A to place on records, my deep

Enroll No: 17BSPHH01C1278

Enroll No: 17BSPHH01C1278
A report submitted in partial fulfillment of the requirements of
MBA Program of IBS Hyderabad
Distribution list
Company Guide:Faculty Guide:
Mr. Saurabh ParikhDr. Debajani Sahoo
Finance Manager IBS Hyderabad
Adani Wilmar Limited
Date of Submission :9TH MAY, 2018
This is to certify that this is a project report submitted in partial fulfillment of the requirements of MBA program of IBS, Hyderabad. This report document titled, “CORPORATE FINANCE INCLUDING TRADE FINANCE AND WORKING CAPITAL MANAGEMENT AND STUDY OF THE FOREX MARKET” is a submission of work done by Mr. Yogesh Lakhotia as part of the completion of the study at Adani Wilmar Ltd. during his Internship Program under the guidance of Mr. Saurabh Parikh
This report has been formally submitted to Dr. Debajani Sahoo Faculty Guide, IBS Hyderabad and Mr. Saurabh Parikh, Finance Manager, Adani Wilmar Ltd., Ahmedabad.

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Knowledge, in itself, is a continuous process. Getting practical knowledge is an important thing, which is not possible without the support, guidance, motivation and inspiration provided by different persons.
The successful completion of this project would have not been possible without the co-operation and the support of my faculty guide who has helped us immensely in the preparation of this project.
I wish to place on records, my deep sense of gratitude and sincere appreciation to Adani Wilmar Limited, who gave me the opportunity to learn and work in the Finance and Accounts department of the company.

I express my deep sense of gratitude to my faculty guide Dr. Debajani Sahoo for guiding me throughout the project. Her invaluable feedbacks and suggestions gave a clear vision of how to take out the best from the internship program. A special word of thanks goes to my company guide Mr. Saurabh Parikh, Finance Manager, whose help and guidance made this effort a bright success.
I am indebted to my colleagues and friends who have helped, inspired and given moral support and encouragement, in various ways, in completing this project. My external gratitude goes to my parents for their love, support, inspiration and dedication.
S.NO Particulars Page number
1 Abstract 8
2 Introduction To Working Capital Management 9
2.1 Current Assets 9
2.2 Current Liabilities 9
2.3 Raising Short Term Finance 10
2.3.1 Cash Credit Account 10
2.3.2 Bill Discounting 10
2.3.3 Buyer’s Credit 10
2.3.4 Letter Of Credit 10
2.3.5 Export Packing Credit 10
2.3.6 Bank Guarantee 11
2.4 Term Loan 11
2.5 Objective 11
2.6 Scope 11
2.7 Methodology 11
2.8 Limitations 11
2.9 Banks 12
3 Adani Wilmar Ltd 13-15
3.1 Details of the Company 15
3.2 Portfolio of the Company 15-17
3.3 Group Companies 18
4 EXIM Documentation 19
4.1 Introduction 19
4.2 Import Procedure 20
4.3 Export Procedure 21
4.4 Bill of Lading 22
4.5 Packing List 23
4.6 Commercial Invoice 24
4.7 Weight and Quality Certificate 25
4.8 Phytosanitary Certificate 26
4.9 Fumigation Certificate 27
4.10 Certificate of Origin 28
5 Basic Understanding of Forex Market 29
5.1 What is Foreign Exchange 29
5.2 Need for Foreign Exchange 29-30
6 Hedging 30
6.1 What is Hedging 30-32
6.2 Difference Between Over The Counter(OTC) and Exchange Traded Hedging Techniques 33-34
7 Hedging Techniques 34
7.1 Forwards 34
7.2 Futures 35-37
7.3 Difference Between Forwards and Futures 37-38
7.4 Options 39-43
8 Financial Model 44
9 Conclusion 45
10 References 46

Figure No Particulars Page No
1 Product Mix of Adani Wilmar Limited 16
2 Chakki Fresh Atta 17
3 Import Procedure 20
4 Export Procedure 21
5 Bill of Lading 22
6 Packing List 23
7 Commercial Invoice 24
8 Weight and Quality Certificate 25
9 Phytosanitary Certificate 26
10 Fumigation Certificate 27
11 Certificate of Origin 28
12 Change in Import Duty 32
13 Short and Long Forward Contract 38
14 Long and Short Call 42
15 Long Put and Short Put 43
Export and import helps to grow the economy and expands the global market. Every country is enriched with own certain advantages in resources and skills. For example, some countries are rich in natural resources, such as fossil fuels, timber, fertile soil or precious metals and minerals, while other countries have shortages of many of these resources. Additionally, some countries have highly developed infrastructures, educational systems and capital markets that permit them to engage in complex manufacturing and technological innovations, while many countries do not.

Imports are important for businesses and individual consumers. Countries often desire to import such goods that are not available domestically or are available cheaper overseas. Individual consumers also benefit from the locally produced products with imported components as well as other products that are imported into the country. Imported products provides variety and a better price or more choices to consumers, which helps increase their standard of living.

