Q1. Analyse the significance and objectives of asset liability management.?

Ans :- Asset Liability Management (ALM) Asset liability management refers to the strategic balance involving risk caused due to the changes ininterest rate, exchange rates and liquidity position in the organisation. The credit risk and contingency risk are the roots of ALM. During the post liberalisation period, India witnessed rapid industrial growth whichhas further inspired the growth of fund raising activities. The changes in the sources and features of funds were remarkable due to rise in demand for funds. Hence this reflected in the organisations profile and exposure limits in interest rate structure for deposits and advances etc. Significance The changing environment in assets and liabilities has brought the following significances of ALM in recent years: 1. Volatility The globalization scenario has led to increase in number of economies. This haspaved way for market driven economies due to the changing dynamics of the financial markets.These changes are reflected in interest rate structures, money supply, and credit position of themarket, exchange rates and price levels. Hence the organisation experiences low market value,net interest income etc. Product innovation The innovation in financial products has grown rapidly. Some of theinnovations are repacked with existing products with slight modifications. These have majorimpact on the risk profile in the organization enhancing the need for ALM. 3. Regulatory environment The integration of domestic and international market has enabled theregulatory bodies of financial markets to initiate number of measures. These measures preventmajor losses that occur due to market impulses. Management recognition The top management in the organisation realised that asset liability is neither a franchise for credit disbursement nor its a place for retail deposit base. It must be considered to relate and link the asset with liability. Hence the need for efficient asset liabilitymanagement came into existence.

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Objectives The objective of ALM is to achieve perfect match in assets and liabilities. The match is related to thechanges in the present value of assets and liabilities. The importance of ALM has led to the

change in thefunctional environment. The ALM objectives are divided into micro and macro levels.The macro level objectives deal with formulation of critical business policies, efficient allocation of capital and designing of products with suitable pricing strategies. At macro level, the ALM aims atobtaining profits through price matching while ensuring liquidity by maturity matching. The process of price matching ensures deployment of liabilities which are greater than costs. Q2. What are the features of a capital market? Ans:- Capital Market A financial market is an organization which permits the employees to trade financial securitieslike stocks, bonds, commodities and so on to raise its net capital in economy. A financial marketincludes parties like brokers, dealers, investment bankers and financial mediators.A capital market is an organization where securities like debt and equity are traded to raise long-term funds in the economy. The capital market is fragmented into stock market which tradeequity securities and the bond market which trade debt securities. Various financial instrumentslike equity, insurance, derivative instruments and so on are traded in capital market to enhanceliquidity.The regulation of an organization is essential for its perfect functioning. In Indian capital marketthe protection of investor's activity is carried out by Features of capital market are as follows: 1. Capital markets deal with primary securities like equities, bonds and so on. 2. Trading in capital market occurs without intervention of financial intermediary. 3. The information structure is complex. 4. The security prices are volatile in nature. Q3. Describe the approaches of CAC. Ans:- Approaches to Capital Account Convertibility (CAC) Capital Account Convertibility (CAC) refers to relaxing controls on capital account transactions. It meansfreedom of currency conversion in terms of inflow and outflows with respect to capital account transaction.Most of the countries have liberalized their capital account by having an open account, but they do retain someregulations for influencing inward and outward capital flow. Due to global integration, both in trade andfinance, CAC enhances growth and welfare of country.The perception of CAC has undergone some changes following the events of emerging market economies (EMEs) in Asia and Latin America, which went through currency and banking crises in 1990s. A few counties backtracked and re-imposed capital controls as part of crisis resolution. Crisis such as economic, social, humancost and even extensive presence of capital controls creates distortions, making CAC either ineffective orunsustainable. The cost and benefits from capital account liberalization is still being debated among academicsand policy makers. These developments have led to considerable caution being exercised by EMEs in openingup capital account. The Committee on Capital Account Convertibility (Chairman: Shri. S.S. Tarapore) whichsubmitted its report in 1997 highlighted the benefits of a more open capital account but at the

same timecautioned that CAC could pose tremendous pressures on the financial system. India has cautiously opened itscapital account and the state of capital control in India is considered as the most liberalized it had been since late 1950s. The different ways of implementing CAC are as follows: 1. Open the capital account for residents and non-residents. 2. Initially open the inflow account and later liberalise the outflow account. 3. Approach to simultaneously liberalise control of inflow and outflow account. Liberalization of current account transactions Current account transaction refers to converting domestic currencies freely into foreign currency and viceversa. The domestic currency is said to be convertible on the current account. This is known as current accountconvertibility. The benefits of current account transaction are as follows: 1. Current account convertibility enhances the increase of capital inflow in to the country. 2. The confidence of a country will be enhanced when the country will manage its affairs withoutexchange restrictions which enhance the international confidence in the countries policies. 3. Relaxing the exchange restrictions has improved the Balance of Payment (BOP) in the Country. The exclusion of exchange restrictions tends to increase the capital inflows and thus promote efficient allocation of inflows to the growth of the countrys economy. RBI has introduced more relaxations in current account transactions. The authorized dealers (ADs) have beenpermitted to provide exchange facilities to their customers up to specified limit without prior approval of theRBI. The liberalization rules regarding current account transaction of RBI under FEMA 1999 are as follows: Authorized Dealers of Category - I banks permits withdrawal of foreign exchange payments belowUSD 2million by the individuals and approval of Ministry of Commerce and Industry, GOI is notmandatory. As per the Rule 4 of FEMA (current account transactions), it is mandatory to get approval of Ministryof Commerce and Industries for drawing foreign exchange remittances ,when the payment exceeds5% on local sales and 8% increase on exports. Liberalized remittance scheme is a facility extended to the residents of India. Under this scheme; theresidents can remit in any current or capital account up to USD 2 million per financial year. Thisfacility is only for resident individuals. The resident individuals can purchase and hold immovableproperty or shares or debt instrument outside India, without the prior approval of RBI. Residents canopen, maintain and hold foreign currency accounts with banks outside India. The liberalizedremittance scheme is not applicable for the following:

