The Institute of Chartered Accountants of IndiaCommittee on Capital Market & Investors Protection

(Set up by an Act of Parliament)

New Delhi

Theory and Practice of Forex and Treasury

Management

Theory and Practice of Forex and Treasury M

anagementM

odule - I

Module - I

ISBN: 978-81-8441-812-5

Committee on Capital Market & Investors Protection The Institute of Chartered Accountants of IndiaICAI Bhawan, Main Building, 2nd Floor, Post Box No. - 7100, Indraprastha Marg, New Delhi - 110 002, India Phone - 011 - 30110473Email id : ccmip@icai.in February/2019/P2422 (Revised)

12CFMIP04-0219

Certificate Course on Forex and Treasury Management

Module-I

The Institute of Chartered Accountants of India (Set up by an Act of Parliament)

New Delhi

© The Institute of Chartered Accountants of India All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means electronic, mechanical, photo-copying, recording, or otherwise, without the prior permission, in writing, from the publisher. All disputes are subject to Delhi jurisdiction only.

DISCLAIMER The views expressed in this book are of the author(s). The Institute of Chartered Accountants of India may not necessarily subscribe to the views expressed by the author(s) The information cited in this book has been drawn from various sources. while every effort has been made to keep the information cited in this book error free, the institute or any office of the same does not take the responsibility for any typographical or clerical error which may have crept in while compilling the information provided in this book. Basic draft for Module I(Chapters 1,2,3,4,5 & 6) is developed by Dr. P. Siva Rama Prasad.

Second Edition : February, 2019

Committee/Department : Committee on Capital Market & Investors Protection

E-mail : ccmip@icai.in

Website : www.icai.org

Price : `

ISBN : 978-81-8441-

Published by : The Publication Department on behalf of the Institute of Chartered Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg, New Delhi - 110 002.

Printed by : Sahitya Bhawan Publications, Hospital Road, Agra - 282 003. February/2018/P2226

Foreword to the Second Edition

By definition, Treasury is a depository where wealth and precious objects can be stored safely. However, in business parlance the term is much broader to cover different aspects of funds management. In view of functional importance, even governments of various countries have segregated treasury management as a separate specialised activity. In business, main treasury management function is related to managing funds in most optimum manner and covers activities such as raising of long-term capital, raising working capital and investing surplus funds. The treasury function has been a challenging area to everybody connected with it as it is important to take quick decisions to mitigate the risks, optimize returns and at the same to ensure adequate financial liquidity for normal functioning of organisation.

Historically, large banks have the stronghold on the provision of treasury management products and services banks and have dedicated departments of treasury management for supporting their clients' needs in this area. Now, smaller banks are also increasingly launching and expanding their treasury management functions and offerings. All this is possible in view of the market opportunities accorded by the recent economic environment, availability of highly seasoned treasury management professionals, access to industry standard, third-party technology providers', products and services made according to the needs of smaller clients, and investment in education and other best practices.

I am glad that the Committee on Capital Market & Investors’ Protection of the Institute of Chartered Accounts of India is bringing out the second edition of the ‘Theory and Practice of Forex and Treasury Management’. This publication covers various facets of Treasury Management in three modules. I take this opportunity to congratulate CA. Rajesh Sharma, Chairman, CA. Sushil Kumar Goyal, Vice Chairman and the entire team of the Committee on Capital Market & Investors Protection for their initiatives and endeavours.

Date: 05. 02.2019 CA. Naveen ND Gupta

Place: New Delhi President, ICAI

Preface to the Second Edition

Treasury department of an organization is a subset of broader financial system of an organization. Treasury management is an important function in big size corporate houses, banks and organizations which is why we have a separate treasury department in such entities.

The strategic importance of the treasury organization has increased steadily over the past few years and has impacted their structure and scope. Treasury organizations have become more important reflecting the increasing complexity of business strategies and are expected to continue to respond to the increasing pace of change. Finding the right response to the right questions on the treasurer’s and CFO’s agenda can make the difference between a thriving company with a solid credit rating and an organization struggling with liquidity and credit downgrades. Therefore, having a scalable and clearly defined target treasury organization, as well as a forward-looking governance structure, is crucial.

