IAISON BETWEEN COMMODITY AND FINANCIAL FUTURES MARKET IN INDIA

Prof.T.Satyanarayana Chary, Associate Professor, Dept of Commerce, Telangana University, Nizambad, A.P. He can be reached at: tsnchary@gmail.com. Mr.Shaik. Masood, Asst Professor, Dept of Business Management, Alluri Institute of Management Sciences, Warangal, A.P. He can be reached at: masoodfru@gmail.com

ABSTRACT Derivative securities have penetrated as old wine in new bottle, even derivatives was started during the Mesopotamia civilization, but organised derivatives markets started three decades old in USA and very young at an age one decade old in Indian market. The derivatives market has been emerging as price risk management, price discovery, hedging, speculation and arbitrage. The emergence of the financial and commodity derives market within a couple year difference, both the market are correlate and played a pivotal role in risk management. The present paper examine the volatility of commodity, financial spot and future market with select indices performance S&P NIFTY, BSE SENSEX, and MCXSCOMDEX, INDEX using ARCH/GARCH models and multiple correlation techniques. KEY WORDS: Volatility, Price Risk, Arch/Garch, Volatility, Commodity Futures And Index. INTRODUCTION The price volatility factors the speed of price changes, the frequency of price changes and the magnitude of price changes performance of the market in contribution to the investors. The word derivative originates from mathematics and refers to a variable, which has been derived from another variable. Derivatives are so called because they have no value of their own. They derive their value from the value of some other asset, which is known as the underlying. Derivatives are a kind of contract between two counterparties to exchange payments linked to the prices of underlying assets. If the underlying asset of the derivative contract is coffee, wheat, pepper, cotton, gold, silver, precious stone or for that matter even weather, then the derivative is known as a commodity derivative. If the underlying is a financial asset like debt instruments, currency, share price index, equity shares, etc, the derivative is known as a financial derivative. Derivative contracts can be standardized and traded on the stock exchange. Such derivatives are called exchange-traded derivatives. Or they can be customized as per the needs of the user by negotiating with the other party involved. Such derivatives are called over-the-counter (OTC) derivatives. -1-

CONCEPT In any economy the prices of commodity and financial securities are penetrating with an expectation of growing the value of the security/asset, but the progress of transferring the securities in the market in between the investors like a game of win-loss, in mean process it is a common phenomenon that prices of commodities, metals, shares and currencies fluctuate over time. As market drive by invisible hands1 which are influence the adverse price changes will create a need to protect from this variation/risk in prices and timing of return from the market. Hence it is given scope to focus on risk management mechanism into the commodity and financial market, as we were aware commodity derivatives was emerged as price risk management and price discovery tool in ancestral days during the Mesopotamia civilization, the same concept of derivation was started using into the financial markets to protect the value of the underlying assets like individual securities, indices, metals, bullion and other commodities etc, REVIEW OF LITERATURE Kumar (1992) presents evidence to support market efficiency and finds in favor of futures prices as unbiased forecasters of crude oil prices. Moosa and Al-Loughani (1994) find evidence of a risk premium in crude oil futures markets and conclude that futures prices are not efficient forecasters of future spot prices. Elfakhani and Choudhury (1995). Antoniou and Holmes (1995) found that the introduction of stock index futures caused an increase in spot market volatility in the short run while there was no significant change in volatility in the long run. Vasilellis and Meade (1996) showthat the implied stock volatility from option prices is an efficient forecast for future volatility. Ghysels et al. (2006) also use higher-frequency data but propose a regression model using a beta weighting function to estimate and forecast volatility. Their model appears to be easier to parameterize and provides better forecasts against traditional ARCH/GARCH models. The IIMB study also finds that spot price volatility increased after introduction of futures in case of wheat and Urad. However, it does not find any major change in volatility for gram, excepting an abnormal rise in FY 2006-07, or for Tur and Sugar.

1 Adam Smith was explains in his book Wealth of Nations that the demand and supply forces are as invisible hands driven the market.

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An important finding of the IIMB study is that many contracts traded on Indian Commodity Exchanges do not satisfy a fairly minimal condition for these to be attractive for hedging by those holding physical commodities. NEED FOR THE STUDY After introduction of commodity derivatives market in India it give new dimension to the investor to investing as well as it used to a perfect substitute for financial markets for hedging and risk management, the issue of the impact of commodity trading on stock market volatility has received considerable attention during past few years. Although many factors contribute to stock market volatility, there is concern about the impact of Commodity trading on stock market volatility. OBJECTIVES OF THE STUDY The prime objective of the study is to examine the volatility of commodity and financial spot and future market, and the relation between commodity derivatives market and securities market study with performance MCXSCOMDEX SPOT, MCXSCOMDEX FUTURE INDEX and S&P NIFTY. DATA AND METHODOLOGY The data collected for the study from MCX commodity derivative MCXSCOMDEX SPOT, MCXSCOMDEX FUTURE INDEX and S&P NIFTY closing values from June 2005 to December 2012 of 90 monthly values taken for analysis. The tools are using for analysis descriptive statistics, co linearity, linear regression, Durbin-Watson models and multiple correlation techniques. ANALYSIS AND INTERPRETATION The analysis done by using the descriptive statistics of MCXSCOMDEX SPOT, MCXSCOMDEX FUTURE INDEX and S&P NIFTY are presented in table 1, it is observed from the analysis that mean value of sample is 0.9554, 1.008 and 1.087 of MCXCOMDEX Future Index, MCXSCOMDEX SPOT and S&P NIFTY respectively, volatility of commodity markets was less than securities market, the skewness shows negative distribution of returns in both the market. -3-

Table No 1 Computation of Mean, Std. Deviation, Skewness and Kurtosis

Std. Deviation Statistic 5.56612 5.67118 8.00676

Mean Std. Error

Skewness Statistic -.813 -1.524 -.735 Std. Error .254 .254 .254

Kurtosis Statistic 2.621 5.355 2.623 Std. Error .503 .503 .503

MCXFUTI NDER MCXSPOT R NSESPOT R Valid N

90 90 90 90

.9554 1.0024 1.0870

.58672 .59779 .84399

HYPOTHESIS H0 : There is positive relation between commodity (MCXSCOMDEX SPOT, MCXSCOMDEX FUTURE INDEX) and securities market (S&P NIFTY). Table 2 Test relationship between of commodity and securities Linear regression and Durbin-Watson
S&P NIFTY
MCXSCOMDEX SPOT & MCXSCOMDEX FUTURE

R2

Df1

Df2

DurbinWatson 1.972

Result

.096

87

Accepted

To test the relation between commodity market and securities market a linear regression model used, where in securities market indices (S&P NIFTY) used as dependent variable and commodity market index (MCXSCOMDEX SPOT, MCXSCOMDEX FUTURE INDEX) independent variable , the result from the above table infuse that coefficient of determination is 0.096 is positive it indicates the data is fit into the linear model, F value is 0.12 (which is above 0.05 significance level), whilst Durbin-Watson is above 1, which clarify there is positive relation between commodity and securities market and its impact is fact on independent variables, so the hypothesis is accepted. -4-

Table 3 Kendalls Correlations

MCXFUTINDER MCXFUTINDER MCXSPOTR NSESPOTR 1.000 .727 .141

MCXSPOTR .727 1.000 .066

NSESPOTR .141 .066 1.000

The Kendalls Tau-b statistics use to find the association and agreement between the variables, whether two variables may statistically dependent and it may not rely on any assumption of the distribution of variable, the test correlation value shows positive between commodity and securities market. CONCLUSION The analysis of the study it is concluded that the introduction of commodity markets emerged as one of the innovative instrument for investing and it is parallels to securities market, from the analysis it is also found that relation between commodity and securities market is positive and interdependence from the correlation is existed it means that investor using the both markets for investment and hedging purpose to protect from the macro economic issues.

REFERENCES 1. Dasgupta Basab (2004) Role of Commodity Futures Market in Spot Price Stabilization, Production and Inventory Decisions with Reference to India, Indian Economic Review, Vol. 39, No. 2, 2004. Fama, E. F., French, K., 2002, the equity premium, Journal of Finance 57, 637-659. FMC (2007) Market Review, Forward Markets Commission, www.fmc.gov.in. Gorton, G., Rouwenhorst, K., 2006. Facts and fantasies about commodity futures, Financial Analysts Journal 62, 4, 86-93. Government of India, Ministry of Civil Supplies (1980): Report of the Committee on Forward Markets, (Chairman: A M Khusro), Delhi. -5-

2. 3. 4. 5.

6. 7. 8.

Hedrick, Robert, and Edward C. Prescott (1997), Postwar U.S. Business Cycles: An Empirical Investigation, Journal of Money, Credit, and Banking. Kabra Kamal Nayan (2007) Commodity Futures in India, Economic and Political Weekly, Vol , No , pp 1163-1170. Kamara, A. (1982), Issues in Futures Markets: A Survey, Journal of Futures Markets, Vol. 2, pp. 26194.

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GROWTH OF COMMODITY DERIVATIVES IN INDIAN MARKET AN EMPERICAL ANALYSIS

1

Prof.G.Sitamber Swamy, Professor and Head Dept of Business Management, Alluri Institute of Management Sciences, Warangal, A.P. K.Damodhar, MBA II year Student of AIMS Warangal. He can be reached on email: damodhar.kolaria@gmail.com N.Rajani, MBA II year Student of AIMS Warangal. she can be reached on email: nagularajini.priya@gmail.com

ABSTRACT: Derivatives are instruments whose value is derived from the value of one or more basic variables called bases in contractual manner. The commodity derivative markets are emerging as price risk management and price discovery mechanism tools. Hence it play a key role in growth of economy and stabilizing the volatility in the commodities and even financial markets, The modern commodity markets have their roots in the trading of agricultural products. Now scope of commodities market has broaden which includes agriculture and non agricultural commodities. The development of commodity market has positive impact on any economy. Commodity derivatives are the best hedging tools for price risk management. This paper is a modest attempt to analyze the growth of commodity market and comparison with equity market, find out the impact of commodity market on economy by using econometric techniques. KEY WORDS: Forward, future, option, spot, derivatives, commodity. INTRODUCTION The term commodity refers to any material which can be bought and sold. A commodity in a markets context refers to any movable property other than actionable claims, money and securities. Over the years commodities markets have been experiencing tremendous progress, which is evident from the fact that the trade in this segment is standing as the boon for the global economy today. Trading on derivatives first started to protect farmers from the risk of their values against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products the farmers can transfer their risk (i.e. fully or partially) by locking the price of their products. This was developed to reduce the risk of the farmers. -7-

