6. treasury management

8/3/2019 6. Treasury Management

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Treasury Management


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Treasury management

MBA Jain University NVH Krishnan2

y Introduction to Treasury management

y Treasury products

y Funding and regulatory aspects

y Treasury risk management

y Derivative products

y Treasury and ALM


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Concept oftreasury


Originally engaged as a service centre

y

only in daily cash managementy preemptive reserve management

yRestricted deployment of surplus

funds


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Concept oftreasury contd


Currently being looked as a profit centre

yWith active operations in all the markets in

the country and abroad except commoditymarkets

y Continues to deal in only short term markets

excepting in case of SLR investments and

capital market products


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Integrated treasury


Implies merger of both domestic and foreign markets

meaning two way movement of funds depending

upon changing market scenarios and emerging

Opportunities

y Forex, money and equity markets

y Possible due to liberalised environment

y As markets are integrated so are the risksy Derivatives are used extensively for the risk

management


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Enabling environment


y Creation of clearing corporation of India

y Establishment of NSDL

y Large number of NBFCs and mutual funds

y Private insurance providers

y FIIs and FDIs

y Availability of derivative products in money, equity

and forex markets for interest and price risk

hedging


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Treasury's role in profit maximisation


yTreasury operations are more

profitable due to:y

Large size deals leading to lesser operationalexpenses

yRelatively risk free markets

yNeed for lesser capital outlay

yHighly leveraged and with higher return oncapital


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Sources ofTreasurys profits


yForex market operationsy both merchant and proprietaryyArbitrage in different markets due to

time differentials though negligible

yBoth in cash and derivative markets


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Sources ofTreasurys profits


yMoney markety Shuffling of investments taking advantage of

price changes in investment holdings

yBorrowing and Lending in money and Repos

markets taking advantage of inherent

strengths

y

Retailing of Govt. securities


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Organisation oftreasury


yFront office or dealing roomyDealers in various segments carrying actual

tradesy Forex markets - there can be specialists

operating in forwards, derivatives

y Securities markets- generally in secondary

marketsy Investment desk operating in primary

markets


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Organisation oftreasury


yBack officeyVerification of deals done and settlements

thereof

yAccounting, maintenance of Nostros andreporting to regulator

yMiddle officeyRisk management and adherence to various

exposure limits and MIS to Board


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Forex treasury products


y Spot trades

y Forwards

Both for merchant cover operations

and proprietary trade for profits

Generally forward rates are related to

interest differentials but in our

country also on demand and supply


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Forex treasury products Contd


y Currency Swaps

y for customers and

y for funding of proprietary transactions and

interest arbitragey Options and futuresy Investments

y Surpluses in short and long term foreign

currency assets treasury bonds, inter bankloans, Nostro balances and also FC loans todomestic customers


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Money markets


y Call money

y Notice money

y Term money

y

Treasury billy Commercial paper

y Certificate of deposit

y Repos and reverse repos (over night by RBI) &

acts as upper band and floor of money marketrates

y Bill rediscounting


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Securities market products


y Government securities (G-sec) and other

approved securities for SLR compliance

y

Market stabilisation schemey Corporate debt non SLR securities

yBoth medium & long term

yRatings, credit quality determine yields


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Corporate debt


y Debentures transferable only by registration

y Bonds transferable by endorsement and

delivery

y Convertible bonds

y Floating and fixed rate bonds

y Callable bonds

y Step up coupon bonds

y Deep discounting/zero coupon bonds


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Bonds Contd..


y Period bonds where repayment is in instalments

y Premium bonds where premium is paid on

redemption

yCollaterlised bonds

y Creation of trustee for managing the affairs and

protecting interest of investors in case of

debentures


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Investments in equity market


y Cap on investments at 20% of net worth

y Both in primary and secondary markets

y As a Qualified institutional investor

y Private placementy Requires an research desk


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Investments from/in

overseas markets


y FII investments

y ADR/ GDR issues of Indian corporates

y EEFC funds

y Foreign currency funds of banksy borrowings & lending in call money markets subject

to ceiling of 100 % and 25 % of net worth


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Preemptory reserves

- Funding aspects


y CRR currently at 5%

y Based on demand and term liabilities

y On fortnightly basis

y Min. 70% on each dayy Exempted liabilities include

y Inter bank, RBI , ACU, CCIL

y Capital, reserves

y ECGC /DICGC SETTLED CLAIMS


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SLR investments


y Currently at minimum 24% of NDTL

y Shortly going to be 25 %

y Approved securities include in addition to GOI

securitiesy Excess cash with branches

y State govt. securities

y Other securities as identified by RBI


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Regulations covering treasury


y Liquidity adjustment facility

y Repos & Reverse Repos

y Payment and settlement systems

yNegotiated dealing and

yRTGS , SFMS


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Risks in treasury


y We have credit, market and operational risks even

in treasury operations

y Credit risk in debt, equity and forexOTC activities

y

Market risks liquidity and interest-in alloperations

y Operational risk is very much present because of

wholesale nature of business


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Risk management


y Organisational controls

y Dual control on activities

y Internal controls

y Exposure ceiling limits

y position limits

y Deal size limits

y Open position limits

y Stop Loss limits


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Risk measurement


y Value at risk (VaR)

y It is an estimate of potential loss

y Derived from the volatility in the market

y

Volatility is the standard deviation of the price over achosen period

y Different methods for VaR

y correlation using historical data

y Simulation using various parameters

y Monte Carlo simulation using larger number ofparameters


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Bond yields


y Yield is

y different from interest (coupon) on a

bondyDepends additionally on price and

intermittent cash inflows (coupon

payments)

y It is IRR of the bond


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Bond yields


y Current yield is coupon divided by the current price

y Yield to maturity is the yield if the bond is held till it

matures

y

Two bonds with same YTM may have differentprices because of frequency of coupons


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Duration


y Duration of a bond is a measure of the time taken to recover

the initial investment in present value terms

y Duration is a measure of the average time prior to receipt of

paymentsy Every bond has a component of intermittent coupon

payments and repayment at maturity

y During the life of the bond if the market interest changes

the bonds price will be effected and also the rate at which

these intermittent coupon payments can be reinvested.