Companies have also come under increased pressure from shareholders and regulators to increase transparency and improve financial performance. These expectations are leading to a significant change to the treasury function as activities are increasingly being centralized. Many organizations have just begun designing future target operating models for their treasury organization.

In any department or function which requires specialized skills and knowledge in that area, we need to be an expert of that particular area. To understand the complex treasury system in financial market we come across treasury functions. We have tried to cover most of the treasury functions into this background material that it will cater in understanding the treasury functions.

I wish to place on record my sincere gratitude to CA. Naveen N D Gupta, President, ICAI and CA. CA. Prafulla Premsukh Chhajed, Vice-President, ICAI for their vision and support to the Committee on Capital Market and Investors Protection.

I would like to thank CA. Sushil Kumar Goyal, Vice Chairman and all the members of the Committee on Capital Market and Investors Protection, CA. Anil Satyanarayan Bhandari, CA. Dhiraj Kumar Khandelwal, CA. Shiwaji Bhikaji Zaware, CA. M. Devaraja Reddy, CA. G Sekar, CA. K Sripriya, CA. Ranjeet Kumar Agarwal, CA. Kemisha Soni, CA. Atul Kumar Gupta who have extended their support and encourage in all committee activities.

I would also like to thank the study group members on capital market CA. Vinod Bansal, CA. Bhatt Madhavendra Krishna, CA. Aman Chugh, CA. Ashwany Kumar Sawhney, CA. Ankit

Garg, CA Madhur Bansal, Shri. TR Shastri, Shri. P Siva Rama Prasad for their technical support and Shri Priyanshu Malhotra, Secretary, Committee on Capital Market & Investors Protection for the administrative support in bringing out this background material on Forex and Treasury Management. Date: 06.02.2019 CA. Rajesh Sharma Place: New Delhi Chairman,

Committee on Capital Market & Investors Protection, ICAI

Contents

S.No. Title Page No.

1. Treasury – Organisational Structure • Treasury – Its Evolution and Objectives • Organisation Structure of Treasury – Front, Back & Mid Office • Functions of Treasury Department • Role of Treasury and Treasurer in:

o Raising Capital o Managing Bank Relationships o Money Management o Treasury Performance Management o Liquidity Management o Credit Management o Forex Management o Risk Management

• Responsiblities of a Treasurer • Intergrated Treasury Management - Cost Centre and Profit

Centre

1-30

2. Treasury — Process • Treasury Management - Systems and Techniques • Treasury Policy and Procedure Manual • Delegation with Accountability:

o Open Position Limits: Daylight, Overnight, Asset Position Limit, Intraday Limit

o Deal Size, Individual Dealer’s Limit o Stop Loss Limits

• Control and Reporting Requirements • Dealing and Trading Operations – Control and Orderly Conduct,

Moral and Ethical Codes, Checks of Balances, Sigining Ethical Code Agreement

• An insight into: o Float, Availability, Swaps

31-67

o Account Analysis, Clearing Houses o Lockboxes, Disbursement

• Benchmark Rates for Discounting Cash Flows • Liquidity and Cash Flow Management - CRR

o Objectives, Sources and Deployment o Internal Control, Netting, Gap Management

• Treasury Management Processes like Domestic Treasury Remittances, International Treasury Remittances

• Payment & Settlement Systems, CCIL, CLS, RTGS, NEFT and SWIFT

• Dealing Room Operations: Nostro / Vostro/ Loro , Mirror A/cs – Open Currency Position, Cash Position by Dealers

3. Treasury — Domestic • Classification of Treasury Market:

o Domestic or National Treasury Market o Forex or International Treasury Markets

• Money Market: o Need for the Market – Participants o Types of Interest / Yield Rate Quotations o FIMMDA, Role of CCIL and Products – CBLO (Collaterized

Borrowing and Lending Obligation), NDS-OM, CROMS • Money Market Instruments:

o Government Securities - Treasury Bills - Promissory Notes - Fixed Income Securities

o Repurchase Agreements (REPOS / Reverse Repo) o RBI Money Market Operations like Sterilization and Non-