THE NEED FOR COMMODITY DERIVATIVES India being an agricultural economy is among the top-5 producers of most of the commodities, in addition to being a major consumer of bullion and energy products. Agriculture contributes about 22% to the GDP of the Indian economy. It employees around 57% of the labor force on a total of 163 million hectares of land. Agriculture sector is an important factor in achieving a GDP growth of 8-10%. All this indicates that India can be promoted as a major center for trading of commodity derivatives. It is unfortunate that the policies of FMC during the most of 1950s to 1980s suppressed the very markets it was supposed to encourage and nurture to grow with times. It was a mistake other emerging economies of the world would want to avoid. However, it is not in India alone that derivatives were suspected of creating too much speculation that would be to the detriment of the healthy growth of the markets and the farmers. Such suspicions might normally arise due to a misunderstanding of the characteristics and role of derivative product. It is important to understand why commodity derivatives are required and the role they can play in risk management. It is common knowledge that prices of commodities, metals, shares and currencies fluctuate over time. The possibility of adverse price changes in future creates risk for businesses. Derivatives are used to reduce or eliminate price risk arising from unforeseen price changes. A derivative is a financial contract whose price depends on, or is derived from, the price of another asset. OBJECTIVE OF THE STUDY To study the growth of commodity derivatives market, its relation with financial markets. COMMODITY TRADING IN INDIA The history of organized commodity derivatives in India goes back to the nineteenth century when the Cotton Trade Association started futures trading in 1875, barely about a decade after the commodity derivatives started in Chicago. Over time the derivatives market developed in several other commodities in India. Following cotton, derivatives trading started in oilseeds in Bombay (1900), raw jute and jute goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in Bombay (1920). However, many feared that derivatives lead to unnecessary speculation in essential commodities, and were harmful to the healthy functioning of the markets for the underlying commodities, and also to the farmers. With a view to restricting speculative activity in cotton market, the Government of Bombay prohibited options business in cotton in 1939. Later in 1943, forward trading was prohibited in oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar And cloth. After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952 which Regulated forward contracts in commodities all over India. -8-

Until 2002 commodity derivatives market was virtually non-existent, except some negligible activity on an OTC basis. In September 2005, the country now has 4 national level electronic exchanges and 21 regional exchanges for trading commodity derivatives as about 95commodities have been allowed for derivatives trading. The value of trading has been booming and is likely to touch $5 Trillion in a few years. the Parliament passed Forward Contracts (Regulation) Act, 1952 which regulated forward contracts in commodities all over India. The Act applies to goods, which are defined as any movable property other than security, currency and actionable claims. The Act prohibited options trading in goods along with cash settlements of forward trades, rendering a crushing blow to the commodity derivatives market. Under the Act, only those associations/exchanges, which are granted recognition by the Government, are allowed to organize forward trading in regulated commodities. The Act envisages three-tier regulation: (i) The Exchange which organizes forward trading in commodities can regulate trading on a day-to-day basis;

(ii) the Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government,and (iii) the Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs GOVERNMENT POLICY Indian economy embarked upon the process of liberalization in 1991, the Government set up a Committee in 1993 to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodity groups. It also recommended strengthening of the Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularly allowing options trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures trading were permitted in all recommended commodities. Commodity futures trading in India remained in a state of hibernation for nearly four decades, mainly due to doubts about the benefits of derivatives. Finally a realization that derivatives do perform a role in risk management led the government to change its stance. The policy changes favoring commodity derivatives were also facilitated by the enhanced role assigned to free market forces under the new liberalization policy of the Government. Indeed, it was a timely decision too, since internationally the commodity cycle is on the upswing and the next decade is being touted as the decade of commodities. To make up for the loss of growth and development during the four decades of restrictive government policies, FMC and the Government encouraged setting up of the commodity exchanges using the most modern systems and practices in the world. Some of -9-

the main regulatory measures imposed by the FMC include daily mark to market system of margins, creation of trade guarantee fund, back-office computerization for the existing single commodity Exchanges, online trading for the new Exchanges, demutualization for the new Exchanges, and one-third representation of independent Directors on the Boards of existing Exchanges etc. Responding positively to the favourable policy changes, several Nationwide Multi-Commodity Exchanges (NMCE) have been set up since 2002, using modern practices such as electronic trading and clearing. The national exchanges operating in the Indian commodity futures market are the Multi-Commodity Exchange of India (MCX), National Commodity and Derivative Exchange of India (NCDEX) and National Multi Commodity Exchange of India (NMCE). Recently, one new national exchange has been given permission to start and another regional exchange has been permitted to upgrade to a national exchange. In line with its modern financial infrastructure, India is one of the few countries worldwide to have commodities delivery in electronic (dematerialised) form. Selected Information about the two most important commodity exchanges in India [MultiCommodity Exchange of India Limited (MCX), and National Multi-Commodity & Derivatives Exchange of India Limited DATA ANALYSIS Table 1 Analysis of growth rate of commodity derivates market in India
Traded Contracts (in Lots) 20349975 45635534 68945925 94310537 161173737 197206801 346192367 388751074 Growth Rate(%) ---124.25 51.07 36.78 70.89 22.35 75.54 12.29 Value (Rs. In Lakhs) 62357456.06 202566482.5 272982099.2 428465316.2 595665592.9 869686959.6 1493285202 1489059633 Growth Rate(%) ---224.84 34.76 56.95 39.02 46.00 71.70 -0.28

Year 2005 2006 2007 2008 2009 2010 2011 2012

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It can be analysed from the table 1, there is a high growth rate in 2005-2006 in trade contracts and trade value and it is declined to 51.079 percent in trade contract and 34.76 percent in trade value. Again in 2008 the trade contract is declined to 36.78 percent and trade value to 56.95 percent. In 2009 the trade contract has been raised to 70.89 percent and the trade value is declined to 39.02 percent, and in 2010 there was a great decline in trade contract from 70.89 percent to 22.35 percent and the trade value has been increased to 46 percent. In 2011, the trade contract has grown highly to 75.54 percent and the trade value also increased to 71.7 percent. Again in 2012, the contract has been declined to 12 percent and the value for the trade was in negative position i.e. -0.2829 percent. Table 2 Correlation of Capital Market, Equity with Derivatives In Terms of Trading Volume
Capital M arket Equity Futures (a) & Options (b)
1,945,287 7,3 56,242

Year

W holesale Debt M arket

Currency F& O *

Total
9,5 20,635

Trade V alue (c) 272982099.2 428465316.2 595665592.9 869686959.6 1493285202 1489059633

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 Correlation B/w a and c a and b

2 19,106 --

3,551,038 2,752,023 4,138,024 3,577,412 2,810,893

13,090,478 11,010,482 17,663,665 29,248,221 31,349,732 0.342432432 0.982839027

16,9 23,833 282,317 -335,952 162,272 14,2 60,729 563,816 1,782,608 24,1 48,113 559,447 3,449,788 36,8 34,868 633,179 4,674,990 39,4 68,794

The trade value is maintaining the positive co-relation with both Capital market and Equity Futures and Options. When the increase is occur in Trade value there is the both Capital market and Equity Futures and Options also increase. CONCLUSION It can be concluded from the analysis that after lifting the ban on commodity trading first year of trading in 2005 to 2006 it was twofold effect shown in growth of trading in terms of value and one fold effect in transaction in trading quantity, later it was decreased but nearly forty to fifty percent compounded growth maintaining except in 2012, the correlation between capital market to commodity derivatives market shown a positive, hence it may conclude introduction of commodity trading one of the components to risk management and fuel to growth of Indian economy. - 11 -

REFERENCES 1. 2. 3. 4. 5. 6. 7. S.L.Gupta J.r.Varma John.c.hull Sankarshan basu www.nseindia.com, www.mcxindia.com, www.rbi.org

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THE HEDGING SCENARIO IN MICRO SMALL AND MEDIUM ENTERPRISES (MSMES) (With respect to the change in RBI guidelines as on 15 December 2011)
1

Dr. Laila Memdani, Faculty Member, IBS Hyderabad, lailamemdani25@gmail.com, lailam@ibsindia.org Karthik Athelli, Student, IBS Hyderabad

ABSTRACT In the world of Globalization where more and more firms are entering the international markets, they are being continuously exposed to foreign exchange rate volatility. Consequently, they are getting more inclined towards financial derivatives for effective foreign exchange risk management. This study aims to analyse the management of the foreign exchange risk by the small and medium enterprises by availing the currency hedging strategies. As the currency derivatives market is still at a nascent stage in India, the use of hedging strategies is a new concept for the firms. Information has been obtained by conducting primary research on the SMEs to determine the usage of the currency hedging strategies and the impact of the latest RBI guidelines (as on December 11. 2011). It has been fount through the study that majority of the firms have been dealing in the foreign exchange market for more than 5 years with Forty percent of them having less than twenty five percent of the business outside India. The Sixty three percent of the SMEs have more than ten Forex transactions in a year. It is surprising that only 11 out of 50 SMEs hedge the Foreign Exchange risk through Currency Forward Contracts. The primary reasons for the low percentage of hedging is due to the lack of awareness about existence the hedging tools, the conservative approach of the SMEs and the uncertainty of currency market. KEY WORDS: Hedging, MSME Sector, Currency exposure. INTRODUCTION In the world of Globalization where more and more firms are entering the international markets, they are being continuously exposed to foreign exchange rate volatility. Consequently, they are getting more inclined towards financial derivatives for effective foreign exchange risk management. This study aims to analyse the management of the foreign exchange risk by the small and medium enterprises by availing the currency hedging strategies. As the currency derivatives market is still at a nascent stage in India, the use of hedging strategies - 13 -

is a new concept for the firms. Information has been obtained by conducting primary research on the SMEs to determine the usage of the currency hedging strategies and the impact of the latest RBI guidelines (as on December 11. 2011). The RBI guidelines W.R.T. notification as on December 15th , 2011, titled Risk Management and Inter-bank dealings on the foreign exchange transactions of SMEs, focuses on the following points:1. 2. Forward contracts booked by residents irrespective of the type and tenor of the underlying exposure, once cancelled, cannot be rebooked. For Importers, 25 % of the average of the previous three financial years (April to March) actual import/export turnover or the previous years actual import/export turnover, whichever is higher. In case of importers who have already utilised in excess of the revised / reduced limit, no further bookings may be allowed under this facility. b. 3. 4. All forward contracts booked will be on fully deliverable basis. In case of cancellations, exchange gain, if any, should not be passed on to the customer.

All cash/tom/spot transactions by the Authorised Dealers on behalf of clients will be undertaken for actual remittances/delivery only and cannot be cancelled / cash settled. Forward contracts booked by the FIIs, once cancelled, cannot be rebooked. However, be rolled over on or before maturity.

