treasury management
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7/17/2019 Treasury Management
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Treasury Management
Virtual classes for CAIIB
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Treasury management
Introduction to Treasury management
Treasury products
Funding and regulatory aspects Treasury risk management
Derivative products
Treasury and ALM
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Concept of treasury
Originally engaged as a service
centre
only in daily cash management
preemptive reserve
management
Restricted deployment of surplusfunds
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Concept of treasury contd
Currently !eing looked as a profit centre
"ith active operations in all the
markets in the country and a!roade#cept commodity markets
Continues to deal in only short term
markets e#cepting in case of $LR
investments and capital market
products
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Integrated treasury Implies merger of !oth domestic and foreign
markets meaning t%o %ay movement of funds
depending upon changing market scenarios
and emerging opportunities Fore#& money and e'uity markets
(eing possi!le due to li!eralised environment
As markets are integrated so are the risksDerivatives are used e#tensively for the risk
management
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)na!ling environment
Creation of clearing corporation of India
)sta!lishment of *$DL
Large num!er of *(FCs and mutual funds+rivate insurance providers
FIIs and FDIs
Availa!ility of derivative products in money&e'uity and fore# markets for interest and
price risk hedging
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Treasury,s role in profit ma#imisation
Treasury operations are more profita!le
due to
Large si-e deals leading to lesseroperational e#penses
Relatively risk free markets
*eed for lesser capital outlay .ighly leveraged and %ith higher
return on capital
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$ources of Treasury/s profits
Fore# market operations
!oth merchant and proprietary
Ar!itrage in different markets due to
time differentials though negligi!le
(oth in cash and derivative markets
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$ources of Treasury/s profits
Money market
$huffling of investments taking
advantage of price changes ininvestment holdings
(orro%ing and Lending in money and
Repos markets taking advantage of
inherent strengths
Retailing of 0ovt1 securities
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Organisation of treasury
Front office or dealing room Dealers in various segments carrying
actual tradesFore# markets 2 there can !e specialists
operating in for%ards& derivatives$ecurities markets2 generally in
secondary marketsInvestment desk operating in primary
markets
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Organisation of treasury
(ack office 3erification of deals done and
settlements thereof Accounting& maintenance of *ostros
and reporting to regulator
Middle office
Risk management and adherence tovarious e#posure limits and MI$ to(oard
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Fore# treasury products
$pot trades
For%ards
(oth for merchant cover operations
and proprietary trade for profits
0enerally for%ard rates are related
to interest differentials !ut in our
country also on demand and supply
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Fore# treasury products
ContdCurrency $%aps for customers and for funding of proprietary transactions and
interest ar!itrageOptions and futures Investments
$urpluses in short and long term foreigncurrency assets 4treasury !onds& inter!ank loans& *ostro !alances and also FCloans to domestic customers
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Money marketsCall money*otice money
Term money
Treasury !illCommercial paper
Certificate of deposit
Repos and reverse repos 5over night !yR(I6 7 acts as upper !and and floor ofmoney market rates
(ill rediscounting
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$ecurities market products
0overnment securities 502sec6 and other
approved securities for $LR compliance
Market sta!ilisation schemeCorporate de!t 4non $LR securities
(oth medium 7 long term
Ratings& credit 'uality determineyields
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Corporate de!t
De!entures transfera!le only !y
registration
(onds transfera!le !y endorsement and
deliveryConverti!le !onds
Floating and fi#ed rate !onds
Calla!le !onds$tep up coupon !onds
Deep discounting8-ero coupon !onds
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(onds Contd11
+eriod !onds %here repayment is in
instalments
+remium !onds %here premium is paidon redemption
Collaterlised !onds
Creation of trustee for managing theaffairs and protecting interest of
investors in case of de!entures
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Investments in e'uity market
Cap on investments at 9:; of net %orth
(oth in primary and secondary markets
As a <ualified institutional investor +rivate placement
Re'uires an research desk
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Investments from8in
overseas markets FII investments
ADR8 0DR issues of Indian corporates
))FC funds Foreign currency funds of !anks
!orro%ings 7 lending in call money
markets su!=ect to ceiling of >:: ; and9? ; of net %orth
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+reemptory reserves
2 Funding aspectsCRR currently at ?;
(ased on demand and term lia!ilities
On fortnightly !asisMin1 @:; on each day
)#empted lia!ilities include
Inter !ank& R(I & AC& CCIL Capital& reserves
)C0C 8DIC0C $)TTL)D CLAIM$
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$LR investments
Currently at minimum 9B; of *DTL
$hortly going to !e 9? ;
Approved securities include in addition to0OI securities )#cess cash %ith !ranches
$tate govt1 securities
Other securities as identified !y R(I
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Regulations covering treasury
Li'uidity ad=ustment facility Repos 7 Reverse Repos
+ayment and settlement systems
*egotiated dealing and
RT0$ & $FM$
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Risks in treasury
"e have credit& market and operational
risks even in treasury operations
Credit risk in de!t& e'uity and fore# OTCactivities
Market risks 4li'uidity and interest2in all
operations
Operational risk is very much present
!ecause of %holesale nature of !usiness
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Risk management
Organisational controls Dual control on activities
Internal controls )#posure ceiling limits
position limits
Deal si-e limits
Open position limits $top Loss limits
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Risk measurement
3alue at risk 53aR6 It is an estimate of potential loss Derived from the volatility in the market
3olatility is the standard deviation of the priceover a chosen period
Different methods for 3aR correlation using historical data
$imulation using various parameters Monte Carlo simulation using larger num!er of
parameters