Countries want to be net exporters rather than net importers. Importing is not necessarily a bad thing because it gives us access to important resources and products not otherwise available or at a cheaper cost. If you import more, than more money is leaving the country than is coming in through export sales.

On the other hand, the more a country exports, the more domestic economic activity and growth will occur. More exports mean more production, jobs and revenue. If a country is a net exporter, its gross domestic product increases, which is the total value of the finished goods and services it produces in a given period of time. In other words, net exports increase the wealth of a country.

This report also sheds light on the intricacies involved in managing the working capital requirements of the company i.e. maintaining an acute balance between the current assets and current liabilities to ensure appropriate cash flow required for the daily activities of the company.

2.1.Current Assets
2.2.Current Liabilities
2.3.Raising Short Term Finance
2.3.1.Cash Credit Account
2.3.2.Bill Discounting
2.3.3.Buyer’s Credit
2.3.4.Letter of Credit
2.3.5.Export Packing Credit
2.3.6.Bank Guarantee
2.4 Term Loan
2.9 Banks
2.1.Current Assets
2.2.Current Liabilities
2.3.Raising Short Term Finance
2.3.1.Cash Credit Account
2.3.2.Bill Discounting
2.3.3.Buyer’s Credit
2.3.4.Letter of Credit
2.3.5.Export Packing Credit
2.3.6.Bank Guarantee
2.4 Term Loan
2.9 Banks

Working capital represents the difference between a firm’s current assets and current liabilities. It involves the relationship between a firm’s short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing the fund based and non-fund based resources. The challenge can be determining the proper category for the vast array of assets and liabilities on a firm’s balance sheet and deciphering the overall health of a firm in meeting its short-term commitments.

Current assets represent assets that a firm expects to convert into cash within a year, or one business cycle, whichever is less. More obvious categories include cash, cash and cash equivalents, accounts receivables, inventory, and other shorter-term prepaid expenses. Other examples include current assets of discontinued operations and interest payable.

In the same way, current liabilities are liabilities that a firm expects to pay within one year or one business cycle, whichever is less. Examples include accounts payable accrued liabilities, and accrued income taxes, dividends payable, capital leases due within a year, and long-term debt is now due within the year.

This account is an account in which Banks lend money against the security of commodities and debt. It runs in a similar way as the current account except that the amount that can be withdrawn from this account is not restricted to the amount deposited in the account. Instead, the account holder is permitted to withdraw a certain sum called “limit” or “credit facility” in excess of the amount deposited in the amount.

Bill discounting is a major activity with some of the small Banks. Under this type of lending, Bank takes the bill drawn by borrower on his (borrower’s) customer and pay him immediately deducting some amount as discount/commission. The Bank then presents that Bill to the borrower’s customer on the due date of the Bill and collects the total amount. If the bill is delayed, the borrower or his customer pays the Bank a pre-determined interest depending upon the terms of transaction.

2.3.3. BUYER’S CREDIT (B.C.)
Buyer’s credit is the credit that is received by an importer (Buyer) to finance the purchase of capital goods or services from overseas Exporter’s i.e. Banks and financial Institutions for payment of his imports on due date. The Exporter’s Bank lends the importer (Buyer) based on the letter of comfort (a type of a Bank Guarantee) issued by the importer’s Bank.

A letter of credit is a letter issued by the bank in favor of the supplier guaranteeing to pay the supplier an agreed amount. In the event when the buyer is unable to make payment on the purchase, the bank is bound to pay the full or remaining amount to the supplier.

Packing credit is nothing but a pre-shipment finance given to exporters with a low interest rate to boost exports. Packing credit is given by authorized bank by the instruction of Reserve Bank as a government policy to promote exporters to earn foreign currency to strengthen financial status of a country.

A bank guarantee is a guarantee or a promise from a Bank ensuring that the due amount of a debtor will be met. In other words, if the debtor defaults in paying the debt, the bank will cover it. Note that there is a difference between Bank Guarantee and Letter of Credit, it is not the same.

Banks gives money when the repayment is to be made in fixed and pre-determined instalments. This type of loan is normally given to the borrowers for acquiring assets for a long term i.e. exceeding at least one year. Purchases of fixed assets like plant and machinery, constructing building for factory, setting up new projects fall under this category.

To acquire knowledge about the various aspects of the foreign exchange transactions and the formalities and the documentation involved therein. Also, to learn how to manage the working capital requirements of the company.
This study will be confined to describing ways to finance the working capital required for the import of raw materials for production purposes. The study will include – export and import (EXIM) documentation, RBI regulations, instruments of corporate debt, and procedure of placement.

Referring to annual report, Company’s Act 2013, RBI regulations, FOREX markets, company records and reports.
Referring credit rating agencies CARE, CRISIL, ICRA etc.
Understanding various concepts and procedure from Employees of the firm.
Indian FOREX market is underdeveloped.

Getting the best quote from the overseas financial institutions to raise capital for import is a tedious and complex job and hard for an intern to understand.

Time has always been a major constraint in terms of gaining all knowledge regarding the topics.