LITERATURE REVIEW According to Jorion (1990), Exchange rates are a major source of uncertainty for companies around the world, which characteristically four times the interest rates and ten times the inflation in terms of volatility. No single firm can avert the impact of international economic changes and foreign exchange rate fluctuations; foreign exchange risk management is of utmost importance for companies dealing in international trade. Managers have to deal with currency rate exposures efficiently and effectively, to mitigate the losses, to prove their executive abilities and flexibilities. Thus, exchange risk management with the use of hedging strategies such as investing in derivative instruments are being used by firms all over the world, to reduce the volatility in return earnings (Froot et al, 1993). Currency exposure has come under the spotlight, in India, as companies were exposed to global competition. The gradual liberalization of Indian economy has resulted in substantial inflow of foreign capital into India (Gambhir and Goel). The demolishment of trade barriers and adoption of Open Door Policy has integrated the Indian economy with the world economy. Indian companies are entering the international markets; an active and rapidly expanding liquid forex derivative market has evolved providing a large range of hedging instruments for effective management of foreign exchange risks. - 14 -

V D M V Lakshmi (2008, Cited in Dr. Devandra Singh 2011) cited the decision taken by RBI to allow exchange traded currency future in India as a gift to traders and investors as it is a standardized and transparent instrument to hedge their currency risk. The author provided an insight on how the currency future can be used by market participants to cover the exchange rate risk in currency market along with the legal framework and sanction approval procedure from the authorized agencies. Nirvikar Singh (2008, Cited in Dr. Devandra Singh 2011) stated that off-shore nondeliverable forward markets have existed in India while the exchange traded currency futures were banned. However, in June 2007, trading of rupee future started on Dubai Gold and Commodities Exchange prompting the RBI to set up a Committee to look into this possibility for India. During 2007 rupee future trading on DGEX was not controlled by the RBI, showcasing that the new market was being used for short-term hedging, probably by parties engaged in international trade. He concluded with statement that the RBI policies need to be from the macroeconomic perspective for the growth of the financial sector in India. Krishnan Sitaraman and Satish Prabhu (2010, Cited in Dr. Devandra Singh 2011) showed the procedure to mitigate exchange Rate risk through illustrations. They showed the progress and development in the currency futures in India. The introduction of the currency options in the market was suggested the authors. Padmalatha Suresh (2008, Cited in Dr. Devandra Singh 2011) stated that the currency future has helped the undernourished Indian financial markets by explaining how the exchange traded futures are the answer to prevent systematic risks in the future. The RBI decision to extend the currency futures market to include three more currency pairs and the introduction of currency options in the future, as natural extension at the currency future market, was lauded by the author. The author analysed the performance of currency futures and provided insights on OTC markets and currency futures ( INR/USD) traded on NSE and MCX showed a remarkable increase in the turnover of derivatives as a percentage of OTC forward turnover. The paper also cited some reasons for inefficient and illiquid market in India such as inadequacy of financial firms, Regulators and structured barriers, Frictions caused by taxes and suggested that currency futures are not an end in themselves but more positive actions from the regulators and government are expected to nourish the market. OBJECTIVES

To find the Hedging opportunities to minimise the foreign exchange risk of the MSMEs. To study the impact of the change in RBI guidelines on the MSME sector - 15 -

METHODOLOGY A sample survey of twenty five exporters and twenty five importers (total of fifty SMEs) from the state of Andhra Pradesh will be done with the help of a structured questionnaire to find out whether SMEs are availing the opportunities of hedging or not and the impact of RBI guidelines on them. RESULTS AND FINDINGS Twenty five responses for each (Importers and Exporters) were collected through personal Interviews with the SMEs. The Industries and the products the SMEs interviewed deal in are shown in the Table below: Table 1 List of Industries to which the SMEs belong to and the Products dealt in the Forex.
Industry Agriculture and food products Engineering Software technology Textiles Power Explosives Pharmaceuticals Glass Chemicals Tyers and Tubes Sanitary Electronic Paint Crops and Seeds Telecom Products Sugar, Sugarcane. Vermicelli, Masalas, Namkeens, Sweets Tramway and railway locomotives, rolling stock, Engineering Parts, Castings spares, Software developments Saris and cloth material Silicon rubber Explosives and Explosive Accessories Medical Equipments, Reagents, Accessories, Spares & Re-Usuable Reading Glasses Sulphur, Ammonia, Urea, Rock Tyres and Tubes, Spares Sanitary ware Electronic Products Paints and chemicals Seed and Crop technology Telecom servicea 1 1 1 1 1 1 1 No of Importers 5 5 3 1 1 1 3 No of Exporters 4 4 4 2 1 1 1 1 2 1 1 1 1

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The profile of the SMEs dealing in the foreign exchange market is shown in the following charts:

Fig. 1 The experience of the export firms dealing in the foreign exchange market.

Fig. 2 The experience of the Import firms dealing in the foreign exchange market.

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Fig 3 Percentage of exports out of the total Sales of the company

Fig 4 Percentage of imports out of the total Purchases of the company

THE FINDINGS OF THE RESEARCH Eighty one percent of the firms have been dealing in the foreign exchange market for more than 5 years. Forty percent of the total firms have less than 25% of their business outside India. The value of the exports and Imports ranges from Rs 40 Lakhs to Rs 13.56 Crores and sixty three percent of the firms have more 10 foreign exchange transactions per year, out of which Twenty four percent of the firms have more than 50 transactions and business and Thirty nine percent of the firms have 10-50 transactions in a year. CURRENT HEDGING SCENARIO OF THE MSMEs It has been found through the interview that only 11 out of 50 companies hedge for the Foreign Exchange risk. All the 11 companies (out of 50) use Currency Forward Strategy to hedge the entire transaction amount against the Foreign Exchange risk The primary reasons for the companies not hedging are: a. b. c. d. e. Lack of awareness about hedging. Companys conservative approach. Chance of losing extra profits during favorable market conditions. The percentage of Forex dealings are significantly low compared to the total business of the company. The additional costs of hedging to be incurred by the company. - 18 -

25 20 15 10 5 0 E xporters Importers NO Y es

IMPACT OF RBI GUIDELINES ON THE MSMES All 11 companies hedging though currency forwards have stated that the latest RBI guidelines have impacted up to 50 % of their business. Majority of the companies have opined that they would seldom or never hedge an anticipated foreign exchange transaction in current conditions. The primary reasons for the negative impact given by the respondents are a. b. c. Reduction in the hedging limits for the Importers. Reduction in hedging anticipated contracts. Reduction in speculation in the foreign exchange market.

Fig.6 Impact of latest RBI Guidelines on the Exporters

Fig.7 Impact of latest RBI Guidelines on the Importers

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Importers F requently S eldom E x porters 0% 20% 40% 60% 80% 100% Never

Fig.8 Willingness of the company to hedge anticipated foreign exchange transactions QUICK FACTS PRICE DETERMINATION FOR : EXPORTERS Regarding price determination twenty four out of twenty five exporters Bill the customers in the foreign currency. Nineteen companies set the price by multiplying the rupee selling price by the foreign currency spot rate when the sale is made. Six companies set the price by multiplying rupee selling price by the foreign currency forward rate when the payment date is due. The reason for the single company to bill in the Indian currency is presence of a Subsidiary company of the customer in India and the price is set by calculating the costs/ prices in the local currency IMPORTERS All the importers are billed by t he foreign suppliers in the foreign currency. FUTURE PROSPECTS FOR HEDGING The companies where provided with the insight about hedging strategies after which the following was the response on the willingness to hedge the foreign exchange risk: - 20 -

20 15 10 5 0 E x porters Importers May be No Y es

Fig. 9 Willingness of the SMEs to hedge the foreign exchange risk. It is clear from the diagram that the number of companies willing to hedge is very less. Large number of companies have responded in negative for the willingness to hedge and still many companies have said that they my hedge or are not sure. CONCLUSION Majority of the firms have been dealing in the foreign exchange market for more than 5 years with Forty percent of them having less than twenty five percent of the business outside India. The Sixty three percent of the SMEs have more than ten Forex transactions in a year. It is surprising that only 11 out of 50 SMEs hedge the Foreign Exchange risk through Currency Forward Contracts. The primary reasons for the low percentage of hedging is due to the lack of awareness about existence the hedging tools, the conservative approach of the SMEs and the uncertainty of currency market. The SMEs hedging in the forwards contracts pointed out the there up to fifty percent reduction in the hedging activities due to the latest RBI guidelines as on December 15th, 2011. They further opined that they would seldom or never hedge for an anticipated foreign exchange transaction beyond their regular contractual obligations.

REFERENCES: 1. Dr.Devendra Singh, Dr. Gaurav Aggarwal, Ms. Satinder Kaur Professor(August 2011), role of currency potential in Indian capital market Journal of Applied Management & Computer Science Volume 3. Available on http://cbsmohali.org/wp-content/ downloads/n4e685095adc32.pdf FAPCCI Import and Export Directory http://rbidocs.rbi.org.in/rdocs/notification/ PDFs/EAP58151211FL.pdf - 21 -

2.

3. 4. 5. 6. 7.

John C. Hull (2006) Options, Futures, and Other Derivatives (6th edition ed.). Upper Saddle River, NJ: Prentice-Hall. Nirvikar Singh Currency future Trading in India Roubini Global Economics, Aug. 2008 Padmalatha Suresh Currency Futures: Heralding a New Dawn The Analyst, March, 2010 Philippe Jorion (Jul., 1990), The Exchange-Rate Exposure of U.S. Multinationals The Journal of Business Vol. 63, No. 3 pp. 331-345 Salil Talwar (September 2006), Currency hedging strategies are beneficial to firms: a study on the developing industries in India, University of Nottingham. Available on http://edissertations.nottingham.ac.uk/723/1/06MAlixst14.pdf

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THE CURRENCY FUTUES TRADING IN INDIA

1

Repalli. Vinod, Assistant Professor, Department of Business Management, Swarna Bharathi Institute of Science &Technology (SBIT), Khammam, vinodethopia@gmail.com mobile: 8374575452.