Any purpose under Schedule I and any item under Schedule II are prohibited for remittance underForeign Exchange Management Rules 2000. The resident individual cannot remit directly to Nepal, Bhutan and Pakistan. There can be no remittances made directly or indirectly towards countries identified as non-cooperative countries and territories by the Financial Action Task Force (FATF). The individuals and organizations identified and advised by the RBI as significant risk of committing terrorism are not eligible for any remittances directly or indirectly. Liberalization of Exchange Earners Foreign Currency (EEFC) account - EEFC account is a foreign currencyaccount maintained by a resident individual with an authorized dealer in India. These accounts are noninterestbearing and they are used for hedging against foreign currency fluctuations by the business organizationswhich have exports and imports in foreign currency payments. Some of the liberalized measures in EEFCaccount are: RBI has permitted to earn interests on EEFC account if the outstanding balance is USD 1million. Due to liberalization, all categories of foreign exchange earners can avail credit in thisaccount based on their foreign exchange earnings. RBI decides on credit and debit limits. If the reimbursement for an international credit card is provided in foreign exchange, it maybe considered as a remittance through normal banking and the earnings can be credited toEEFC account. Other measures The other measure taken towards CAC is fuller capital account convertibility which is explained as follows: Fuller Capital Account Convertibility (FCAC) Indias cautious approach towards capital account and assessing it as a liberalisation process based on certain pre conditions has held India in good state. But with the changes that have taken place over the last twodecades, India felt the need to revisit the CAC and suggested a new map towards FCAC based on currentsituations. RBI, in consultation with the Government of India (GOI) appointed a committee on FCAC. S.STarapore was the chairman of committee. The committee suggested several recommendations for thedevelopment of financial market in addition to addressing issues related to interaction of monetary policy andexchange rate management, regulation and supervision of banks, and the timing and sequencing of capitalaccount liberalization measures. The objectives of FCAC are as follows: Economic growth - It facilitates economic growth through higher capital investment .This will lead togrowth in employment opportunities, infrastructure development and other areas. Improvement in financial sector - Huge capital flow into the system will lead to the improvement of financial sector which will enhance performance of the companies. This will enhance the liquidity inthe system.

Diversify the investment The diversification of investment will help ordinary people, to invest inforeign countries without restriction. This will help them to diversify their portfolio. Q4. Explain the IRR hedging techniques. Ans:- Bank uses a number of derivative instruments like interest rate futures, interest rateoptions, interest rate caps, collars and interest rate swaps to hedge against interest rate risk. Thefollowing are the IRR hedging techniques: Interest rate swaps Interest rate swap is the contractual understanding between twobanks under which one bank pays periodically to the other for a contracted time periodbased upon an estimated principal amount. Swaps transform cash flows through a bank toclosely match the cash flows pattern as desired by the management. From 1995, Reserve Bank of India (RBI) started allowing the usage of swaps bycounterparties in India from 1995 on a sequential case basis. Each transaction needs tohave an explicit RBI approval. However, RBI started to relax the rules from 1999 andallowed banks to enter into swap contracts and report such deals to it on a quarterly basis.Since 2005, swap related transactions have been legalized by a special approval from theparliament. The most common type of swap is the plain vanilla interest rate swap. In thisswap, a company agrees to pay cash flows equal to interest at a predetermined fixed rateon an estimated principal for a number of years. In return, it receives interest at a floatingrate on the same estimated principal for the same time period. The floating rate in mostinterest rate swap agreements is the London Interbank Offered Rate (LIBOR). LIBOR isthe rate of interest at which a bank is prepared to deposit money with other banks in theEurocurrency market and is a reference rate of interest for floating rate loans ininternational financial markets. Interest rate futures Interest rate future is an agreement between a buyer and a sellerthat calls for the delivery of a particular security in exchange for cash at some future date.It is a financial derivative with an interest bearing instrument as the underlying asset.Interest rate futures are used to hedge against the possible movement of interest rates inthe adverse direction. Buying an interest rate futures contract allows the buyer of thecontract to lock in a future investment rate. Interest rate caps An interest cap is an Over the Counter (OTC) derivative that protectsthe holder from rise in short term interest rates by making a payment to the holder whenan underlying interest rate exceeds a specified strike rate. Interest rate caps protect anindividual holder from the increase in market interest rates. Borrowers are assured thatthe organisations which lend them money cannot increase their loan rate above the levelof the cap. When conditions of loss arise, the banks buy interest rate caps. Interest rate floors - A bank holds on establishing an interest rate floor under its loans sothat during certain situations like dropping of loan rates, it is guaranteed some minimumrate of return. Bank