Not all the information is provided by the company due to confidential and security reasons.
2.9 Banks
Banks through which we manage our Working Capital i.e. Fund and Non-fund based are:
4314825-381000003505200-289559400000ADANI WILMAR LTD.
38100176530MINI CONTENT BOX:
3.1.Details of the Company
3.2.Portfolio of the Company
3.3.Group Companies
3.1.Details of the Company
3.2.Portfolio of the Company
3.3.Group Companies

Adani Wilmar Ltd. (“AWL” or the “Company”), incorporated in January 1999, is a 50:50 Joint Venture between Adani Enterprises Limited (AEL) and Lence Pte. Ltd. (LPL). AEL, the flagship company of Adani Group, is engaged in the business of coal trading and is India’s largest importer of coal. The Adani Group is a diversified conglomerate having business interests in Coal, Edible Oil, Gas Distribution, ITES, Logistics, Oil ; Gas Exploration, Ports, Power Generation, Real Estate and SEZ. LPL is an investment holding company and is engaged in the trading of edible oils. It is a wholly-owned subsidiary of Wilmar International Ltd., the flagship company of Singapore based Wilmar Group. Wilmar Group is one of Asia’s leading agro-business groups and is amongst the largest processors, refiners & traders of edible oil in the world.

AWL is engaged in the business of manufacturing edible oil, specialty fats, vanaspati & oleo chemicals and trading of non-edible oil (castor oil). The company has 12 manufacturing facilities and 7 in-house packaging facilities across India. The company has crushing, solvent extraction and refining capacities of 5,290 TPD, 1,075TPD and 8,040 TPD respectively and produces oil of numerous varieties viz. Cotton-seed, groundnut, mustard, Palm, rice bran, soya bean, and sunflower. Further, the company has 1,395 TPD Hydrogenation capacities to manufacture vanaspati & specialty fats such as bakery shortening, cocoa butter substitute etc. which have applications in food additives, confectionery, bakery products etc. The company has recently ventured into the oleo chemicals segment, which are preliminary chemicals derived from plant and animal fats. The most common applications of oleo chemicals are in the production of biodiesel, detergents, lubricants, personal care products and pharmaceuticals.

AWL offers a wide range of edible oils and has built a strong brand portfolio in the segment with brands such as Fortune, Fortune Plus, King’s Bullet etc., with Fortune rated no. 1 edible oil in India with 16.4% market share, as per Nielsen Report in 2011-12.AWL also exports its products to more than 19 countries across Middle-East, South East Asia ; East Africa. The company’s refined oils meet the AOCS, FAO &WHO standards and AWL has further applied for HACCP &ISO: 9001 certification.

AWL derives strength from the parentage of both AEL and Wilmar Group. AEL, on a standalone basis, has mainly coal trading, power trading and coal Mine Developer & Operator (MDO) businesses, whereas, Adani Group as a whole has evolved in to a diversified conglomerate and is engaged in various businesses across a range of sectors, primarily energy (including coal mining), power generation and transmission, port operations, logistics, oil and gas exploration and city gas distribution. The parentage of AEL provides the company with required financial flexibility for its business and technical/managerial resources owing to AEL’s vast experience in trading and logistics business across the country. The Singapore based Wilmar Group is one of the leading vertically integrated agri-business groups in Asia with business interests including palm plantations, edible oil crushing and refining facilities, manufacturing of sugar, speciality fats, oleo-chemicals, fertilizers as well as grain processing and storage facilities. It encompasses more than 500 manufacturing facilities and an extensive distribution network spread across the globe, aided by a sizeable fleet of vessels for logistics. Wilmar group has one of the largest palm plantations in the world and is the largest soya bean crusher in China. Wilmar group’s financial flexibility is further strengthened by its promoter, Kuok group, one of the largest corporate groups in Asia and strategic stake of Archer Daniels Midland Company (ADMC) group, one of the largest agro commodity companies in the world. The business of AWL has strong operational synergies with that of Wilmar Group, which provides it with global linkages for the procurement of raw materials. AWL imports a sizeable quantity of its total raw material purchase, drawing upon the expertise of the Wilmar Group in procurement as well as distribution of its products. Mr Kuok Khoon Hong, the Chairman of Wilmar Group is also the vice chairman of AWL.

AWL’s manufacturing facilities are located at the major procurement centers of its raw materials, i.e. seeds and crude edible oil, translating into lower logistics costs for procurement of materials and centralized storage facilities for crude as well as processed oil and other products. While the port based facilities of the company are engaged in refining of imported crude edible oil, mainly from Indonesia, Malaysia and others which are major exporters of crude edible oil, mainly palm; the inland facilities manufacture various oils like sesame, soya, sunflower, mustard, cotton seed, groundnut, coconut, etc. and are located in the centre of the respective cultivation/procurement region. Further, all the locations have dedicated storage facilities for crude as well as processed oils which enhance the company’s inventory holding capacity for optimum realisation of product prices.