ABSTRACT The capital market has come to realize that liberalization had led the country to an ecstatic phase of development. The development and emergence of the vibrant capital market has contributed to the expansion of opportunities. In India the capital market has emerged as a major contributor to the growth of foreign exchange reserves of the country. In fact, in the emerging world market, India has crossed several developing countries. Financial intermediaries overseas have created new verities of instruments and transactions called derivatives and risk management tools such as options, futures and swaps which are used to transform one or more properties of an asset or liability. These are reflecting the price moment of an underlying security. KEY WORDS: Currency Futures, Derivatives, SEBI INTRODUCTION Never keep all your eggs in one basket - Financial markets are a classic example of this proverb. These markets all around the world in all categories and at all points of time have taught us to keep our investments diversified into various instruments. Currency derivative is a contract between the seller and buyer, whose value is to be derived from the underlying asset, the currency amount. A derivative based on currency exchange rates is a future contract which stipulates the rate at which a given currency can be exchanged for another currency as at a future date. A currency future, also FX future or foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date. It is a transferable futures contract that specifies the price at which a specified currency can be bought or sold at a future date. Typically, one of the currencies is the US Dollar. The price of a future is then in terms of US dollars per unit of other currency. This can be different from the standard way of quoting in the spot foreign exchange markets. The trade unit of each contract is then a certain amount of other currency, for instance . 125,000. Most contracts have physical delivery, so far those held at the end of the last trading day, actual payments are made in each currency. However, most contracts - 23 -

are closed out before that. Investors can by closing out before that. Investor can close out the close out the contract at any time prior to the contracts delivery date. Thus, we can say that currency future are futures market where the underlying commodity is a currency exchange rate, such as the Euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency future are essentially the same as all other futures markets (index and commodity futures markets), and are traded in exactly the same way. Futures based upon currencies are similar to the actual currency market (often known as Forex), but there are some significant difference. For example, currency futures are trade via exchanges, such as the CME (Chicago Mercantile Exchange), but the currency markets are traded via currency brokers, and are therefore not as controlled as the currency futures. Some day, trades prefer the currency futures are recommended as they do not suffer from some of the problems. That currency markets suffer from, such as currency brokers trading against their clients, and non centralized pricing. More than five decades of Indian economic planning and subsequent liberalization had led the country to an ecstatic phase of development. The development though disintermediation deregulation globalization and emergence of the vibrant capital market has contributed to the expansion of opportunities. As a result capital market has emerged as a major contributor to the growth of foreign exchange reserves of the country in fact in the emerging world market Indian has beaten several developing countries. In the post liberalization era, the finance sector has witnessed a complete metamorphosis. The global forex market is the largest market in the world with over $4 trillion traded daily, according to Bank for International Settlements (BIS) data. The forex market, however, is not the only way for investors and traders to participate in foreign exchange. While not nearly as large as the forex market, the currency futures market has a respectable daily average closer to $100 billion. Currency futures - futures contracts where the underlying commodity is a currency exchange rate - provide access to the foreign exchange market in an environment that is similar to other futures contracts. Figure 1 shows a price chart of one of the many currency futures contracts. Financial intermediaries abroad have created new varieties of instruments and transactions called derivatives and risk management tools such as options futures and swaps which are used to transform one or more properties of as asset or liability. Financial liberalization has brought inherent risk and as a result, corporate and institutional investors are looking toward derivatives for hedging the risk since the volume of international trade and capital flows are rising more and more and more banks to bring variations in the sensitivity of their funds also the underlying portfolio. - 24 -

A future trading is the most important and popular financial instrument under derivative through which the trading are done in the capital market. Thus before going in depth regarding Currency futures it is necessary to explain with derivatives are. What financial instrument =s are included in derivatives? And they are activated and executed in day to day trading by the players of the capital market? Most of us do hear these terms but are not so familiar with their exact meaning. WHAT ARE DERIVATIVES? Derivatives are financial instruments whose value is based on the market value of an underlying asset such as stocks bonds or a commodity. In other words derivatives are financial contracts that derive their values from other underlying instruments for, example currencies securities, indexes. They are instruments providing exposure to all or part of the reference instrument. Derivatives are used as risk management tools by governments and corporations to reduce exposure to risk mainly related to fluctuations in foreign exchange and interest rates. Derivative instruments include swaps, options, and futures and forward counteract and are used by banks in two principal activities: sales/trading and asset/liability management Thus we can say that derivatives are index futures and options that reflect the price movement of an underlying security, but are trading separately from the cash market. As already mentioned derivative instruments include options swaps and futures .Options can be either call Options and Put Option. Futures include speculation and Hedging and Swaps consist of buying and selling of forging currency by the banks. The following chart shows the various instruments that are options futures and swaps which come under derivatives and their sub-classifications.

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OPTIONS An Option is the right but not the obligations to buy or sell something on a specified date at a specified price. In the securities market an options is a contract between to buy or sell specified number of shares at a later date on a specified price. Options are basically or currencies. Three parties are involves. There parties are involved in the option trading, the option seller or writer who grants someone else the option to buy or sell and receives a premium on its price the option buyer who pays a price to the option writer to induce him to write the option and the broker who acts as an agent to find the option buyer and the seller, and receives a commission or fee for it. An option contract gives the holder the right to buy or sell the underlying stock at a price on future date. This price is referred to as strike price. Depending on whether the holder is a buyer or seller, the options are termed put and call. A call option conveys the right of the holder to buy a specified quantity of stock while a put option conveys the right of the holder to sell. The buyer or the holder gets the right as laid down in the option. While the writer has the obligation to honour the terms when the option is exercised. Option trading has a good market in India since there is enough scope for specification. FUTURES A future is a financial contract which derives its value from the underlying assets. It is a contract specifying a future date of delivery or receipt of a certain amount of a specific tangible or intangible product. The commodities traded in futures markets include stock index futures; agricultural products like wheat, soybeans and pork bellies; metals; and financial instruments. Futures are legally binding standardized agreements to busy or sell a commodity, currency or security at a fixed time in the future, at a price upon today. It is an exchange traded contract that confers an obligation to buy or sell a physical or financial commodity at a specified price and amount on a future date. Futures are essentially a series of forward contract, two parties agree to buy or sell some underlying asset on some future date at a stated price and quantity. The forward contact involves no money/transaction at the time of signing the deal. But the forward market has problem of lack of centralization of trading, liquidity and counterparty risk. Futures markets are designed to solve the problems of trading liquidity and counterparty risk. Basically futures markets resemble the forward market but they ensure standardized contracts, centralized trading and settlement through clearing houses to avoid counterparty risk. A future contract also differs from an option contract in the sense that is gives the holder the obligation to buy or sell, whereas an option contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract, but both parties of a future contract must fulfill the contract on the settlement - 26 -

date. The seller delivers the underlies to the buyer, or, if it is a cash-settled futures, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to officer his/her position by either selling a long position or by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations. Futures contracts, or simply, future, are exchange derivatives. The exchanges clearinghouse acts as counterparty on all contracts, sets margin requirements, and crucially also provides a mechanism for settlement. There are two types of people who deal in futures- speculator and hedgers Speculators buy and sell futures for the sole purpose of making profits by selling them at a price that is higher than their buying price. Such people neither produce nor use the asset in the ordinary course of business, in contract, hedgers buy and sell futures to offset an otherwise risky position in the spot market. In the ordinary course of business, they either produce or use the asset. Typically include producers and consumers of a commodity. For example, in traditional commodity. Market, farmers often sell future contracts for the crops and livestock they produce to guarantee a certain price. Making it easier for them to plan. Similarly livestock producers often purchase futures to cover their feed costs, so that they can plan on a fixed for feed. Almost the same is there in the financial markets as well. SWAPS A swap deal is a transaction in which the bank buys and sells the specified foreign currency simultaneously for different maturity dates which should help banks to eliminate exposure risk. It can also be used as a tool to enter arbitrary operations that led the economy to be fully opened up. HISTORY Currency futures were first created at the Chicago Mercantile Exchange (CME) in 1972, less than one year after the system of fixed exchange rates was abandoned with the gold standard. Some commodity traders at the CME did not have access to the inter-bank exchange markets in the early 1970s, when they believed that significant changes were about to take place in the currency market. They established the International Monetary market (MM) and launched trading in seven currency futures on May 16, 1972. Today, the IMM is a division of CME. In the second quarter of 2005, averages of 332,000 contrasts with a notional value of $43 billion were traded every day. Currently, most of these are traded electronically. - 27 -

Other futures exchanges that trade currency futures are Euro next. Life and Tokyo financial exchange. The IMM dates are the third Wednesday in March, June, September and December. PRICING The pricing of a currency futures contract is completely determined by the prevailing spot rate and interest rates. Otherwise would be able to arbitrage the difference between the futures and spot price. The Futures price is given by; F= Futures price S=spot price rt=interest rate of the term currency rB=interest rate of the currency T =tenor USES: (i) HEDGING Hedging means minimize loss or risk. It means taking a position in the futures market that is opposite to a position in the physical market with a view to reduce or limit risk associated with unpredictable changes in the exchange rate. Investors use these futures contracts to hedge against foreign exchange risk. If an investor will receive a cash flow denominated in a foreign currency on some future date that investor can lock in the current exchange rate by entering into an offsetting currency futures position that expires on the date of the cash flow. For Example, peter is a US based investor who will receive is 2/E. he can lock in this exchange rate by selling $1000000 worth of futures contracts expiring on december1. That way he is guaranteed an exchange rate of $1.2/e regarded of exchange rate fluctuations in the meantime. (ii) SPECULATION Currency futures can also be used to speculated and by incurring a risk attempt to profit from rising or falling exchange rates. For example peter buys10 September CME Euro FX Futures at $1.2713/e. At the end of the day the futures close at $1.2784/ E. the change in price is $0.0071/E.As each contract is over E125,000,and he has 10 contracts, his profits is $8,875. As with any future this is paid to him immediately. More generally each change of $0.0001/E (the minimum Commodity tick size) is a profit or loss of $12.502per contract. - 28 -

SETTLEMENT AND DELIVERY As currency futures are based upon the exchange rates of two currencies they are settled in cash in the underlying currency. For example, the EUR futures market is based upon the Euro to US Dollar Exchange rate and has the Euro as it s underlying currency. When a EUR futures contract expires the holder receives delivery of $125000 worth of Euros in cash. Note that only happens when the contract expires and as day traders do not usually hold futures contracts until they expire they should not be involved in the settlement and will not receive delivery of the underlying currency. POPULAR CURRENCY FUTURES Many of the most popular futures market that is based upon currencies are offered by the CME (Chicago Mercantile Exchange) including the following;

EUR-The euro to US Dollar currency future GBP-The British Pound to US Dollar currency future. CHF-The Swiss France to US Dollar currency future. AUD-The Australian Dollar to US Dollar Currency future CAD-The Canadian dollar to US Dollar currency future. RP-The Euro to British Pound Currency future RF- The Euro to Swiss France currency future.

