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8/3/2019 6. Treasury Management
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Treasury Management
8/3/2019 6. 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
MBA Jain University NVH Krishnan3
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
MBA Jain University NVH Krishnan4
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
MBA Jain University NVH Krishnan5
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
MBA Jain University NVH Krishnan6
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
MBA Jain University NVH Krishnan7
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
MBA Jain University NVH Krishnan8
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
MBA Jain University NVH Krishnan9
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
MBA Jain University NVH Krishnan10
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
MBA Jain University NVH Krishnan11
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
MBA Jain University NVH Krishnan12
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
MBA Jain University NVH Krishnan13
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
MBA Jain University NVH Krishnan14
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
MBA Jain University NVH Krishnan15
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
MBA Jain University NVH Krishnan16
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..
MBA Jain University NVH Krishnan17
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
MBA Jain University NVH Krishnan18
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
MBA Jain University NVH Krishnan19
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
MBA Jain University NVH Krishnan20
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
MBA Jain University NVH Krishnan21
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
MBA Jain University NVH Krishnan22
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
MBA Jain University NVH Krishnan23
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
MBA Jain University NVH Krishnan24
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
MBA Jain University NVH Krishnan25
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
MBA Jain University NVH Krishnan26
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
MBA Jain University NVH Krishnan27
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
MBA Jain University NVH Krishnan28
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
MBA Jain University NVH Krishnan29
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.
MBA Jain University NVH Krishnan30
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..
MBA Jain University NVH Krishnan31
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
MBA Jain University NVH Krishnan32
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
MBA Jain University NVH Krishnan33
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
MBA Jain University NVH Krishnan34
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
MBA Jain University NVH Krishnan35
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..
MBA Jain University NVH Krishnan36
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
MBA Jain University NVH Krishnan37
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
MBA Jain University NVH Krishnan38
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..
MBA Jain University NVH Krishnan39
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
MBA Jain University NVH Krishnan40
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
MBA Jain University NVH Krishnan41
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
MBA Jain University NVH Krishnan42
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
MBA Jain University NVH Krishnan43
Spot price
+ cost of borrowing
income on the asset
= Futures price
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Swaps
MBA Jain University NVH Krishnan44
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
MBA Jain University NVH Krishnan45
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
MBA Jain University NVH Krishnan46
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
MBA Jain University NVH Krishnan47
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THANK YOU
MBA Jain University NVH Krishnan48