The key details of the company are given below:
Company Adani Wilmar Limited
Constitution Public Limited Company
Group Adani Group
Date of Incorporation 22nd, January 1999
Registered Office ‘Fortune House’, Near Navrangpura Railway Crossing,
Ahmedabad – 380 009
Industry FMCG
CEO Mr. T. K. Kannan
Existing Business Edible oil and non edible oil products
The company is engaged in manufacturing of Edible Oil and associated products such as de-oiled cakes, vanaspati, specialty fats & oleo chemicals and trading of Non- Edible Oil. During FY17, AWL continued to maintain its market leadership position in edible oil segment in India. Over the years, the ‘Fortune’ brand of AWL has established leadership position in the branded edible oil segment. The company has a leadership position in soya bean oil and is amongst the leaders in palm oil, sunflower oil and rice bran oil. AWL has an established position in the domestic market for its products under various brands focussed on various market segments. Furthermore, the company has established a wide network of 4500 distributors, 95 stock points and presence at more than 10 lakh retail outlets. During FY17, branded sales contributed 58% of the company’s total sales. The product portfolio of AWL consists of a wide range of products including edible oil, non-edible oil, de-oiled cake (DOC), vanaspati, etc. In addition to its manufactured products, the company also trades in various agro-commodities like sugar, grains, pulses, etc. based on available opportunity. Furthermore, AWL has entered in to a joint venture with established regional players for production of various oils like castor oil, sunflower oil, etc. to take advantage of the manufacturing/sourcing expertise of these players. The diversified product portfolio of the company enables it to mitigate the agro-climatic risk associated with a single product or change in customer preferences due to sudden movement in finished product prices. The product mix of AWL’s products is given below:

Figure 1: Product Mix of Adani Wilmar Ltd

Figure 2: Chakki Fresh Atta

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4.2. Import Procedure
4.3.Export Procedure
4.4.Bill of Lading
4.5.Packing List
4.6.Commercial Invoice
4.7.Product Certificate
4.8.Phytosanitary Certificate
4.9.Fumigation Certificate
4.10.Certificate Of Origin
4.2. Import Procedure
4.3.Export Procedure
4.4.Bill of Lading
4.5.Packing List
4.6.Commercial Invoice
4.7.Product Certificate
4.8.Phytosanitary Certificate
4.9.Fumigation Certificate
4.10.Certificate Of Origin

International trades are exposed of Foreign exchange risks that arises due to the change in the exchange rates. Therefore, it is very important to have information about the updated exchange rates and factors determining these rates.

Export requires special documents depending upon the type of product and the location of the destination. It gives information about the contents of the package, the amount due to the buyer, quality of the product and helps in determining custom duties, tax amount.

Import’s Procedure:
Whenever company do trade or import goods from other other countries the captain of the ship gives bill of lading to our exporter and that exporter gives that bill of lading to its Bank. The importer issues a letter of credit to its bank which further pass on to the exporter’s bank. After confirmation of all the documents and matching of documents importer get it’s goods.

Figure 3: Import Procedure
For export we can’t say that it is totally opposite of import’s procedure. As AWL is a star exporter it can do transaction directly from its bank to the importer’s place but mostly it do transaction from it’s bank to importer’s bank. We mostly do export on Cash against documentations basis. Bank takes all the certificates like bill of lading, packing list, product certificate etc and after assuring all the certificates it gives cash to the exporter(AWL). The below figure shows the standard procedure of export…

Figure 4: Export Procedure
Bill of lading (B/L) is an important document that serves as a receipt of shipment when the cargo or goods are delivered at the desired location and it must be signed by the authorized persons such as the shipper, carrier and receiver.

Figure 5: Bill of Lading
A document which shows the information related to the contents of the shipment which is to be known by the transport agencies, government authorities and the customers.

Figure 6: Packing list
A commercial invoice is a document between the exporter and the importer that gives information related the goods and the amount that the importer is liable to pay and this document helps the customs in calculating the custom duties.

Figure 7: Commercial Invoice
Product certificate is a certificate that gives the assurance about the quality of the product and meets the qualification criteria as desired by the contract between the parties.

Figure 8: Weight and Quality Certificate
A Phytosanitary Certificate is a certificate that gives assurance about that the crop or plant in transactions between parties are free from the harmful pests and diseases.

Figure 9: Phytosanitary Certificate
Fumigation certificate is a certificate that is desired by a Buyer when wood materials are used to export goods. Fumigation is a way of killing the pests or any other harmful organisms. This becomes mandatory to keep away harmful pests entering an importer’s country.

Figure 10: Fumigation Certificate
A Certificate of origin is a document used in international trade that gives information about goods in an export shipment have been produced, manufactured or processed in a particular country.

Figure 11: Certificate of Origin
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5.1.What is Foreign Exchange
5.2.Need for Foreign Exchange
5.1.What is Foreign Exchange
5.2.Need for Foreign Exchange

The foreign exchange is the exchange of one currency for another or the conversion of one currency into another currency. Foreign exchange also refers to the global market where currencies are traded virtually around-the-clock. The term foreign exchange is usually abbreviated as “Forex” and occasionally as “FX”. The primary purpose of the Forex market is to provide the mechanism for making cross-border payments and determining exchange rates between currencies.