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(ond yields
ield is
different from interest 5coupon6 on a
!ond Depends additionally on price and
intermittent cash inflo%s 5coupon
payments6
It is IRR of the !ond
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(ond yields
Current yield is coupon divided !y the
current price
ield to maturity is the yield if the !ond isheld till it matures
T%o !onds %ith same TM may have
different prices !ecause of fre'uency of
coupons
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Duration
Duration of a !ond is a measure of the time taken to
recover the initial investment in present value terms
Duration is a measure of the average time prior to
receipt of payments
)very !ond has a component of intermittent coupon
payments and repayment at maturity
During the life of the !ond if the market interest changes
the !ond/s price %ill !e effected and also the rate at
%hich these intermittent coupon payments can !e
reinvested1
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Duration
Duration takes into account thefre'uency of coupon payments andstudies the price movements of a !ond
The period can !e different for different!onds of same maturity !ecause of si-eof intermittent payments
Duration of a !ond %here there is nointermittent payments coincides %ith thetenor of the !ond
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Duration Contd1
It is o!tained as sum of the %eighted
averages of present values of inflo%s
%ith %eights !eing the time in years ofthe respective coupons
Modified duration D8 5> E yield6
+rice variation in percentage terms
2MD change in yield in !ps
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Duration Contd11
Longer the duration& higher is the volatility
Treasurer arrives at the duration of a portfolio !y
adding the durations of each of the mem!er of
the portfolio To protect the portfolio from any interest rate
risk & the portfolio is to !e held for a period e'ual
to its duration
This process needs fre'uent shuffling of the
mem!ers since duration %ill change as the
maturity date approaches
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Derivative products
Over the counter and e#change traded
For%ards 8 Options
Futures 5stocks& currency 7 interest6$%aps 5 currency & interest rate 7 !asis6
+rice insuring products5 options6
+rice fi#ing products 5others6
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Derivatives
Derivatives are used !yGMarket makers
G.edgersG$peculatorsGar!itragers
Take an opposite position in derivative
market to the position in the underlying
8cash market
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For%ards
OTC contracts
(oth parties are committed to contract
5definite delivery6+rice fi#ing in nature
+ay offs are linear to the underlying
)#istence of credit risk results in counterparty e#posure limits
For%ard price spot price E cost of carry
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Options
Types !y rights Call and +ut
Types !y mode of settlement )uropean
and American
Types !y !enefit At the money& in the money and out of
money
ses of options are as a hedge againstprice risk and also for trading for profit
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Options Contd11
In the money& at the money and out of
money depends upon %hether the strike
price is !etter& e'ual or %orse than the
market price of optionCurrent price of an option %ill depend
upon a host of factors like underlying
asset price and its volatility& strike price&
interest rates& time to e#piration All factors have a positive correlation
%ith strike price e#cept the strike price
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Options Contd
There is a mathematical relationship
!et%een the current prices of a Call and
a +ut option %ith the same e#piry date
and same strike price and is called+T 4 CALL parity
3 c 4 3 p +a 4 H %here
3 c value of call 3 p value of put+a price of underlying asset and
H +3 of e#ercise price
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Futures
Futures are !oth financial andcommodity
Currency futures are similar to for%ardsCurrency& stock and inde# futures are
hedging instruments against pricefluctuations
Interest futures are a hedge againstinterest rate movements
)ither delivery or !ack out
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Futures Contd11
Margin re'uirements
Initial margin2 ena!les trading in very
high volumes compared to o%n stake3aria!le margin 4 due to daily MTM
Maintenance margin 5minimum margin to
!e maintained at all times6
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)#change traded currency futures
Recently introduced as an e#changetraded product
(anks complying %ith the follo%ing can
!e clearing mem!ers Minimum net %orth of Rs1 ?:: crore1 Minimum CRAR of >: ;1 *et *+A should not e#ceed J ;1
(ank should have made a net profit in lastJ years1
Can trade for themselves8clients
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)#change traded interest
futuresnderlying security is >:r @; coupon
02$ec
Contract si-e is Rs 9 lacs
Tenor of the contract is ma#1 >9 months
Availa!le contracts are B 'uarterly ones
Day count convention is JK: days
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.edging investments risks %ith
long positions in futures Investor/s risk is a fall in market
interest %hich %ould impact his
return on investment1 "hen interestrates fall price of futures increases1(y going long on futures 5s6he cantake advantage of a reduced interest
situation in case it happens %hich%ill offset his loss in underlyingmarket
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+ricing of Futures
$pot price
E cost of !orro%ing
4 income on the asset
Futures price
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$%aps
Interest rate & e'uity and currency s%aps Interest rate s%aps can !e
Floating to fi#ed
Floating to floating or a !asis Coupon s%aps
For%ard rate agreement 5FRA6
Currency s%aps
Only principal Only interest +rincipal and interest
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R(I guidelines on derivatives
Only plain vanilla s%aps are permitted
(anks can use them even for profit
$D 8 I*R and cross currency options are
permitted !ut only for hedging
$pecific R(I permission is re'uired to trade in
options for profit
Trading positions in derivatives to !e MTM on
daily !asis
(anks can !ecome mem!ers of F7O segment
to trade in e#change traded derivatives
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Treasury/s role in ALM
$ince treasury deals in large volumes offunds it can !oth mo!ilise and deploy thefunds as per the !anks/ re'uirementeither domestically or in overseas
centres(eing in constant touch %ith market
players& treasury can have a !etterestimate of future interest rate
movements in the market Treasury is also engaged in determining
the transfer price mechanism
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Important from e#am point of vie%
Role of each segment in treasury
Relation !et%een spot and for%ard ratesRelation !et%een t%o spot rates
Diff1 types in money market
Duration
sage of repo 7 reverse repo in controlling li'uidity