Complete description of many of the above currency futures including the exchange rate that they are based upon the futures contract specifications and market holiday are available in their Market Profiles. CURRENCY FUTURES IN INDIA On August 29, 2008,the Indian financial market witnessed the first currency future trading of the country when the union finance Minister. Mr. P. Chidambaram clicked the first trade on the national stock Exchange (NSE).The much hyped currency future debuted with a turnover of nearly Rs.291 crore, which is a good volume on the debut day. East Indian Securities struck the first future deal buying 50 November contract at Rs 44.15 a dollar for its client Budge Refineries Ltd, the Mumbai based brokerage. Among the bank participants HDFC Bank carried out the first trade. ICICI Bank Ltd .sold 100 September contracts for Infosys between Rs.4+3.835 and 43.8375. The largest trade was by Standard Chartered Bank constituting 15000 contracts Banks share of the total gross volume was 40 percent. - 29 -

In order to encourage active participation in the Currency Derivatives segment the NSE had decided that no transaction charges will be levied on the trades dons in this segment on the exchange from August 29 till September 30. However every trading member participating in currency derivatives during the above period shall be required to make a lump sum contribution of Rs500 towards an investor protection funds. At present only US Dollar Indian rupee contract are allowed Foreign Institution Investors (FIIs) and Nonresident Indians (NRIs) are barred from this market. The contract size is 1000 US dollars and tick size (minimum price fluctuation) will be 0.25 paisa. But our Union finance Minister has assured that the currency future s trading will be allowed to FIIs and non-resident investors and in other currencies also. He also said that Indian will introduce futures trading in interest rate also to boost the corporate bond market to keep pace with Dubai and Singapore as financial centers. He further added that the Government of India is seriously thinking about removal of entry barriers for domestic companies and foreign financial firms in all segments in the financial services industry. SEBI chairman Mr. C.B. Bhave has advised the intermediaries in the currency futures market to maintain discipline and avoid excessive speculation. Nearly 70000 contracts were traded on the NSE on the initial day and around 300 trading members including 11 banks were registered in this segment. The total traded volume on the first day was $65.8 million according to data compiled by Bloomberg from the bourse. The 12 serial month 2008 expiry with around 43000 contracts being traded. The near month contract traded at a premium of 0.40 percent to the spot price. Aseem dhru, MD of HDFC Securities said that the volumes in the market were good to begin with and day futures were taking cues from the movement of forward dollar rates from the OTC market. The prices in currency derivatives segment shall be displayed traded and reported up to the fourth decimal place instead of up to two. for example Rs 42.50 shall be displayed as Rs 425000 .All group I securities ,bank guarantees, receipts of fixed deposits will be allowed as collaterals for the margins required to be deposited by the investors trading in currency futures. The trade in currency futures will co-exist with the already prevalent OTC market for forwards where the banks and corporate have been hedging their foreign currency risks so far. The OTC market has an average daily volume of $34 billion according to the NSE. Unlike OTC contracts that are bilateral, the exchange traded currency futures counteract will be transparent. Banks are also allowed to become members of ht exchange to participate in currency futures trade. All resident Indians are allowed to participate in currency futures but as already mentioned NRIs and FIIs are not eligible to trade but this expected to change once the local market has reached a maturity level. - 30 -

Thus Indias biggest stock exchange started trading in currency futures on August 29 the first time the product for the first time in India , it will be possible to trade on currency futures on an exchange platform said the National stock Exchange, which earlier this month received an in-principal approval from India stock market regulator to offer the derivative contract. The NSE;s announcement was welcomed by market players because the contract will make it easier fro bankers brokers and private investors to interact in the currency market and to hedge their foreign exchange risks when trading . As brokers we will have new instruments to trade and it will make everything much more transparent said Sandeep singal head of futures and options at Emkay Global Financial Services. In India there is already an active over the counter market for currency forwards Swaps and options with an average daily turnover of $34bn, according to the NSE which is Indians biggest stock exchange in terms of volumes traded. However this, market is virtually non accessible to individuals as trades are arranged directly between counterparties. The NSEs new electronic trading platform is expected to attract many small private investors, according to market players. Foreign Institutional Investors and Non-ResidentsIndians will not be allowed to trade directly but this is expected to exchange once the local market has reached a maturity level said traders. The NSEs rival, Bombay stock exchange and Indians multi Commodity Exchange (MCX) also filed an application to the Securities and exchange Board of India to start trading currency futures. MCX got approval to offer trading in futures on August 25, 2008. The Bombay Stock Exchange got the approval on August 31, 2008. The NSE said that currency futures contracts would have a maximum value of $ 1000, although they will be settled in rupees and each contract will have a 12 month maturity period. The securities and Exchange Board of India is mulling over the introduction of rupee euro and rupee yen contracts in currency futures soon. SEBI is in the process of studying the market for rupee-yen and rupee euro and the contracts would be launching after considering the outcome of the study said SEBI chairman, Mr.C.B.bhave. He also said that the market regulator would be launching interest rate futures within the next five months. SEBI in this regard has released criteria will get permission to it the qualified banks must be authorized by RBI ,must have minimum net worth of Rs.500-crores,minimum CRAR of 10 percent ,net NAP should not exceed 3 percent and have earned net profit for the last 3 years. RBI has also stated that there should be separate membership of recognized stock exchange for currency future trading for equity derivatives segment or the cash segment. Thus trading in currency future started in the Indian financial market too. According to Joseph masse, Chief Executive Offer ,Multi Commodity Exchange (MCX)this is the - 31 -

appropriate time to launch currency futures as a significant of the market has been left exposed to exchange rate risk for too long According to the central bank ,the futures allow grate transparency ,efficiency and accessibility. CURRENCY FUTURES: A CRITICL ANALYSIS The greatest advantage of future trading is that it helps in hedging risk as it facilitates exchange of financial
Main Highlights of the Currency Futures Trading in India Currency futures trading in India was inaugurated on August 29, 2008 by the Union Finance Minister, Mr. P. Chidambaram. It was stared through NSE from Sepetmbe,2008 At present only Indian Rupee and US Dollar are being traded. Presently it is allowed only to the Indian residents and not FIIs and NRIs. The minimum counteract size is 1000US Dollars Maturity period the contact is 12 months. Future Strategy To allow trading in Currency Futures to FIIs and NRIs To allow trading in other foreign currencies also To allow future trading in interest rates

Assets in the future at price already determined in present and the price is lock-in for future transaction, thus uncertainty arising out of future fluctuations in assets prices is eliminated. Exporters importers hedge funds non-banking institutions and speculators alike can take advantage of this alternative venue of FX liquidity and use the currency futures markets to manage forging exchange risk gain price improvement on trades achieve lower trading costs and conduct their cross border transactions more efficiently and securely . One of the most significant benefits of the currency trading is the high amount of leverage of trading currency futures will be: DIVERSIFICATION Currency futures can provide investors with a well balanced portfolio through diversification and low systematic risk. Price fluctuations in currency futures have very low correlations with price movements in stock market values and interest rates. This lack of any systematic relationship can lower portfolio risk when the equalities and interest rates are in a depresses state. 24 - HOUR TRADING Currency futures trading nearly 24-hours a day in the CME, Globex market or open out-cry trading pits. - 32 -

HIGHLY LIQUID Investors can enter the currency futures markets and exit position efficiently, as they are one of the largest and most liquid markets in the world. Currency futures markets can absorb trading volume and transaction size that draft the capacity of many of the worlds equity markets. But the concept of currency futures suffers from certain disadvantages and criticisms too. It may not provide opportunity for making profits there is illiquidity and there is a default risk (credit party) that is the party at disadvantage may default. In futures commission clearing and exchange fees are also charged which many speculators are unaware of .Futures go by tick prices it is common that the private sector banks in India have mislead the small and medium scale exporters by luring them into currency derivatives they didnt understand after their best went sour. Many of them are on the stage of bankruptcy today as they were made to believe that they will not suffer any risk in currency futures. Most of such exporters have no etc have no detailed knowledge on the working of the currency futures market. Banks like ICICI, HDC, AXIS, ABN AMRO etc have caused loss of crores of rupees of ht exporters. Since the exporters had their accounts in these banks the amount of losses were directly deducted from their accounts. The chairman of the Forum, Mr, Raja. M accused that the banks have not followed the RBI regulations, in this regard and mislead the exporters. Sundaram Multi Pap Ltd. Is among a dozen Indian companies that have filed accusing this year against local banks including ICICI Bank Ltd. Kotak Mahindra Bank Ltd and Axis Bank Ltd. Accusing them of hiding risk and causing losses of the exporters. CONCLUSION The introduction of equity index futures markets enabled traders to transact large volumes at much lower transaction costs relative to the cash market. The consequence of this increase in Trading volume in futures markets remains unresolved both on theoretical and an empirical front. The study seeks to examine the stock market in spot market after the introduction of derivatives trading in India. Further, our study makes an attempt to examine the history of currency futures of a currency futures contract is completely determined by the prevailing spot rate and interest rates Currency futures speculation settlement an Aseem dhru, MD of HDFC Securities d delivery of the most popular futures market that is based upon currencies are offered by the CME advises from SEBI chairman Mr. C.B. Bhave, Aseem dhru, MD of HDFC Securities. And introduced in the Indian stock market in recent years. The results of this study are especially important to stock exchange officials and regulators in designing trading mechanisms and contract specifications for derivative contracts, thereby enhancing their value. - 33 -

REFERENCES 1. Bhargava V, Malhotra D.K. (2007). The relationship between futures trading activity and exchange rate volatility, revisited. Journal of Multinational Financial Management, 17, pp. 95-111. Chatrath, A., S. Ramchander and F. Song (1996), The Role of Futures Trading Activity in Exchange Rate Volatility. The Journal of Futures Markets, Vol. 16, No. 5, 561584. Donald E.fischer, Ronald.R Jordon Security Analysis And Portfolio Management, 6/ E2009 Pearson publication, pp. 486 521. h t t p : / / w w w . d r e a m g a i n s . c o m / c a m p a i g n s / Stock_Futures.html?gclid=CJbYjI7037QCFcQc6wodkCkAyw http://www.goodreturns.in/bse/sector-watch.html h t t p : / / w w w . r b i . o r g . i n / s c r i p t s / ACBS_EntireSearch.aspx?searchString=futures%20trading Reserve Bank of India (2008), Report of the Internal Working Group on CurrencyFutures.http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?From date= 4/28/2008% SECID= 21&SUBSECID=0

2.

3. 4. 5. 6. 7.

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COMMODITY FUTURES AND SPOT MARKET - A STUDY OF MCX INDICES

1

Syeda Rukhsana Khalid, Research scholar, School of Management Studies, University of Hyderabad, Hyderabad, A.P.

ABSTRACT Commodity markets are of two types: Spot and Futures. Commodity Futures market are the part of financial derivative market where futures contract are traded on commodity exchanges and are regularized and standardised markets unlike commodity spot market.Commodity derivative trading in India has a long andchequered history, which is dated back to nineteenth century.Commodity futures trading was started in 1875 with the setup of Cotton Trade Association, followed by oilseeds in Bombay. It was almost dormant for forty years because of the apprehensions among the people that it would be detrimental for the functioning of financial markets and only got revived after liberalization. This market has twin important functions of price discovery and risk management. This present paper tried to find out that is there any preliminary evidence that supports the effective carrying out of the two aforesaid functions? MCX future and spot indices have been selected which are MCXAgri and MCXSAgri, MCXMetal andMCXSMetal, MCXEnergy and MCXSEnergy, MCXComdex and MCXSComdex. Daily closing prices of the indices have been collected from the website of MCX for the year 2012. Price volatility is found out in both price series. Standard deviation is used to find out the price volatility. Correlation analysis is used to know the strength of relationship between the two series. The findings of this study are that the two series moves in unison i.e. they are positively and highly correlated except MCXAgri and MCXSAgri which shows low correlation of 0.2. Price volatility is high for MCXAgri, MCXAgri and MCXSAgri monthly volatilities also do not move in unison, the reason could be late reflection of price in agri commodities and over speculation. The results are the preliminary evidence that futures market could be useful for hedging and carrying out price discovery function. The findings are supported by Sushmita Bose findings in 2008. KEY WORDS Commodity, Futures, MCX Indices. INTRODUCTION Commodity markets in India are gaining importance day by day and have opened avenues for retail investors, producers, traders, speculators etc. and are expected to surpass the equity markets in turnover with in few years. These are the markets where raw or primary products are exchanged.Basically, commodity markets are of two types, commodity - 35 -