Let us consider a case where Indian company exports cotton fabrics to USA and invoices the goods in US dollar. The American importer will pay the amount in US dollar, as the same is his home currency. However, the Indian exporter requires rupees, its home currency, for procuring raw materials and for payment to the labor charges etc. Thus, it would need exchanging US dollar for rupee. If the Indian exporters invoice their goods in rupees, then importer in USA will get his dollar converted in rupee and pay the exporter.

From the above example we can infer that in case goods are bought or sold outside the country, exchange of currency is necessary.

Sometimes it also happens that the transactions between two countries will be settled in the currency of third country. In that case both the countries that are transacting will require converting their respective currencies in the currency of third country. For that also the foreign exchange is required.

6.1.What is Hedging?
6.2.Difference Between Over the Counter (OTC) and Exchange Traded Hedging Techniques
6.1.What is Hedging?
6.2.Difference Between Over the Counter (OTC) and Exchange Traded Hedging Techniques

A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related exposure, such as a futures contract.

Hedging is analogous to taking out an insurance policy. If you own a home in a flood-prone area, you will want to protect that asset from the risk of flooding – to hedge it, in other words – by taking out flood insurance. There is a risk-reward trade-off inherent in hedging; while it reduces potential risk, it also chips away at potential gains. Put simply, hedging isn’t free. In the case of the flood insurance policy, the monthly payments add up, and if the flood never comes, the policy holder receives no pay-out. Still, most people would choose to take that predictable, circumscribed loss rather than suddenly lose the roof over their head.

Hedging can be done through various techniques. Some of these are over the counter (OTC) and some are exchange traded.

Exchange traded hedging techniques: Futures and Options.

Over the Counter techniques: Forwards, Options and Swaps.

AWL’s profitability is exposed to sudden and sharp volatility in the prices of crude edible oil, which are in turn highly dependent upon various factors including cost of imports, agro-climatic conditions in the major cultivation regions as well as minimum support price (MSP) for various raw materials procured from the domestic market. At times, oil seed crushing operations become economically unviable due to higher oil seed prices in India compared to those available in the international markets. Additionally, as AWL imports around 80% of its raw material requirements, it is also exposed to the volatility in foreign exchange rate, mainly United States Dollars (USD). However, the management is taking steps to mitigate the forex risk to an extent by hedging 90-95% of its import payables. During FY17, the company incurred forex loss of Rs.109 crore (FY16 – forex loss of Rs.120 crore). Furthermore, agriculture being a priority sector for national governments, AWL is also exposed to adverse changes in regulatory and import/export duty structures based on actions of the government. The price of oil primarily palm and soya bean imported by India from the exporters like Indonesia and Malaysia (for palm) are affected by the frequent duty structure changes done by the respective national governments to protect their domestic industries. The price differential for carrying out edible oil refining operations in India depend upon the difference in duty between the export duty levied by the exporters on crude palm oil and refined palm oil and the import duty on the same by India. This duty differential should be large enough to absorb the variable costs of carrying out refining operations. As per the notification released by the Central Board of Excise and Customs (CBEC), the government raised the import duty on crude palm oil from 7.50% to 15% and increased the import duty on refined palm oil from 15% to 25%. Furthermore, the government also hiked import duty on crude soya bean oil to from 12.50% to 17.50%. With the hike in import duty, the duty differential between crude and refined palm oil imports now stands at 10% from 7.50% earlier which is expected to benefit the refiners in India. Although, the increase in import duty of crude soya bean oil is expected to increase the utilization of the crushing capacity of the company, it exposes the company higher working capital intensity. However, AWL’s management has articulated that it has a defined system for hedging of its commodity price exposure where in risk tolerance limit and stop loss limits are set for various commodities across different hierarchy in the company; the same has largely enabled the company to maintain its PBILDT margin within a narrow band. These limits are reviewed continuously based on the sensitivity analysis and stress testing. AWL also derives benefits from its association with Wilmar group which is the largest player of palm plantation in the world and largest soya and rape seed crusher in China. AWL has access to real time market information due to its association with Wilmar group which provides it with competitive edge in decision making. Furthermore, AWL has to continuously ensure that the various food products supplied by it comply with the laid down food safety and standards of The Food Safety and Standards Authority of India (FSSAI) for human consumption. Any laxity in this can have adverse impact on its brand image and market share. Nevertheless, automated and state of art facilities of AWL mitigate this risk to an extent.

Change in import duty:

Figure 12: Change in Import Duty
Over the Counter SecuritiesMany derivative instruments such as forwards, swaps and most exotic derivatives are traded OTC.

OTC securities are essentially unregulated
Dealers offer to take either a long or short position in options and then hedge that risk with transactions in other derivatives.

Buyer faces credit risk because there is no clearing house and no guarantee that the seller will perform
Buyers need to assess sellers’ credit risk and may need collateral to reduce that risk.

Price, exercise price, time to expiration, identification of the underlying, settlement or delivery terms, size of contract, etc. are customized
The two counterparties determine terms.

