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FINANCE
CAIIB-Risk Management
Treasury Management Module C
21/11/2008
6-7.30 pm
By
C.S.BALAKRISHNAN
chitturb@rediffmail.com
Syllabus
Module C: Treasury Management:
Treasury management; concepts and functions; instruments in
the
treasury market; development of new financial products; control
and supervision of Treasury management; linkage of domestic
operations with foreign operations.
Asset-liability management; Interest rate risk; interest rate futures;
stock options; debt instruments; bond portfolio strategy; risk
control and hedging instruments.
Investments Treasury bills Money markets instruments such
as CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance and
rediscounting facilities.
Example
Which of the following about a callable bond is
true?
a. Callable bonds always trade at a discount to noncallable bonds.
b. Callable bonds expose issuers to the risk of reduced
re-investment return.
c. Callable bonds are actually variable tenor bonds.
d. Callable bonds are not as liquid as non-callable
bonds.
Ans: c.
Treasury Products
Products of Foreign Exchange Market.
-Most Liquid
-Most Transparent
-Virtual Market
-Its a near perfect market with efficient price
discovery system.
ABC Bank enters into an Interest Rate Swap with XYZ Ltd on the
following terms
Principal Amount
Rs. 100crores
Corporate to Pay
6.50% Fixed
Corporate to Receive
Start date
25-4-08
Tenor
6 months
Termination date
25-10-08
First Fixing
6.10%
1000000000*90*.4
------------------------36500
Assets
Rs
Liabilities
Paid up capital
10,000
Current Account
Building
10000
Car
20000
180,000
SB
Cash Credit
1000000
Term Loan
800000
450,000
Fixed Deposit
600,000
Interest accrued
10000
Margin on LCs
Suspense Account
10000
Branch Adjustment
Account
20000
2,000
TT Payable
1,000
CBLO(Colaterised
Borrowing & Lending
Obligations)
600,000
ECGC Claims
7,000
18 60
3)Other demand
and time
Liabilities
amounts to
a)
b)
c)
d)
10000
17000
18000
None of the
above
computation
a. Amount received from
DICGC Claims
b. Amount received from
Insurance company on ad
hoc settlement of claims
c. Amount received from the
court receiver
d. Amount held as margin
against LC*********
Exposure
Rs. In crores
Extent of
downgrade
AAA
20
200
20 %
AA
50
200
20 %
50
100
20 %
BBB
100
200
20 %
BB& Below
150
100
800
Minimum capital
under Basel II
Rs.48.60 crores
a)52.38 crores***********
b)58.6 crores
c)60.6 crores
d)52.6 crores
Working
Ratin Risk
g
Weig
Scal ht
e
Expos
ure
AAA
20%
200
AA
50%
50%
BBB
RWA
Before
down
grade
Exposur
e after
Downgra
de
RWA
AFTER
DOWNGRA
DE
40
160
32
200
100
200
100
100
50
120
60
100% 200
200
180
180
150
140
210
540
582
Integrated Treasury
Integrated Treasury refers to integration of money
market, securities market and foreign exchange
operations.
-Meeting reserve requirements
-Efficient merchant services
-Global cash management
-Optimizing profit by exploiting market
opportunities in forex market, money market and
securities market
-Risk management
-Assisting bank management in ALM
FRONT OFFICE
Dealing
MID OFFICE
BACK OFFICE
settlement
MIS
Treasury
Money Market
Certificate of Deposit
CDs are short-term borrowings BY BANKS
in the form of Usance Promissory Notes
having a maturity of not less than 7 days up
to a maximum of one year.
CD is subject to payment of Stamp Duty
under Indian Stamp Act, 1899 (Central Act)
Features of CD
Issued by all scheduled commercial banks
except RRBs
Minimum period 7 days
Maximum period upto 1 year
Minimum Amount Rs 1 lac and in multiples
of Rs. 1 lac
CDs are transferable by endorsement
CRR & SLR are to be maintained
CDs are to be stamped
Commercial Paper
Commercial Paper (CP) is an
unsecured money market
instrument issued in the form of a
promissory note by
corporates/PDs/FIs
Who can issue Commercial
Paper (CP)
Highly rated corporate borrowers,
primary dealers (PDs) and all-
Rating Requirement
All eligible participants should obtain the credit rating for
issuance of Commercial Paper
Credit Rating Information Services of India Ltd. (CRISIL)
Investment Information and Credit Rating Agency of India
Ltd. (ICRA)
Credit Analysis and Research Ltd. (CARE)
Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India)
To whom issued
CP is issued to individuals, banking
companies, other corporate bodies
registered or incorporated in India and
unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional
Investors (FIIs).
Maturity
CP can be issued for maturities between a
minimum of 7 days and a maximum upto
one year from the date of issue.