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Duration


y Duration takes into account the frequency ofcoupon payments and studies the pricemovements of a bond

y The period can be different for different bondsof same maturity because of size ofintermittent payments

y Duration of a bond where there is no

intermittent payments coincides with thetenor of the bond


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Duration Contd.


y It is obtained as sum of the weighted averages of

present values of inflows with weights being the

time in years of the respective coupons

y

Modified duration = D/ (1 + yield)y Price variation in percentage terms

= -MD * change in yield in bps


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Duration Contd..


y Longer the duration, higher is the volatility

y Treasurer arrives at the duration of a portfolio by

adding the durations of each of the member of the

portfolioy To protect the portfolio from any interest rate risk ,

the portfolio is to be held for a period equal to its

duration

y This process needs frequent shuffling of themembers since duration will change as the maturity

date approaches


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Derivative products


y Over the counter and exchange traded

y Forwards / Options

y Futures (stocks, currency & interest)

y Swaps ( currency , interest rate & basis)y Price insuring products( options)

y Price fixing products (others)


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Derivatives


Derivatives are used by

Market makers

HedgersSpeculators

arbitragers

Take an opposite position in derivative

market to the position in the underlying

/cash market


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Forwards


y OTC contracts

y Both parties are committed to contract (definite

delivery)

y

Price fixing in naturey Pay offs are linear to the underlying

y Existence of credit risk results in counter party

exposure limits

y Forward price = spot price + cost of carry


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Options


y Types by rights Call and Put

y Types by mode of settlement European and

American

y Types by benefity At the money, in the money and out of money

y Uses of options are as a hedge against price

risk and also for trading for profit


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Options Contd..


y In the money, at the money and out of money

depends upon whether the strike price is

better, equal or worse than the market price of

option

y Current price of an option will depend upon a

host of factors like underlying asset price and

its volatility, strike price, interest rates, time to

expiration

y All factors have a positive correlation with

strike price except the strike price


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Options Contd


There is a mathematical relationship between

the current prices of a Call and a Put option

with the same expiry date and same strike

price and is calledPUT CALL parity

V c V p =Pa X where

V c = value of call; V p= value of put

Pa = price of underlying asset and

X = PV of exercise price


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Futures


y Futures are both financial and commodity

y Currency futures are similar to forwards

y Currency, stock and index futures are hedginginstruments against price fluctuations

y Interest futures are a hedge against interest ratemovements

y Either delivery or back out


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Futures Contd..


Margin requirements

y Initial margin- enables trading in very high volumes

compared to own stake

y

Variable margin due to daily MTMy Maintenance margin (minimum margin to be

maintained at all times)


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Exchange traded currency futures


y Recently introduced as an exchange tradedproduct

y Banks complying with the following can beclearing members

y Minimum net worth of Rs. 500 crore.

y Minimum CRAR of 10 %.

y Net NPA should not exceed 3 %.

y Bank should have made a net profit in last 3

years.y Can trade for themselves/clients


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Exchange traded interest futures


y Underlying security is 10Yr 7% coupon G-Sec

y Contract size is Rs 2 lacs

y Tenor of the contract is max. 12 months

y Available contracts are 4 quarterly onesy Day count convention is 360 days


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Hedging investments risks with long

positions in futures


y Investors risk is a fall in market interestwhich would impact his return oninvestment. When interest rates fall price

of futures increases. By going long onfutures (s)he can take advantage of areduced interest situation in case ithappens which will offset his loss in

underlying market


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Pricing ofFutures


Spot price

+ cost of borrowing

income on the asset

= Futures price


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Swaps


y Interest rate , equity and currency swaps

y Interest rate swaps can be

y Floating to fixed

y Floating to floating or a basis

y Coupon swaps

y Forward rate agreement (FRA)

y Currency swaps

y Only principal

y Only interest

y Principal and interest


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RBI guidelines on derivatives


y Only plain vanilla swaps are permitted

y Banks can use them even for profit

y USD / INR and cross currency options are

permitted but only for hedgingy Specific RBI permission is required to trade in

options for profit

y Trading positions in derivatives to be MTM on

daily basisy Banks can become members of F&O segment to

trade in exchange traded derivatives


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Treasurys role in ALM


y Since treasury deals in large volumes of fundsit can both mobilise and deploy the funds asper the banks requirement eitherdomestically or in overseas centres

y Being in constant touch with market players,treasury can have a better estimate of futureinterest rate movements in the market

y Treasury is also engaged in determining the

transfer price mechanism


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Recap

Role of each segment in treasury

Relation between spot and forward rates

Relation between two spot rates

Diff. types in money market

Duration

Usage of repo & reverse repo in controlling liquidity



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THANK YOU


6. treasury management

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