Treasury

Division & its

functions
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 TREASURY ACTIVITIES
Treasury Division – Heart of the
bank
 Managing Asset & Liabilities of the bank –
‘The Balance Sheet Management’.
Thereby enhancing the risk-adjusted
return on equity.

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 Objectives: Maximizing Risk Weighted
Returns
Risk Weighted Returns take into account liquidity and interest rate gap
risk associated with certain asset or liability instead of applying same
interest rate to assess the cost/return of liability/asset
e.g.: Branch ‘A’

Liabilities:
Assets:
i. Cash
i. Current Deposits
ii. Running Finance & ERF
iii. Advances linked with
ii. Savings Deposits
KIBOR, T Bills – Short Term
iii. Term Deposits (TDRs)
iv. Advances linked with PIBs
- Long Term Fixed
iv. Interest Payables
v. Advances linked with PIBs
v. Others
- Long Term Floating

vi. Investments – Advances

converted into Bonds
vii. Others
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 MONEY MARKET

MECHANISM, MARKET
& INSTRUMENTS
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 Functions of Money Market Desk
The need for financial institutions to indulge in money market transactions arises
primarily from the statutory reserve and liquidity requirements imposed by the
State Bank.
Statutory Liquidity
Statutory Cash Requirement
Reserve
Requirement

Average 5% of Total Time

& Demand Liabilities for Week 15% of TDL
& Minimum Daily 4% of TDL in Eligible Liquid Assets

1. Treasury Bills
A/C with SBP
2. FIBs/PIBs Not More Than 5% of TDL
Rate of Return = 0% 3. Reverse Repos - Repos
Opportunity Cost = Av. Weekly 4. Other Approved Assets i.e. NIT,
O/N Rate Cash in Vault, Foreign Currency Held,
Excess in SCR etc.

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 MARKET TYPES

Primary Market
This constitutes all securities issued for
the first time.

Secondary Market
The securities issued in the primary
market are then traded in the secondary
market among banks, investors etc.

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MARKET PARTICIPANTS

Commercial Banks /NBFIs.

State Bank of Pakistan.
Corporate Treasuries.
Public Sector/Government.
Inter-Bank Brokerage Houses-
Playing the role of facilitators.
Exchange Companies

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 PRIMARY DEALER SYSTEM

 The PDs are Price makers, quoting two-way

prices reflective of market sentiment and actively
participating in trading of all marketable securities.


PD must be a Band/ DFI/ Investment Bank/ Listed
Brokerage House.


The PD status is assigned by the SBP.

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 Money Market Activities
Money Market Transactions
Call/Term lending/borrowing
Clean lending/borrowing among banks.
Providing KIBOR as a benchmark for term
lending to the corporate sector.
Less developed as compared to other
countries because of the presence of more
developed REPO/Reverse REPO market.

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 Money Market Activities
Money Market Transactions Cont’d.
 REPO/Reverse REPO
Repurchase of securities. Introduced in
early 80s. Akin to Collateralized lending
borrowing and Governed by Master REPO
Agreement.
Securities usually repurchased are T Bills,
FIBs, PIBs etc.

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 Money Market Activities
Money Market Transactions Cont’d.
 Outright Purchase/Sale of Securities
Purchase of government securities i.e.
Treasury Bills and Pakistan Investment
Bonds (PIBs) for portfolio management.
Purchase/Sale of securities is based on the
portfolio strategy and market conditions.

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 Money Market Activities

Major Money Markets instruments.

Market Treasury Bills.
 3, 6 and 12 months maturity, zero coupon
instruments priced at discount.
 Issued by Govt. to finance current expenditure.

Sold by SBP through auctions.
 Risk free, highly liquid and reserve eligible.

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 Money Market Activities
Federal Investment Bonds.
 Half yearly coupon bonds. 3,5 & 10 years
maturity.
 Discontinued in the Primary Market
 Issued by GoP, these bonds are only traded
in the secondary market.
 Are SLR eligible security.

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 Money Market Activities
Pakistan Investment Bonds.
 Launched in the year 2000 to replace FIBs as
a long term investment.

Half yearly coupon bonds. 3, 5, 10, 15 & 20
years maturity. Are sold to Primary Dealers
through auction.
 Active secondary market catering to banks
and institutional investors etc.
 Are SLR eligible securities up to 5% of DTL.

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 Money Market Activities
Outstanding Stock

T-Bills PKR 274.6 billion

PIBs PKR 278.9 billion

DTL PKR 2,090 billion

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 MARKET YIELDS
T-Bills

Tenor W.A.Rate(%) Cut-Off (%) Mkt.Yield%

3-Months 3.9161 3.9462 3.75-3.60%

6-months 3.7321 3.8426 4.10-3.90%

1-Year 4.4290 4.4946 4.70-4.50%

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 MARKET YIELDS
PIBs

Tenor Coupon Rate(%) Cut-Off (%) Mkt.Yield(%)

3-Year 6.00 4.3500 5.60-5.40%

5-Year 7.00 5.3500 6.70-6.50%

10-Year 8.00 7.3700 7.75-7.65%

15-Year 9.00 8.9988 8.85-8.70%

20-Year 10.00 9.9942 9.85-9.70%

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 BENCHMARK RATES
Discount Rate
 The SBP discount window facility offer funds to banks
as the lender of last resort.

Current rate is 7.5%.

Karachi Inter-bank Offer Rate (KIBOR):

 Lending rate for 1, 2 weeks and 1, 3, 6, 9 and 12
months.
 Recently established as a benchmark rate for all
corporate term lending.