Exchange-Traded SecuritiesA security traded on a regulated exchange where the terms of each option are standardized by the exchange. The contract is standardized so that underlying asset, quantity, expiration date and strike price are known in advance. Over-the-counter securities are not traded on exchanges and allow for the customization of the terms of the contract.

All terms are standardized except price.

The exchange establishes expiration date and expiration prices as well as minimum price quotation unit.

The exchange also establishes whether the option is American or European, its contract size and whether settlement is in cash or in the underlying security.

The most active options are the ones that trade at the money, while deep-in-the-money and deep-out-of-the money options don’t trade very often.

Usually have short-term expirations (one to six months out in duration) with the exception of LEAPS, which expire years in the future.

Can be bought and sold with ease and holder decides whether or not to exercise. When options are in the money or at the money they are typically exercised.

Most have to deliver the underlying security.

Regulated at the federal level.

7.3.Difference Between Forwards and Futures

7.3.Difference Between Forwards and Futures

A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging. Unlike standard futures contracts, a forward contract can be customized to any commodity, amount and delivery date. A forward contract settlement can occur on a cash or delivery basis. Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk. As a result, forward contracts are not as easily available to the retail investor as futures contracts.

Consider the example given for transaction exposure. The exporter can reduce his risk by drawing a forward contract in this case which locks the exchange rate at 65. Thus, even if the exchange rate falls to 60 at the end of the contract, the exporter will still get INR 6,500,000 at the hedged exchange rate of 65. The downside is that if the exchange rate were to be 60 at the end of the contract, the exporter will lose out on profit as the exchange rate will still be 65.

Thus, to protect themselves from such volatile market changes, the importer and the exporter enter into a forward contract and fix the rate, quantity, quality, and the time of settlement of the contract. In short, they are hedging against the risk of exposure due to the volatile nature of the exchange rates.

A future contract is an agreement to buy or sell an asset on specified date in future for a specific price. They are traded only over organized exchanges. Investors use these futures contracts to hedge against foreign exchange risk. They can also be used to speculate and, by incurring a risk, attempt to profit from rising or falling exchange rates. Investors can close out the contract at any time prior to the contract’s delivery date. The International Monetary Market (IMM) was formed as a division on Chicago Mercantile Exchange in 1972 for futures trading in foreign currencies. Other future exchanges are the Philadelphia Board of Trade, New York, Board of Trade, London International Financial Future Exchange and Singapore International Monetary Exchange.

All futures are traded on organized exchanges. The markets are auction markets with a trading floor or pit. Bids and offers are made through an open outcry system that relies on hand signals and shouts. In an auction market any offer of trader must be to public. It must be made openly to all interested parties on a location on the exchange.

Corporate, banks and other institutions use currency futures for hedging purposes. In hedging with the currency futures, the traders make use of the market currency futures in order to hedge their foreign exchange risk. For example, a company in India imports goods from USA for consideration of USD 100,000. The importer needs to pay this amount after 2 months. So he will purchase USD in the future market which would lock in the price to be paid to the exporters in terms of USD at a future settlement date. By holding future contract, the importer does not have to worry about any changes in the spot rate of USD.

XYZ stock futures are traded in the market. The underlying is the shares of XYZ. Therefore, if XYZ shares were to go up in value, its stock futures will also appreciate. Similarly, a decline in XYZ shares pulls down the value of its stock futures.

The rate of interest that equates the cash price to the futures price is the cost of carry. The futures price is given by the formula FP = S X (1+r)^t
FP = Futures Price
S = Spot Price t = number of days
r = cost of carry
Suppose, cost of carry is 6%, and XYZ shares are trading at Rs. 4,000. Value of XYZ stock futures, maturing in 20 days, can be calculated as
Rs. 4,000 X (1+6%)^(20÷365)
i.e. Rs. 4,012.80 (rounded to nearest 5 paise)
(In practice, the cost of carry is calculated from the independently traded price of the share and the stock futures.)
If the share price were to increase, other things remaining the same, the stock futures will also appreciate, as would be evident from the formula.

In the same example, let us now suppose that XYZ is expected to give a dividend of Rs. 1 per share in 12 days.

An investor holding the underlying share will receive the dividend. But the holder of XYZ futures will not be entitled to the dividend. The Present Value of Dividend (PVD) therefore will need to be subtracted from the spot price.

PVD = Rs. 1 ÷ (1 + 6%)^(12/365)
= Rs. 0.998 FP = (S0 – PVD) X (1+r)^t = (4,000 – 0.998) X (1+6%)^(20÷365)
= Rs. 4,011.80 (rounded to nearest 5paise)
This calculated price is the “no arbitrage” price, where the investor is neutral between buying in the cash market and futures market. If XYZ futures are available in the market at a price lower than the “no arbitrage” price, then the investor would prefer to take the position with XYZ futures instead of the underlying XYZ shares.

As in the case of shares, the pay-off matrix can be prepared for investment strategies of going long or short on XYZ futures.