spot market and commodity futures market. Spot trading takes place in commodity spot market which is a kind of transaction where delivery either takes place immediately, or with a minimum lag between the trade and delivery due to technical constraints. Spot trading normally involves visual inspection of the commodity or a sample of the commodity, and is carried out in markets such as wholesale markets. Commodity futures market, on the other hand, require the existence of agreed standards and are regulated by Forward market commission and FRCA act 1952.Commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized contracts known as future contracts; future contract is a an agreement between buyer and sellerto sell or purchase an asset (here commodity) at a predefined rate and on predefined date known as maturity date. The commodity markets have the twin important economic functions of Price Risk management and Pricediscovery. Price risk management function is carried out through the strategy of hedging where the price risk is replaced by a smaller risk known as basis risk.Both the contemporaneous futures and spot pricescontribute to price discovery and the futures market can provide informationfor current spot prices and thus help to reduce volatility in the spot prices of the relevant commodities and provide for effective hedging of price risk.Price volatility is wide swings in prices due to market conditions, expectations, and sentiment over a period of hours, days, weeks or months. REVIEW OF LITERATURE This paper deals with future trading in agricultural goods, and the main finding is that future tradingespecially in food itemshas neitherresulted in price discovery nor less of volatility in food prices. It was observedthat the steep increasesin spot prices for major food items along with a granger causal link from future to spot pricesfor commodities on which future data was available. It was also noticed a pattern whereinvestments in stock markets have links with those in the commodity market via portfolioadjustments. Moreover, with the opening of cross border trade, commodity prices have alsobeen guided by the upward movements in prices in international markets. For India furtheropening of the future market in commodities, and especially of food, needs to be dispensedwith and be treated with caution, in order not to let speculators have a wider playground toplay with. (SunandaSen&Mahua Paul, 2010) The main purpose of the present study would be to look into somecharacteristics of the Indian commodity futures market in order to judgewhether prices indicate efficient functioning of the market or otherwise, particularly as this market is less developed compared to the financial derivativesmarkets, being constrained by its chequered history with many - 36 -

policyreversals. Using the available notional price indices for the commodity market we find that multi-commodity indices, which have higher exposure to metalsand energy products, with clear and efficient price dissemination in nationaland international markets, behave like the equity indices in terms of efficiencyand flow of information. Both the contemporaneous futures and spot prices contribute to price discovery and the futures market can provide informationfor current spot prices and thus help to reduce volatility in the spot prices ofthe relevant commodities and provide for effective hedging of price risk.Agricultural indices on the other hand do not exhibit such features veryclearly. The results also help to build a case for opening up of parts of the Indian agricultural futures market.( Sushmita Bose, 2008) This study is descriptive in nature and the author discusses about development, regulation and future prospects in commodity derivatives market in India. He began it with the chequered history of commodity markets in India till the unprecedented boom in 2002 in terms of the number of modern exchanges, number of commodities allowed for derivatives trading. The author also suggests there are several impediments to be overcome and issues to be decided for sustainable development of the market. (L.Ahuja, 2006). HISTORY& GROWTH OF COMMODITY MARKETS Commodity futures Market have a long and chequered history in India, it started way back in 1875 almost a century and a quarter ago, with the startup of Cotton Trading Association then followed by oilseeds in 1900in Bombay. But there were apprehensionsthat future trading wouldcreate unnecessary speculationsand would result in unhealthy functioning of financial markets. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. The act prohibited options trading in Goods along with cash settlement of forward trades, rendering a crushing blow to the commodity derivatives market.In 1990, after Liberalization and Globalization, Government of India, , started encouraging commodity markets and set up a committee (Kabra : 1993) to examine the role of futures trading. Another major policy statement, the National Agricultural Policy, 2000, also expressed support for commodity futures. The Expert Committee on Strengthening and Developing Agricultural Marketing (Guru Committee: 2001) emphasized the need for and role of futures trading in price risk management and in marketing of agricultural produce. Strengthening of forward regulation act, setting up of nationwide multi commodity exchanges(five in 2012) and regional commodity exchanges(sixteen in 2012), and expansion of list of commodities(113) permitted for trading under forward regulation act made a way for the commodities future markets to grow at a rapid stage, the volumes of the market have grown 5.5 times from Rs.20.53 trillion in 2005-06 to Rs.112.52 trillion in 2010-11. - 37 -

Chart No 1

As per the Forward Markets Commission data, released on 9 January 2012, the turnover of the commodity exchanges in India has increased by 66% and last year the markets have seen 14025.74 lakh tone turnover of worth 18126103.78 crore rupees. Chart No 2 Value in Lakh Crore.

Source: FMC Website - 38 -

OBJECTIVES 1. 2. To examine the volatility in the commodity futures and spot indices. To correlate the aforesaid indices and to study whether they change in tandem with the market information or not. RESEARCH METHODOLOGY The present study deals with the volatility and price discovery in commodity futures and spot market. To study this, indices from Multi Commodity Exchange (MCX) have been taken.The index is a significant barometer for the performance of commodities market and would be an ideal investment tool in commodities market over a period of time. The MCX COMDEX is the simple weighted average of the three group indices - MCX AGRI, MCX METAL & MCX ENERGY. MCX also computes the daily Spot Index value for its MCX COMDEX, MCX AGRI, MCX METAL & MCX ENERGY by using the current spot prices of the respective commodities vis a vis their spot prices in the same base period of average of 2001. SAMPLE DATA AND TYPE Daily closing prices of the MCX future and spot indices are collected. The data is collected for the last year i.e. from January 1, 2012 to December 31, 2012. The data is of secondary in nature and total of 307 observations are collected. The future and spot indices selected are as follows:

I.The Four future indices are: 1.MCXComdex, 2.MCXAgri, 3.MCXMetal, 4.MCXEnergy

II.TheFour spot indices are: 1.MCXSComdex, 2.MCXSAgri, 3.MCXSMetal, 4.MCXSEnergy

- 39 -

Table No 1
MCX COMDEX 2009 Weights Commodity Weight (New)

MCX COMDEX

Group Adjusted Wts.

MCX METAL INDEX

Gold Silver Copper Zinc Aluminium Nickel Lead

15.21% 9.66% 7.13% 2.00% 2.00% 2.00% 2.00% 40.0%

MCX ENERGY INDEX

Crude Oil Natural Gas

35.41% 4.59% 40.0%

MCX AGRI INDEX

Ref. Soy Oil Potato Chana Crude Palm Oil Kapaskhalli Mentha Oil

3.91% 4.76% 4.14% 3.19% 2.00% 2.00% 20.0%

Source:MCX Website To know the volatility of the aforesaid indices for the past one year, standard deviation is calculated for the daily closing prices and to know whether the future and spot indices are moving in tandem or not with any new information correlation analysis is carried out between respective future and spot indices. - 40 -

DATA ANALYSIS Table No 2

MCXCOM DEX 3811.427 3800.02 4033.2 3604.44 107.3562 0.096671 1.945811 MCXSCOM DEX 3882.276 3882.2 4206.29 3666.7 103.522 0.445504 3.412959 MCXME TAL 5051.607 4968.2 5485.99 4719.5 190.1822 0.662646 2.283374 MCXSME TAL 4995.022 4914.72 5440.1 4637.99 186.8278 0.665603 2.267838 MCXENE RGY 3409.034 3417.59 3685.98 3066.16 135.5438 -0.304882 2.628804 MCXSENE RGY 3363.297 3374.07 3683.37 3016.9 140.9232 -0.181624 2.725926 MCXA GRI 2898.23 5 2814.21 3716.58 2071.77 510.964 0.02046 5 1.65050 8 MCXSA GRI 3556.592 3515.39 3916.34 3221.9 187.6732 0.250803 2.023659

14.69372 0.000645

12.33665 0.002095

29.03648 0

29.52532 0

6.518608 0.038415

2.648707 0.265975

23.3166 9 0.00000 9

15.41205 0.00045

1170108 3526757 307

1191859 3279342 307

1550844 11067795 307

1533472 10680811 307

1046573 5621868 307

1032532 6076957 307

889758 7989176 2 307

1091874 10777700 307

In all the pairs of commodity futures and spot indices exceptMCXEnergy and MCXSEnergy, future indices are having more volatility when compare to spot indices.MCXAgri is having the most volatility with highest standard deviation of 510. All the indices are platykurtic(<3) except MCXSCOMDEX which is leptokurtic(>3), indicating the variance is stable and risk is predictible. All the indices are positively skewed with longer right tailed distributions except three which are MCXEnergy,MCXSEnergy and MCXAgri which are negatively skewed with longer left tailed distributions. - 41 -

GRAPHICAL ANALYSIS

From the above graphical analysis of the respective future and spot indices where monthly volatility(standard deviation) is plotted on the line chart, it is clear that all pairs of future and spot indices are moving in unison except the pair of MCXAgri and MCXSAgri, indicating the volatility was not the same in both the series.

- 42 -

CORRELATION ANALYSIS Table No 3

MCXCO MDEX MCXSC OMDEX MCXME TAL MCXSM ETAL MCXENE RGY MCXSEN ERGY MCXAG RI MCXSA GRI

MCXCO MDEX MCXSC OMDEX MCXME TAL MCXSM ETAL MCXEN ERGY MCXSEN ERGY MCXAG RI MCXSA GRI

1 0.537343 0.081189 0.023401 0.821233 0.779686 0.596691 0.330385

0.537343 1 0.685156 0.675667 0.663881 0.700407 -0.27477 0.483406

0.081189 0.685156 1 0.984041 0.068838 0.081084 -0.69232 -0.10734

0.023401 0.675667 0.984041 1 0.027097 0.049044 -0.72143 -0.11833

0.821233 0.663881 0.068838 0.027097 1 0.964454 0.315795 0.409997

0.779686 0.700407 0.081084 0.049044 0.964454 1 0.280213 0.418126

0.596691 -0.27477 -0.69232 -0.72143 0.315795 0.280213 1 0.224093

0.330385 0.483406 -0.10734 -0.11833 0.409997 0.418126 0.224093 1

FINDINGS From the table 3, the correlation analysis suggestpositive correlation between the future and spot indices. MCXMetal and MCXSMetal (0.98), MCXEnergy and MCXSEnergy(0.96) are very highly correlated with each other. MCXAgri andMCXSAgri are having very low correlation of 0.2 CONCLUSION Indian markets have recently thrown open a new avenue for retail investors and traders to participate: commodity derivatives, but the commodities are subject to constant and extreme price fluctuations. Traders, producers are the worst sufferers of the price risk. Derivative contracts have come to the rescue from price risk through hedging. For, hedging to be successful the two price series i.e, future and spot should be strongly related and should move in unison.Correlation analysis reveals a very high correlation betweenthe spot and futures indices. This implies there is a strong relationship between the future and spot price series, and provides preliminary evidence thatboth series respond similarly to changes in market fundamentals. MCXAgri and MCXSAgri are having very low correlation of 0.2, - 43 -