uses interest rate floors when their liabilities have longer maturitiesthan their assets or when they are funding floating rate assets with fixed rate debt. Interest rate collars - This instrument combines an interest rate cap and an interest ratefloor in one agreement. The collars' purchaser pays a payment for the rate cap whilereceiving a premium for accepting the rate floor. The net premium paid for the collar canbe positive or negative, depending upon the interest rate view. Banks can use collars toprotect their earnings when interest rates appear to be volatile and there is considerableuncertainty about the movement of market interest rates. Q5. Define VaR and illustrate its components? Ans:- VaR is the most popularly used and powerful tool to calculate, tackle and control market risk. VaRgained so much of importance only because it is easily and spontaneously understood in simple terms. It isused to communicate easily within the company, and between the company and its investors.The biggest advantage of VaR lies in the implementation of a structured methodology for analytical thinkingabout risk. With the growing importance of VaR, firms need to compulsorily tackle their exposure to financialrisk and set up independent risk management departments supervising the financial fluctuations.VaR estimations should not be considered as an accurate number since it does not produce accurateinformation. However, it indicates the amount of risk involved. It also helps in identifying the developments inthe behaviour of individuals, companies or markets.There is no other risk management tool that addresses most of the aspects of risk measurement in a singleframework. Therefore VaR has been proved as a very successful tool. Multiple organizations acknowledgedthe importance of VaR in handling various risks faced by financial institutions irrespective of its shortcomings. Components of VaR VaR can be defined as the maximum amount of loss a portfolio of securities can face from uncertain eventsover a specified time period with a specified level of probability. For example, a trading security has a VaR of Rs. 20 lakhs for one day at a probability of 10%. It means that the firm can expect a loss of Rs. 20 lakhs in oneday with a probability of 10%. This indicates that there is a probability of 90% that the firm cannot lose morethan Rs. 20 lakhs in one day. The components of VaR are market factors, factor sensitivity, market volatilityand defeasance period. Market factors Any external factor that brings changes in the price of an instrument is a market factor. VaR methodologiesdiffer with respect to the simulation and changes in transformation of market rates. Large institutions requiresimulation of thousands of general and specific market factors to compute VaR. Factor sensitivity It is the impact of movements of portfolio of assets in the relying risk parameter of an individual asset. Toestimate the component VaR of factor, its marginal VaR should be multiplied with the evaluated factorsensitivity. Market volatility

The factors or events which cannot be predicted are market volatility. It illustrates the investment opportunitiesin the future. Previous studies regularly and strongly support the relationship between the stock marketvolatility and the priced factors. Defeasance period It is the time consumed to liquidate the position on the basis of liquidity in the secondary market. This periodincreases VaR. Defeasance period is vibrant and fluctuating. It also experiences changes on account of product-specific or general market conditions Q6. What are the functions and benefits of integrated treasury? Ans:- Let us first understand the concepts and benefits of integrated treasury management.Treasury function was restricted to fund or liquid management. Fund management includesmaintaining adequate cash balances to meet the daily requirements, implementing the surplusfunds in other operations, sourcing the funds to even the gaps in cash flow. The treasurydepartments in banks are responsible to meet the Cash Reserve Requirement (CRR) and investthe funds in securities under Statutory Liquid Ratio (SLR). Treasury basically deals with short-term cash flows(less than one year), but investment in some securities exceeds more than oneyear.Integrated treasury came into existence as a result of financial reforms, the most important beingthe deregulation of rupee and partial convertibility of rupee. Rupee is freely convertible oncurrent account. Due to the relaxations of RBI in Foreign Direct Investment (FDI), rupee is nowpartially convertible on capital account. Banks are permitted a larger limit in terms of their networth, and overseas borrowing and lending. The functions of integrated treasury are notrestricted to traditional functions.The major functions of integrated treasury are as follows: Performing reserve management, which involves meeting CRR and SLR obligations. Deploying surplus funds in securities which have low risk and earn profits. Performing global cash management. Providing effective and efficient merchant services. Improving the profit by exploring market opportunities in money market, securitiesmarket and forex market. Assisting the banks in Asset-Liability Management (ALM). Managing market risk for the entire bank.Treasury is the back bone of the financial institutions and banks. Integrated treasury helps banksand financial institutions to effectively manage the resources and comply with the regulatoryrequirements.The benefits of integrated treasury are as follows: Improves cash planning and monitors the cash position of the organisation.

Prepares the financial statement and other financial reports for analysis, financial controland budgeting. Allows greater financial control by integrating budget and budget execution data. Enhances the quality of data for budget execution.