Thus, both cash market and futures market give the investor a similar profile of returns. Why should an investor opt for the futures market?
One reason was given earlier as part of the calculation of futures price. If the futures are trading below their theoretical price (given the cost of carry for the investor), then buying the futures is more sensible than buying the XYZ shares.

Another reason to favour futures is the leveraging it offers. On purchase of XYZ shares, the investor has to pay the entire price by the settlement date. However, in the futures market, the investor pays only a margin. Suppose the initial margin is 20%, then the investor needs to pay only 20% of the value of the position taken. For the same outflow as in the case of cash market, the investor can take a futures position that is 100 ÷20 i.e. 5 times.
In the normal course, companies leverage by borrowing money. In the case of futures, the leveraging is built into the product. So the investor does not need to go about mobilising debt to take the higher exposure.

A point to note is that apart from initial margin, there are also daily mark-to-market margins. Thus, if an investor is long or short on the futures, and the position is in profit on any day, the investor will receive mark to market margin. However, if the position is in a loss, then the investor will need to pay mark to market margins. Investors should consider their ability to pay mark to market margins before taking positions in the futures market.

The explanations given above for stock futures are equally applicable for index futures, interest rate futures and currency futures. However, in line with the difference in underlying, there are differences in the contract structure between different types of futures.

Forwards are like futures. The differences are as follows:
• Unlike futures, forwards are not traded in the stock exchange. This raises issues about liquidity, transparency of pricing, transactional convenience etc.

• In order to enable trading in the stock exchange, futures trade on the basis of standardized contracts. For example, all futures contracts are settled in the National Stock Exchange (NSE) on the last Thursday of the concerned month. Since forwards are OTC products, the parties can customize a contract structure that meets their mutual needs best.
• Since futures are traded in the stock exchange, transactions are guaranteed by the clearing house. Therefore, exposure of the investor is not to the party at the other end of the trade, but to the clearing house.
In the case of forwards, the investor is exposed to the counter-party risk. If the counterparty defaults, then courts will need to be approached to enforce one’s rights.

While investors can cover their foreign currency risks through currency futures, in many instances, forward contracts are used. Suppose, an exporter expects to receive USD1mn after 1 month. He wants to freeze his export receipts in rupees. He will enter into a forward contract with his banker to sell USD at, say, Rs. 60. If USD subsequently depreciates to a spot rate of Rs. 59, then his forward contract is profitable to the extent of Rs. 1. But if USD
appreciates to a spot rate of Rs.61, then the forward contract is a loss to the extent of Rs. 1. Thus, his position is one of being short on the USD.
An importer who needs to pay USD is in a reverse position. In order to freeze the rupee outflow, he will book a forward contract to receive USD i.e. he will go long on the USD.

Point to note is that the profit or loss in the payoff matrix refers to the forward contract in isolation. The exporter and importer have entered into the forward contract to hedge their position of USD receivable or payable. When the exporter receives the export proceeds in USD, these will be sold at a profit (if the USD appreciates and forward contract is in loss) or a loss (if the USD depreciates and forward contract is in profit). Thus, the overall currency impact will be neutral, for both exporter and importer. This is the purpose of the hedge.

Figure 13: Short and Long Forward Contract
Many companies, banks and governments have extensive experience in the use of forward exchange contracts. With a forward contract one can lock in an exchange rate for the future. There are a number of circumstances, however, where it may be desirable to have more flexibility than a forward provides. For example a computer manufacturer in California may have sales priced in U.S. dollars as well as in German marks in Europe. Depending on the relative strength of the two currencies, revenues may be realized in either German marks or dollars. In such a situation the use of forward or futures would be inappropriate: there’s no point in hedging something you might not have. What is called for is a foreign exchange option: the right, but not the obligation, to exchange currency at a predetermined rate.
A foreign exchange option is a contract for future delivery of a currency in exchange for another, where the holder of the option has the right to buy (or sell) the currency at an agreed price, the strike or exercise price, but is not required to do so. The right to buy is a call; the right to sell, a put. For such a right he pays a price called the option premium. The option seller receives the premium and is obliged to make (or take) delivery at the agreed-upon price if the buyer exercises his option. In some options, the instrument being delivered is the currency itself; in others, a futures contract on the currency. American options permit the holder to exercise at any time before the expiration date; European options, only on the expiration date.

The date on which an option contract matures or expires is known as the expiration date. It is the last day on which the option may be exercised. The time period between the contract date and the expiration date is the lifetime of an option.

Let us re-visit the earlier example of importer doing a 1-month forward contract for USD1mn at Rs. 60 =1USD.

Variation 1
Suppose the importer, instead of being obliged to buy the dollars (which was the case in the forward contract), had the right to buy the dollars – but he was not obliged to buy them. Thus, 1 month down the line, importer can choose, NOT to buy them. Such contracts are option contracts.

In this case, the importer, the buyer of USD, has the option (but the bank is committed. If the importer decided to buy the dollars, the bank is obliged to sell them at Rs. 60=1USD). Such contracts, where the party has the option to buy the underlying are called call options. In option terminology,
• Importer has bought the call option (to buy USD)
• The bank has sold (or written) the call option.