this low correlation could be due to the late reflection of prices in agri market as the spot prices of agri commodity varies from region to region all over the country and also due to over speculation. Price volatility is part and parcel of Commodity Markets and Commission had resorted toregulatory measures like imposing different types of margins, revision of open position limitsand in extreme cases even closing out of contract, but there must be measures to curb over speculation, excessive hoarding of agri commodities by rich trdaersetc, then only there will be stability in agri futures and spot market. REFERENCES 1. 2. 3. 4. 5. 6. Bose.Sushmita (2008).Commodity Futures Market in India.A Study of Trends in the Notional Multi-Commodity Indices. ICRABULLETIN Money & Finance. Enabling farmers to leverage commodity exchanges.Report submitted by cardinal edge management services ltd. to MX in 2008. Kevin.S.(2010).Commodity & Financial Derivatives.New Delhi:PHI Learning. L.Ahuja.(2006),Commdity Derivatives Market In India:Development ,Regulation and Future Misra,S.N., &Sunder.S, (2007).Commodity Derivatives. Mumbai: MacMillan. Mukherjee, Dr. Kedarnath(2011),Impact of Futures Trading on Indian Agricultural Commodity Market. MPRA Paper No. 29290,Retrieved from http://mpra.ub.unimuenchen.de/29290 Sahadevan(2007). Advantages of commodity futures trading through electronic trading platfor for farmers of uttarpradesh-a study of potato and mentha.Report submitted to MCX. Sen.Sunanda&Paul.Mahua(2010).Trading in Indias Commodity Future Markets. Working Paper /ISID2010/03. Prospects.International Research Journal Of Finance and Economics,2,Retrieved from http://www.eurojournals.com/ IRJFE%202%2011%20Ahuja.pdf Velmurugan,P.S.,Palanichamy,P., &Shunmugam,V. (2010). Indian Commodity Market(Derivatives and Risk Management). New Delhi: Serials Publications. www.investopedia.com www.mcx.com www.ncdex.com www.thehindubusinessline.com - 44 -

7.

8.

9.

Web Sites

FINANCIAL PERFORMANCE OF INDIAN TEXTILE INDUSTRY AN EMPIRICAL STUDY ON KG DENIM LIMITED

1

Marimuthu, K. N, Research Scholar, School of Management Studies, University of Hyderabad, Hyderabad, A.P. 500046. Can be reached at email: knmarimuthuproject@gmail.com Dr. Mary Jessica, Associate Professor, School of Management Studies, University of Hyderabad, Hyderabad, A.P. 500046.

ABSTRACT The main objective is to evaluate the financial performance of Indian textile Industry of KG Denim Limited. This paper will study the relationship between liquidity and profitability with the help of Correlation. The study is based on secondary data for the year 2001-02 to 2010-12 from top most listed on BSE Tamil Nadu textile industry. The study concludes with the investment and profitability of liquidity position of KGDL is increasing positively and decreasing the debt-coverage ratio is the strength to the firm. The present study limits/concentrates only one top most company & not comparing with others. Growth and development of industry financial performances and its main paramount in investment decision makings as per expediency. KEY WORDS: Decision making and Profits, Profitability and Liquidity INTRODUCTION Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds on the enterprise. It means applying general management principles to financial resources of the enterprise. Financial accounting main aim is to ascertain profit or loss and to indicate financial position of an enterprise for the particular period. It is also useful to the firm shareholders/owners, Government and Creditors by providing relevant information for their requirements. Management accounting provides information to the management to use it as a base for decision making and it may helpful in critical position to take up the right decisions on working capital/current assets. It may reduce the elevated risk and increase the profit (Reddy and Hari 2003). Working capital is an excess of current assets over current liabilities. Working capital shows strength of business in short term period of time. If a company has some amount in the form of working capital, it means company has liquid assets with this money company can face every crises position in market. The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. - 45 -

Indian textile industry is the second largest industry in the world after China and it is self reliant and independent industry and has greater diversification and versatility. As per AEPC, this industry contributes nearly 3 to 4 percent to GDP; next to agricultural sector, it generates employment for more than 35 million and indirectly helping to other sector also. Textile excise collections nearly 9 percent and it contributes to 16 percent share of the countrys export. About 27 percent of the countrys foreign exchange comes from the textile exports (Marimuthu 2012). It contributes to nearly 14 percentage of the total industrial production of the country. It is expected to reach US $ 100 billion by 2016 growing at a compounded annual rate of 12 percent. Recent rupee depreciation helped to increase export (textile and garment export $34bn 2011-12) value of domestic currency by 10.4% to Rs.65377.41crore in Apr-Sep 2012. The three segments account for around 82% of the total textile and garment supplies from the country. According to AEPC advantages of India-fact sheet;

India is the largest producer of jute products, Second largest producer of silk and Cotton Yarn Second largest producer of cellulosic fiber/yarn Third largest producer of raw cotton Fourth largest producer of synthetic fibers/yarn

NEED FOR THE STUDY The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc. Liquidity plays a crucial role in the satisfactory ongoing of a firm. Liquidity management has broad aspect of judging the performance of a corporate entity. Liquidity should be neither excessive nor inadequate. Excessive Liquidity is an indicator of idle funds, on the other hand, adversely affects the creditworthiness of the firm, interrupts the production process and hampers its earning capacity to a great extent. So, efficient liquidity management has become essential for the smooth running of any business enterprise. Review of Literature (Khatik and Rashmi 2009) analyzed the working capital position of Madhya Pradesh State Electric Board and it was found the positions of financial ratio analysis are not satisfactory because these ratios are not up to the standard bench mark. Further the liabilities side has had negative impact on the board because in this situation, creditors or outsiders do not feel secure. Rakesh and Kulkarni (2012) evaluated the working capital of Gujarat textile industry on selected five companies for the eleven years and performed descriptive statistics - 46 -

with ratio analysis sound effective. Singh and Shishir (2012) attempted on working capital analysis of national aluminum company and performed financial ratios as well as used important statistical analysis on working capital. Amalendu and Uddin (2011) analyses the association between the liquidity management and profitability of select Indian private sector steel companies. It found that satisfactory level of liquidity and solvency with efficient management from descriptive analysis as well as the lower degree of association between the liquidity and management and profitability. Zahid and nanik (2011) overall performance of the textile sector was adversely affected by crisis through analysis of income statement, debt payment ability, management and inventory sales, receivables, productivity, fixed assets, etc. Abuzar (2004) empirically examined the relationship between profitability and liquidity on a sample of joint stock companies in Saudi Arabia using correlation and regression. The study found that cash conversion cycle or the cash gap is more importance as a measure of liquidity than current ratio that affects profitability. Shishir Pandey (2012) analyzed the financial structure which helps to indentify the shortcoming and inadequacy of the fund to raise profit during the period of 2005 to 2011. Bhaskar and Basanta (2012) proved the hypothesis ineffective capital mix through multi-regression analysis. Negative correlation and insignificant regression are results on lack of favorable impact of working capital on profitability etc. Nusrat and Assocham (2008) analyzed the performance of sector analysis on 28 textile companies from Mumbai Stock Exchange with the attributes of net sales, net profit, interest cost, raw material, power and fuel cost. Virambhai (2010) textile industry productivity and financial efficiency focused on industrys current position and its performance. Sasikala (2012) concluded the company/management should try to increase the production, minimize the cost and operating expenses, exercise proper control on liquidity position, reduction of power, fuel, borrowing funds, overheads, Interest burden, etc. Ajay Kumar (2011) discussed on Indian textile industry analysis with inflation, textile production, sales, Income, PAT, Income, etc. and found the export and import performance in the crisis period. Shruti Jhawar (2009) prescribed the Indian textile industry mission, vision, history of textile industry in addition; it discussed the case study of textile industry performance evaluation etc. Swaran and Bansal (2010) evaluated on co-operative sector comparative study and performed working capital management and used ratio analysis, t-test and operating cycle analysis etc. it concluded with both sector should concentrate on their liquidity and current assets utilization and concentrates working capital management techniques, implementation, profitability measures etc. OBJECTIVES OF THE STUDY

To analyze the performance of KGDL listed company of Indian Textile Industry To find out the correlations between financial ratios of KGDL company - 47 -

METHODOLOGY OF THE STUDY KG Denim Limited (KGDL) has been selected for the study. It is one among Textile Companies from Tamil Nadu listed on BSE. The secondary data had been collected for the period of 2001-02 to 2010-12 from the website money control, annual reports, journals, and publications etc. The data has been analyzed using the financial and statistical tools using SPSS package. ANALYSIS AND INTERPRETATIONS The primary objective of any firm/company is to maximize the profit, maximize the investors return on their investments; providing high security for creditors. Financial Statements generally replicate the running position/conditions of company. They are of two types: Balance Sheet and Income Statement. Financial statement is an organized collection of data according to logical plus steady accounting procedures. It will help to find the sound factors; profitability and financial soundness. It is important tool to evaluate the financial performance analyses. In this study, the financial health of selected textile company is measured from the following perspectives. The below chart clearly shows that company industrial performance as per the respective annual income statement, total income and expenses, total assets and liabilities, current assets and liabilities, sales and net worth.
Table No 1 Main Variables of KGDL (Rs. in Cr)
Year 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Avg Min Max Med STDEV Sales Turnover 171.14 267.51 223.8 218.01 199.39 217.38 209 215.58 229.53 269.03 343.02 400.66 247.00 171.14 400.66 220.91 65.19 Total Income 170.97 255.23 212.95 221.9 192.4 232.73 223.66 215.05 236.91 267.99 356.85 413.36 250.00 170.97 413.36 228.20 69.13 Total Exp 147.8 215.09 158.77 177.29 172.27 191.51 205.17 194.52 220.95 235.32 317.77 366 216.87 147.80 366.00 199.85 64.50 Operating Profit 22.66 34.32 52.87 42.86 19.69 42.08 10.68 14.96 13.78 30.43 34.2 44.19 30.23 10.68 52.87 32.32 13.80 PBDT -0.06 23.86 44.3 33.38 13.31 31.85 3.28 2.89 -3.82 13.02 19.94 24.13 17.17 -3.82 44.30 16.63 15.02 Depr 5.1 6.36 5.31 6.54 5.32 7.77 11.84 12.78 13.06 12.9 12.93 13.08 9.42 5.10 13.08 9.81 3.58 PBT -7.25 14.88 25.93 26.65 7.85 24.05 -8.56 -9.89 -16.88 0.12 7.01 11.05 6.25 -16.88 26.65 7.43 14.94 NP -5.13 12.82 18.56 10.46 5.25 15.73 -6.92 -6.85 -12.16 0.17 4.5 7.37 3.65 -12.16 18.56 4.88 9.89 EPS(Rs) -2.55 6.36 9.22 0.72 2.24 7.82 -3.44 -2.67 -4.74 0.07 1.75 2.09 1.41 -4.74 9.22 1.24 4.51