Sterilization - LAF o Commercial Paper, Certificate of Deposits. o Alternative Investments - Bills Discounting, Refinance and

Rediscounting Facilities, Inter Bank Dealings, Factoring, Forfating Mutual Funds

• Capital Markets: o Primary & Secondary Market o Principles of Valuation-Settlements of Transactions

• Bond Market – Types and its Futures o Corporate Bonds, Zero Coupon Bonds ,Perpetual Bonds o NCDs, STRIPS, Venture Capital, Private Equity, Angel

68-138

Funds, Investment in ARCs. • Understanding Current Yields, YTM, Changes in Yields,

Different Maturities of Treasury Bonds, Revaluation – Mark to Market and Profit Calculations, VaR (Value at Risk)

• Negative list of investments. • Guidelines on Non-performing investments. • Commodity Market:

o Structure of Commodity Market o Leading Commodity Exchanges in India o Commodity Futures Trading in India o Linkage Domestic with Foreign Operations

4. Treasury — Forex • Foreign Exchange Markets:

o Different Kinds of Inter - Bank Forex Markets o Highly Traded Markets - Cash/OTC o Nature of Transactions o Cross Border Currency Flows o Liberalization of Exchange Control o Role of Banks in Forex Market o Factors Impacting Forex Market o Convertibility and BOP

• Forex Concepts: o Exchange Rate Quotes o Factors affecting Exchange Rates o Exchange Rate Mechanism o Spot and Cross and Forward Rates o Premium and Discount o Forward Contracts–Booking, Extension, Cancellation

• International Treasury: o Market Participants o Various Forex Treasury Products o Volatility of Major Currencies o Currency Trading o Global Securities – Portfolio Management

• External Commercial Borrowings (ECBs)

139-271

o FEMA Regulations for Import / Export Transactions - Current A/c Rules – Capital Account Transactions

o FDI / FPI Guidelines in India and impact of Inflows & Outflows on Forex Treasury

o GDRs / ADRs, Pass Through Certificates o Loan Syndications and FRN o Interest Rates and Volumes

of Tax Implications o International Funding Organisations o Impact of Recent Global Crises – Role of IMF,

FEDAI/WORLD BANK/NEW DEVELOPMENT BANK/AIIB BANK

• Derivative Markets o Futures, Options and Swaps o Price Calculation of Various Instruments o Swaps - Outright Deals, Dealer Operations o Trends in Futures Market o Short Term Interest Rate Futures

• Practical Concepts of Options Market: o Comparison on Options & Synthetics o Rules of Options – OTC/Exchange Traded o Option Strategies like KIKOs

• Black Scholes and Beyond – In Options. • Settlement of Futures / Option Contract • Swaps Market:

o OIS Swap o MIFOR Swap o INBMK Swap o Coupon - Only Swap o Hedging of Buyers Credit / ECB

• Hedge Accounting • Standard International Agreements

5. Treasury — Mathematics • Concept of Time Value of Money • Hypothesis Testing – Time Series Analysis • Technical Analysis – Evaluating Securities

272-358

• Linear Programming – Decision Making – Simulation • Core Tools for Cash Management - Cash and Liquidity

Forecasting • YTM – Yield Curve, Modified YTM, Current Yield, Different

Versions – Callable Bonds, Callable Yield Notes, Puttable Bonds

• Building ZCC and and Use of ZCC Yields. • Bootstrapping Process to derive the Zero Curve. • Liquidity & Interest Rate Sensitivity Gap measures – RBI

Guidelines. • Bond & Securities Valuation – Bond Dynamics – Duration –

Modified Duration • Risk Measures – VaR – Mecaulay Duration • Back Testing of VaR:

o By Historical Simulation Method o By Monte Carlo Simulation Method

• Investment Appraisals • Financial Statement Analysis:

o Cash Return on Assets Ratio o Returns Ratios o Solvency Ratios o Liquidity Ratios o Profitability Ratios and Growth o Efficiency Ratios & Valuation Ratios