Variation 2
Suppose the exporter, instead of being obliged to sell the dollars (which was the case in the forward contract), had the right to sell the dollars – but he was not obliged to sell them. Thus, 1 month down the line, the exporter can choose, NOT to sell them. Such contracts are also option contracts.

In this case, the exporter, the seller of USD, has the option (but the bank is committed. If the exporter decided to sell the dollars, bank is obliged to buy them at Rs. 60 =1USD). Such contracts, where the party has the option to sell the underlying, are called put options. In option terminology,
• Exporter has bought the put option (to sell USD)
• The bank has sold (or written) the put option.

The party that buys an option (a call or a put) is said to have a long position; the party that sells (a call or a put) is said to have a short position.
It should be noted that:
• In the first two types of derivative contracts (forwards and futures), both the parties (buyer and seller) have an obligation i.e. the buyer needs to pay for the asset to the seller; and the seller needs to deliver the asset to the buyer on the agreed date (settlement date).
• In case of options, only the seller of the option (the option writer) is under an obligation and not the buyer of the option (the option purchaser).
? In a call option, the buyer of the option has the right to BUY the underlying
? In a put option, the buyer of the option has the right to SELL the underlying.

? In either case, the price at which the option can be exercised is called “exercise price”
The option buyer may or may not exercise his right. In case the buyer of the option does exercise his right, the seller of the option must fulfil whatever is his obligation (for a call option, the option-seller has to deliver the asset to the buyer of the option; for a put option the option-seller has to receive the asset from the buyer of the option).
In order to enter into such a contract, the option seller will expect to receive a compensation from the option buyer upfront. This is the option premium. It is an income for the seller and expense for the buyer, irrespective of whether or not the option is subsequently extinguished.

In the above cases, the option was to be exercised 1 month down the line i.e. on a specific date (settlement date, at the end of the contract period). Such options are known as European option contracts.
If in the above cases, the option buyer {Importer (in the case of Variation 1) or Exporter (in the case of Variation 2)} could exercise their option anytime up to the expiry of the contract period. This would be an American option contract.
The examples above were explained in the context of OTC options sold by the bank. Options are also traded in stock exchanges. Exchange-traded options have a standardized contract structure and are guaranteed by the clearing house. They offer the benefits of liquidity, pricing transparency, transaction convenience etc.

Since one party (seller of the call or put option) is committed, while the other party (buyer of the call or put option) has the option, the pay off profile is different as compared to forwards and futures.
• The maximum income for the seller is the option premium earned. However, if the market moves adversely (USD becomes stronger for call option or weaker for put option), then the losses increase.

• The maximum expense for the buyer is the option premium earned. However, if the market moves favorably (USD becomes stronger for call option or weaker for put option), then the profits increase.

• Since the USD can go up to any price, the maximum profit for the buyer of the call and maximum loss for the seller of the call is unlimited.

• Since the USD cannot go below zero, the maximum profit for the buyer of the put and maximum loss for the seller of the put are capped.

The payoff graphs are shown in Figures 2.4 (for call) and 2.5 (for put). Option premium is assumed to be Rs. 3. Breakeven point in the case of call option is at Exercise Price + Option Premium i.e. Rs. 63. In the case of putoption, it is at Exercise Price – Option Premium i.e. Rs. 57.

Payoffs in the case of direct exposures, futures and forwards are depicted as a straight line. Therefore, these products are said to have a symmetric payoff.

Payoffs in the case of options do not follow a straight line. So, options are said to have an asymmetric payoff.

In the case of futures, both buyer and seller are liable to pay margins to the stock exchange. However, in the case of options, only the option seller pays margins to the stock exchange. Payments for the option buyer are capped at the option premium (plus exercise price if option is exercised).

Figure 14: Long And Short Call

Figure 15: Long Put and Short Put
8. Financial Model
This thing also I have learnt in my internship period. Financial model helps to give us the summary of the financial performance of the company during the past and current year as well as helps us to estimate the future performance of the company based on the certain assumption like operating and financial assumptions. It helped me to forecast the future performance of the company.

It gave me the knowledge to analyze the trend of the company by comparing the ratios throughout the years.
It helps to raise loan/funds for the company as for raising funds the lender asks for certain projections and asks for the reason of the assumptions buyer has taken in making the financial statements of the company. Therefore, financial model tool helps the company in raising loans.

I have learnt a lot of new things in last 3 months in Adani Wilmar Limited, Ahmedabad. I got knowledge related to corporate finance. I have studied the financial statements of the company and it is a financial data I was not in a position to write anything about that data in my report as it is totally confidential.

Got to know about the working capital management of the company. How the company manages its capital (fund and non-fund based) for it’s day to day operations.

Then I got to know the import and export procedure of the company. How the company do the export on the Cash against document basis.

Then my mentor gave me brief about the hedging process and its techniques like options, forwards, futures. Then I studied these topics in depth.

And at the end I worked on the financial model which I believe will be very beneficial for me in near future.

So, in total this internship has helped me a lot to increase my knowledge base.