Source: Dion Global Solutions Limited & Money Control.com

- 48 -

The above financial statement shows the growth up-trend of KGDL through high utilization volatility on its income and expenses during 2000-01 to 2011-12. Average sales turnover is Rs.247cr and its varying between the highest of Rs.171.14cr to 400.66cr during the study period, continue by average of total income (Rs.250cr), average of net profit (3.65cr) etc. operating profits are decreased highly from the year 2007 (-6.92) onwards to (-12.16) 2009 (for the reasons, imports of cotton from abroad in low cost and domestic manufactured firm not able to sell with cost of goods sold as well as expected profit. So the trade cycle couldnt able to maintain) aftermath of global meltdown but this industry recovered with the help of Indian strong economic growth. The current ratio of select textile company varied between highest of 1.62 times and the lowest of 0.73 times with the twelve years average of 0.97times. This current ratio is going downward trends from 2001 (0.81) to 2005 (0.73) and afterwards going upward from 0.9 times to 1.27 times in 2012 reveals that company is highly utilizing the working capital for the growth of industry. Many of the company could not able to maintain current ratio in the recent period but this company somewhat maintaining their current ratios. Further in the last two years are showing the uptrend of company average times compared with previous years. It reflects the high variation of standard deviation of 0.33 compiled current ratio times of twelve years with the median of 0.83. The below chart reflects the growth rate of operating profit, gross profit and net profit year-wise smoothly, except in the year 2008-09 for the reason impact of global meltdown on various parameters. Effect of US crisis experienced world-wide for the reason of collaboration with MNCs. Indian was not an exception to this, falling sales, rising inflation, increasing costs and drying cash flow are some of the effects faced by industry-wise. Operating profit margin, gross profit margin and net profits margin are uptrend during the period that years 2007-09 performed very low for the reason of meltdown.

- 49 -

Table No 2 Financial Ratios of KGDL

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Avg Min Max Med SD

Profitability Ratios

OPM

13.77

13.74

24.97

20.69

9.88

19.36

5.11

6.94

11.3

9.97

11.04

12.73

5.11

24.97

11.17

6.16

PBIATM GPM NPM ROCE

10.66 1.36 -3.11 10.8

11.15 8.39 5.11 19.68

22.33 21.72 8.71 28.13

17.45 16.87 5.02 34.29

7.2 7.37 2.62 13.42

15.73 16.19 7.2 18.6

-0.53 -0.55 -3.19 3.55

0.99 1.01 -3.1 3.76

0.3 0.31 -5.18 3.32

6.4 6.51 0.06 13.63

6.11 6.2 1.29 16.38

7.71 7.77 1.82 24.45

8.79 7.76 1.44 15.83

-0.53 -0.55 -5.18 3.32

22.33 21.72 8.71 34.29

7.46 6.94 1.56 15.01

7.08 7.16 4.50 9.90

RONW

-42.71

42.9

38.68

21.64

9.96

22.98

-13.43

-12.52

-28.59

0.39

9.53

10.74

4.96

-42.71

42.90

9.75

25.80

Liquidity and Solvency Ratios CR QR DER LTDER 0.81 1.75 1.68 2.51 0.87 1.36 5.73 4.16 0.85 0.93 2.35 1.5 0.81 0.48 1.82 1.15 0.73 0.46 1.55 0.85 0.9 0.67 2.23 1.69 1.62 0.64 2.63 2.63 0.76 0.84 2.38 1.56 0.74 0.62 3 1.92 0.73 0.65 2.75 1.64 1.57 0.69 2.38 2.38 1.27 0.46 1.8 1.8 0.97 0.80 2.53 1.98 0.73 0.46 1.55 0.85 1.62 1.75 5.73 4.16 0.83 0.66 2.37 1.75 0.33 0.39 1.10 0.86

Interest-Coverage Ratio IC 0.76 1.85 4.54 4.26 2.73 4.63 0.44 0.39 0.32 1.27 1.37 1.48 2.00 0.32 4.63 1.43 1.64

Management Efficiency Ratios ITR DTR ITR FATR TATR 5.14 4.79 5.8 2.16 1.12 6.69 8.75 7.54 3.46 1.87 4.13 8.88 4.57 2.86 1.66 3.39 10.88 3.72 2.65 1.91 3.17 11.04 3.36 2.43 1.83 3 11.21 3.23 1.96 1.15 3.01 9.51 3.01 1.02 1.12 4.07 7.71 4.07 1.01 1.17 3.93 8.17 3.93 1.05 1.35 4.77 9.65 4.77 1.23 1.68 4.19 11.67 4.19 1.59 2.15 3.93 15.62 3.93 1.8 2.86 4.12 9.82 4.34 1.94 1.66 3.00 4.79 3.01 1.01 1.12 6.69 15.62 7.54 3.46 2.86 4.00 9.58 4.00 1.88 1.67 1.05 2.63 1.26 0.80 0.52

Source: Dion Global Solutions Limited & Money Control.com Notes: OPM=Operating Profit Margin (%), PBIATM=Profit Before Interest And Tax Margin (%), GPM=Gross Profit Margin(%), NPM=Net Profit Margin(%), ROCE=Return On Capital Employed(%), RONW=Return On Net Worth(%), CR=Current Ratio, QR=Quick Ratio, DER=Debt Equity Ratio, LTDER=Long Term Debt Equity Ratio, IC=Interest Cover, ITR=Inventory Turnover Ratio, DTR=Debtors Turnover Ratio, ITR=Investments Turnover Ratio, FATR=Fixed Assets Turnover Ratio, TATR=Total Assets Turnover Ratio. Debt and equity ratio measures the relative proportions of the firms assets that are funded by debt or equity. Lower values of debt-to-equity ratio are favorable indicating less - 50 -

risk. Higher debt-to-equity ratio is unfavorable because it means that the business relies more on external lenders thus it is at higher risk, especially at higher interest rates. A debtequity ratio of 1.00 means, that half of the assets of a business are financed by debts and half by shareholders equity. A value higher than 1.00 means that more assets are financed by debt that those financed by money of shareholders and vice versa. An increasing trend of debt-to-equity ratio is also alarming three times in 2009 because it means that the percentage of assets of a business which are financed by the debts is increasing. Long-Term Debt to Equity expresses the degree of protection provided by the owners for the long-term creditors. A company with a high long-term debt to equity is considered to be highly leveraged. But, generally, companies are considered to carry comfortable amounts of debt at ratios of 0.35 to 0.50 debts to every 1.00 of book value (shareholders equity). These could be considered to be well-managed companies with a low debt exposure. It is best to compare the ratio with industry averages. The above table shows firm startling year 2001 more debt exposure and maintaining somewhat less long-term creditors. Further, crisis time in 2009 it maintained leverages of 1.92 followed by 2012 maintained at 1.8. Interest Cover ratio (Average=2.0) determine the company pay interest on outstanding debt and its calculated by dividing companys earnings before interest and taxes of one period by other period interest expenses of company. It is important to look at prior trends of a particular company as the interest coverage ratio does not consider future projected earnings. A liquidity ratio indicates the firms short term financial situation expressing the extent to which a firm is able to know bottom line condition current year compare with previous year. Profitability ratio provides useful information/combination of liquidity, operating performance and debt management etc. It may measure the profit margin, return on total asset and equity etc. Efficiency ratio also provides an indication of a firms receivables, efficient usage and controls its assets, pays its suppliers and uses its equity borrowed funds etc. Comparing a firm to the aggregate economy is important because fluctuations can influence the profitability of the firm. Firm profits may impact with the firm of both internal and external factors. CORRELATION ANALYSIS AMONG LIQUIDITY AND PROFITABILITY RATIOS Company is having any significant correlation between liquidity performance and its profits oriented through current ratio, quick ratio, debt-equity ratio etc reflects on the below chart from the year 2000-01 to 2011-12 increasing trend line of all ratios as per requirement of liquidity position to the firm. - 51 -

Table No 4 Correlation Analysis between Liquidity and Solvency Ratios

CR 1 CR QR DER LTDER NPM

-.204 QR .526 -.042 DER .897 .314 LTDER .321 -.121 NPM .708

.355 .257 .621* .031 -.092 .777

.809** .001 .099 .759

-.099 .759

*Correlation is significant at the 0.05 level (2-tailed). **Correlation is significant at the 0.01 level (2-tailed). - 52 -

Correlation matrix table varies between liquidity and profitability ratios show that positive and negative association. Current ratio are having less negative correlation with quick ratio (-0.204), Debt-equity ratio (-0.042) and Net profit margin as -0.121. Plus current ratio is having the positive correlation with long term debt-equity ratio (0.314). Quick ratio is positively related with Debt-equity ratio (0.355) and more positive correlation with LTDER (0.621) at 5% level of significance. Meanwhile there is a less negative correlation by quick ratio with CR (-0.204) and net profit margin as -0.092. Debt-Equity Ratio is having the negative correlation with current ratio as -0.042 and less positive correlation with quick ratio (0.36) and net profit margin (0.099) as well as highest positive correlation with LTDER as 0.809 at 1% level of significance. LTDER is having the highest positive correlation with quick ratio as 0.62 at 5% level of significance and less positive correlation with current ratio (0.314). Follow by LTDER is having high positive association with Debt-equity ratio as 0.809 at 1% level of significance. Further, net profit margin are having the less negative correlation with current ratio (-0.121), Quick ratio (-0.092), LTDER (-0.099) and positive association with Debt-equity ratio (0.099). The debt-equity ratio is the combination of debt and equity capital of companys capital depends upon owners and preference capital. The company CR is having the negative relationship with QR and DER. So to avoid debt, firm should change its capital structure and give more priority on equity capital. FINDINGS AND SUGGESTIONS 1. 2. 3. 4. KGDL financial performance is highly modified as well as performed very well in the competitive market & bringing good financial activities with good presentation Investors should invest in the long term perspective and constant on their profit margin is very important Long run production process more inventory are required as well as more working capital needs for the time beings otherwise company may get in struggle If current ratio is below one (current liabilities exceed current assets), then the company may have problems paying its bills on time. However, low values do not indicate a critical problem but should concern the management. On the other hand, a company with low current ratio may be able to pay its current obligations as they become due if a large portion of its current assets consists of highly liquid assets. KGDL should consider short-term outlook for that effect as; less concentration of earning capacity, highest debt proportion, less yield on assets etc. The study analyzed the structure of income statement, balance sheet and working capital with the twelve year averages. The study also indicates positive correlation between the profitability and liquidity ratios. - 53 -

5. 6.

7. 8. 9.

Board should adopt matching investment policy, in this regard; current liabilities should be used in current asset and not in fixed assets and vice versa. Indian textile industry having a low FDI, its highly depending on less cost cotton, less modernization productivity, high fragmentation-requires new technological innovation. To meet the competitors, Indian textile industry require government support on interest rate, transaction cost and multi-infrastructure facilities, etc

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