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 BONDS
Investments for period of more than 1
year.
Currently, PIBs are auctioned by SBP
(traded in Primary Market).
FIBs are no more auctioned and are
traded in the secondary market.
Riskier than T-Bills because of longer
maturity and presence of coupons.

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 Bonds’ Pricing
A Bond’s price is simply the present value
of its:

Coupons to be received during life of the
bond, and
 Principal repayment at the maturity.

Price = C1 + C2 + .…………………+ Cn + FV

1+ i (1+ i)2 (1+ i)n (1+ i)n

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 Bonds’ Pricing
Issued / traded at Premium or Discount
depending upon the coupon rate and the
market yield for the tenors.
Bond trades at Premium when:
Coupon Rate > Market Yield
and vice versa.

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 Bonds’ Pricing
Bonds’ price (whether at premium or at
discount) converges to its par value as the
bond reaches its maturity.

Premium Bond

Maturity
Par
Value

Discount Bond
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Sensitivity Measures for Bonds
Duration

Price Value of a Basis Point (PVBP or PV01)

Convexity

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 Duration
Measures the Interest Rate Risk or Price Risk.
Measures the change in price of the bond
w.r.t change in the yield.
Price

Change in Price as the yield drops by

1%

Yield
3% 4%

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 Duration
Higher for papers with longer maturity.
Lower for bonds with higher coupon rate.
For a zero coupon bond, duration is
approx. equal to life of the bond.
However, duration of a zero coupon
security is higher compared to that of
coupon bonds.

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 PVBP
Calculates the change in price as a result
of 1 basis point (0.01%) change in yield.
As Duration measures the change in price
for 100 basis point change in yield, PVBP
is:

PVBP = Duration (for 1%) / 100

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 Convexity
The change in duration for a change in yield.
Convexity adjusts the flaw in the price estimated
by duration, especially for larger changes in the
yield.

Convexity
Price Adjustment

Price estimated
through Duration

Yield
1% 4%

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 Convexity
Duration underestimates the increase in
Bond’s price and overestimates the
decline.
Therefore, Convexity adjustment is to be
added to the duration estimate in both the
cases of price increase or decrease.

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 Interest Rate Derivatives

Interest Rate Swap (IRS)

Forward Rate Agreement (FRA)

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 The Derivatives Market
A Derivative transaction is a contract whose value
depends on (or derives from) the value of an underlying
asset, reference rate or index. (Group of Thirty, Global
Derivatives Study 1993).
Underlying asset may refer to:

Currency
 Interest Rate
 Stock Price

Commodity
Derivatives are sometimes referred to as ‘contingent
claims’.
Derivatives contracts are of two types:

Exchange traded contracts.

OTC (Over the Counter) Contracts.

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Forward Rate Agreement (FRA)
An agreement to fix interest rate for a future transaction
based on a certain benchmark.
Agreement to borrow/lend an amount of money (nominal
principal)…
 At a specified future date (‘settlement date’)

For a specified tenor

For a specified interest rate (‘forward rate’)
FRA buyer hedges against rising interest rates.
Buy a 6-over-9M FRA for PKR10 Million at 9%

Agreement to…...
Borrow PKR 10 Million for 3M
At a date 6M from today
At 9% cost

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 FRAs – A Practical Example
A bank needs to fund a six month fixed rate Dollar Loan.
Two choices are available:

 Borrow for six months at KIBOR, 8 3/8%.

 Fund the first three months using its own funds at a cost of 8
1/16%.

In choosing option 2 the runs the risk that interest rates will rise within
three months and that overall funding cost will be above 8 3/8%

To guard against this risk, the bank could buy a three against six FRA
which is being quoted at 8 ¼ - 8 ½ ..

By buying a 3/6 FRA at 8 ½ % the bank locks in a borrowing cost of 8

½ % from the third to the sixth month. The overall cost of borrowing in
this fashion is 8.36% almost exactly the same as borrowing for six
months at 8 3/8 %.
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Forward Rate Agreements - Settlement
Suppose after three months, three month KIBOR has risen
to 10 ½ %. The bank receives the difference between the
current KIBOR and the agreed FRA rate (10 ½ - 8 ½ = 2%).

Suppose FRA bought had been for a notional principal of

PKR 10 M. Settlement would be as under:

The buyer of the FRA would gain 2% on PKR 10 M for

three months, discounted to take account of the fact that it
is being paid at the start rather than the end of the three
month period. This comes to :
PKR 10,000,000 * 2 * 0.25 = PKR 48,721.07
1+ (10.5*0.25)
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 Interest Rate Swaps
An Interest Rate Swap is an agreement between counter
parties in which each party agrees to make a series of
payments to the other on agreed future dates until
maturity of the agreement. Each party’s interest
payments are calculated using different benchmarks by
applying the agreement terms to the notional principal
amount of the swap.
An agreement to exchange:

Floating rate payments for fixed rate payments (or vice-versa)

At regular intervals over a pre-specified period

On a certain principal amount
Typical features:

Payments denominated in the same currency

Payments are netted

Principal in not exchanged
 Tailor made

 Off Balance Sheet

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 IRS Floating to Fixed Swap
Fixed 3.8%
ABC Ltd Bank

6m KIBOR
Current
2.25%
5 year
Floating rate
Loan

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 IRS - Applications
If the borrower’s view is that PKR interest rates
will go higher an IRS synthetically converts a
floating rate loan into a fixed rate loan (or vice
versa).
Users may be able to better match assets and
liabilities using an interest rate swap; matching
dates, floating or fixed interest rates.
Exchange certainly for uncertainty
Synthetically convert a fixed rate liability into a
floating rate liability if the borrower’s view is that
PKR interest rates will move lower.

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