6. Treasury — Technology • Role of Information Technology in Treasury Management –

Global Scenario • Overview of Software used in Treasury – Banks, Insurance

Companies and Corporates • Storage of Data Files - Reports Generation, IT Risks Mitigation

Measures like Business Continuity Plan (BCP), Disaster Recovery Plan (DRP) and Transaction Protections

• Bloomberg / Thomson Reuters screenshot showing Forward Markets and their Interpretation. FX Swap Curve across the globe and Indian and Correlation between Swap Curves

359-418

1 Treasury – Organisational Structure

Treasury – Its Evolution and Objectives Evolution of the Treasury Function In the early stages, the treasury function was undertaken by banks, which managed the inflow and outflow of cash. As economies grew complex, the regulators rolled out guidelines for the management of funds. The role of the treasury in banks was then enhanced but still restricted to dealing in permissible securities and managing the funds flow. Over a period of time, the role of the treasury in Indian banks has evolved from just being the cash manager to the risk manager. The departments have now assumed a strategic role and undertake profit-making activities within the stipulated risk framework so as to reduce the cost of funds. Typically, a bank treasury would be organised into: • Money market desk • Forex desk • Capital market desk • Asset liability management desk • Risk management desk • Transfer pricing desk The desire to reduce the cost has led to mammoth growth of the corporate treasury in large and mid-sized corporates. A corporate treasury department can be viewed as an in-house solution for managing the funds of the business house. The corporate treasury performs functions such as cash management, liquidity planning, procuring finance and managing risk for the business. The turbulent and unstable global economic environment is a contributing factor in the growth of the corporate treasury in India. Companies now aim at preserving wealth along with riskless profit making. The corporate treasury can be viewed as an in-house bank, providing services to various departments of the organisation. However, the scale of operations is much larger for banks. Corporate treasurers are continuously battling with issues such as cash visibility, exposure recognition as well as the absence of a long-term treasury strategy.

Module 1 : Certificate Course on Forex and Treasury Management

2

Treasury management (or treasury operations) include management of an enterprise's holdings, with the ultimate goal of maximizing the firm's liquidity and mitigating its operational, financial and reputational risk. Treasury Management includes a firm's collections, disbursements, concentration, investment and funding activities. In larger firms, it may also include trading in bonds, currencies, financial derivatives and the associated financial risk management. Most banks have whole departments devoted to treasury management and supporting their clients' needs in this area. Until recently, large banks had the stronghold on the provision of treasury management products and services. However, smaller banks are increasingly launching and/or expanding their treasury management functions and offerings, because of the market opportunity afforded by economic environment (Banks of all sizes focusing on the clients they serve best), availability of highly-seasoned treasury management professionals, access to industry standard, third-party technology providers' products and services tiered according to the needs of smaller clients, and investment in education and other best practices. For non-banking entities, the terms Treasury Management and Cash Management are sometimes used interchangeably, while in fact, the scope of treasury management is larger (and includes funding and investment activities mentioned above). In general, a company's treasury operations come under the control of the CFO, Vice-President / Director of Finance or Treasurer, and are handled on a day-to-day basis by the organization's treasury staff, controller, or comptroller. Bank Treasuries may have the following departments: • A Fixed Income or Money Market desk that is devoted to buying and selling interest

bearing securities. • A Foreign exchange or "FX" desk that buys and sells currencies. • A Capital Markets or Equities desk that deals in shares listed on the stock market. • A commodity Desk to deal in commodities like crude, gold and metals. In addition, the Treasury function may also have a “Proprietary Trading” desk that conducts trading activities for the bank's own account and capital, an Asset Liability Management (ALM) desk that manages the risk of interest rate mismatch and liquidity and a Transfer Pricing or Pooling function, Price liquidity business lines (Liability & Asset sales teams) within the bank. As businesses recover from the global meltdown, treasury management is becoming essential. Treasury management has long been an important aspect of many corporations’ financial management. It ensures that the business is accurately tracking its daily sales and payments in an effective manner, while also having sufficient liquidity to meet both expected and unexpected financial obligations.