expenses Commission on sales Fee and Taxes Business Promotion Expenses Net Sales Foreign Excahange Earning as %age of total Forex Outgo Export Earnings as a %age of Net Sales Expenses as a %age of Net Sales
By seeing the above table we can clearly analyse that approximately 66% of foreign exchange outgo is Companys export. This leads us to conclusion that 66% of the Currency risk can be hedged naturally but this is not the case for the company. Whenever Company receives any proceeds of export it cannot put that money idle to make payment in the same currency because of time value of money. So it discounts approximately all the proceeds of the export. So there is hardly any case of natural hedge. Therefore, to hedge this Currency risk company can go for Derivatives. In using Derivatives there are four alternative before the company which are as follows: Forward Contracts Futures Options Swaps
If we start analysing the swaps this instrument is basically used by large Corporations which Foreign Debt in their Balance Sheet and are operating in many countries. The company which we are concerned with is not a very large organisation with approximate sales turnover of only Rs.1000 Crore. Also the company do not have much credibility in the market.
If we compare between Futures and Forwards contract Forward contract seems to be more useful for the company. In futures there is only one pre specified date on which settlement can happen but Forward contract can be customized with payment to payments. This advantage of Forward Contract over the Futures inclines the company to use Forward contract for hedging. If we consider Options the same problem as of Futures comes into the picture. As in India Currency market is not much developed. Only European Options are allowed in Indian Currency Trading. These things lead us to a conclusion that hedging through Forwards is best strategy for the Company. Along with these advantages in the Forward Contracts the fixed charges for booking of a future contract is also very low. Cost of Forward Contract: Parabolic Drugs Ltd. pays 700/- annually for the booking of the Forward Contracts with the banks. But the actual cost of forward contracts depends upon the expected spot rate at time when cash flows are paid or received. The formula for the calculation of the cost of forward contract to the company is as follows: Cost of Forward Contract = ( ) 360 Days
Where, F is Forward Rate of the contract
Es is the expected spot price at the time when cash flows are paid or received So it can also be very high for the company. Companys Plan: While working its hedging strategies the company should try to net off its import payments against its export earnings. It should continuously monitor its import payments which are to be made in future and what exactly it is going to receive as export revenue. After netting off all the export revenue and import payments the company can go for forward contract booking fully or partially by keeping eye on overall Indian and global economy conditions. If the overall outlook is bearish then it should increase its forward booking and if the overall outlook for the economy is bullish then the company can go for reduction in o. forward contracts booking to take the advantage of rupee depreciation.
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References
References from various Companies Reports: Annual Reports of the Company Prospectus of the Company Analysts reports available at Companies Website Official Data of the Company Books Referred: I.M. Pandey: Financial Management Narinder Kumar: Export financing in India Maria Kavaliova: Foreign Exchange Risk Management: Which hedging techniques can be used by a mid-size company Nidhi Jain: Foreign Exchange Risk Management Eugene F. Brigham/Michael C. Ehrhardt: Financial Management Some Websites Referred on Internet: www.moneycontrol.com www.parabolicdrugs.com www.sbi.co.in www.reuters.com www.finance.yahoo.com http://www.eximguru.com/exim/Guides/Export-Finance
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Submitted By- Harsh Gupta

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The recent trends pertaining to the global pharmaceutical markets are:

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Indian pharmaceutical industry:

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R&D Centre Barwala

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Shareholding Pattern of Parabolic Drugs Ltd.

Other Non-Institution's Shareholding

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Share Price of the Company over the Years:

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Need and problem of the study

Scope of the study

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Objectives of the study

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Working Capital Management:

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Methods of Estimating Working Capital Requirement:

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Approaches for Determining Financing Mix of Working Capital:

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Procedure for working capital finance:

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Credit monitoring arrangement (CMA):

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III Adequate Average

VI Inadequate VII Low VIII High Risk

IX Substantial Risk Default

Drawing power of the borrower:

Rs 130 lacs Rs 100 lacs Rs 110 lacs 25 %

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Drawing power of borrower

110-(0.25 110) = Rs 82.5 lacs

Submitted By- Harsh Gupta

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Submitted By- Harsh Gupta

University Business School

Submitted By- Harsh Gupta

University Business School

Submitted By- Harsh Gupta