If the maturity date is a holiday, the
company would be liable to make payment
on the immediate preceding working day.
Meaning of Repo
It is a transaction in which two parties agree to sell
and repurchase the same security. Under such an
agreement the seller sells specified securities with
an agreement to repurchase the same at a
mutually decided future date and a price
The Repo/Reverse Repo transaction can only be
done at Mumbai between parties approved by RBI
and in securities as approved by RBI (Treasury
Bills, Central/State Govt securities).
Repo
Uses of Repo
It helps banks to invest surplus cash
It helps investor achieve money market returns
with sovereign risk.
It helps borrower to raise funds at better rates
An SLR surplus and CRR deficit bank can use the
Repo deals as a convenient way of adjusting
SLR/CRR positions simultaneously.
RBI uses Repo and Reverse repo as instruments
for liquidity adjustment in the system
Example
Treasury Bills
Treasury bills, commonly referred to as TBills are issued by Government of India
against their short term borrowing
requirements with maturities ranging
between 14 to 364 days.
All these are issued at a discount-to-face
value. For example a Treasury bill of Rs.
100.00 face value issued for Rs. 91.50 gets
redeemed at the end of it's tenure at Rs.
100.00.
Y= (100-P)*365*100
----------------------P*D
Y = Yield
P= Price
D =Days to maturity
Example
91 days treasury bills maturing on 612-2008
Purchased on 12-10-2008 Rate
quoted is Rs.99.1489 per Rs100
(100-99.1489)*365*100= 31065.15
---------------------------(99.1489*55 days) =5453.18
=5.70%
Debenture
A Debenture is a debt security issued by a
company (called the Issuer), which offers to
pay interest in lieu of the money borrowed
for a certain period.
These are long-term debt instruments
issued by private sector companies. These
are issued in denominations as low as Rs
1000 and have maturities ranging between
one and ten years.
Current yield
This is the yield or return derived by the
investor on purchase of the instrument (yield
related to purchase price)
It is calculated by dividing the coupon rate
by the purchase price of the debenture. For
e. g: If an investor buys a 10% Rs 100
debenture of ABC company at Rs 90, his
current Yield on the instrument would be
computed as:
Current Yield = (10%*100)/90 X 100 , That
is 11.11% p.a.
Primary Dealers
Primary Dealers can be referred to as
Merchant Bankers to Government of
India, comprising the first tier of the
government securities market. These
were formed during the year 1994-96
to strengthen the market infrastructure
OMO
OMO or Open Market Operations is a
market regulating mechanism often resorted
to by Reserve Bank of India. Under OMO
Operations Reserve Bank of India as a
market regulator keeps buying or/and selling
securities through it's open market window.
It's decision to sell or/and buy securities is
influenced by factors such as overall liquidity
in the system,
YIELD CURVE
The relationship between time and yield on
a homogenous risk class of securities is
called the Yield Curve. The relationship
represents the time value of money showing that people would demand a
positive rate of return on the money they are
willing to part today for a payback into the
future
LIBOR
LIBOR stands for the London Interbank
Offered Rate and is the rate of interest at which
banks borrow funds from other banks, in
marketable size, in the London interbank
market.
LIBOR is the most widely used "benchmark" or
reference rate for short term interest rates. It is
compiled by the British Bankers Association
as a free service and released to the market at
about 11.00[London time] each day.
SLR
SLR is to be maintained in the form of the
following assets:
Cash balances (excluding balances
maintained for CRR)
Gold (valued at price not exceeding current
market price)
Approved securities valued as per norms
prescribed by RBI.
VaR
Value at Risk (VaR) is the most probable loss that
we may incur in normal market conditions over a
given period due to the volatility of a factor,
exchange rates, interest rates or commodity
prices. The probability of loss is expressed as a
percentage VaR at 95% confidence level,
implies a 5% probability of incurring the loss; at
99% confidence level the VaR implies 1%
probability of the stated loss. The loss is generally
stated in absolute amounts for a given transaction
value (or value of a investment portfolio).
VaR
A VaR of Rs. 100,000 at 99% confidence
level for one week for a investment
portfolio of Rs. 10,000,000 similarly
means that the market value of the
portfolio is most likely to drop by
maximum Rs. 100,000 with 1%
probability over one week.
Principles
Direct Quotation: Buy Low, Sell High:
The prime motive of any trader is to make profit.
By purchasing the commodity at lower price and
selling it at a higher price a trader earns the profit.
In foreign exchange, the banker buys the foreign
currency at a lesser price and sells it at a higher
price.
Indirect Quotation: Buy High, Sell Low:
A trader for a fixed amount of investment would
acquire more units of the commodity when he
purchases and for the same amount he would part
with lesser units of the commodity when he sells.
Interpretation of Quotation
The market quotation for a currency consists
of the spot rate and the forward margin.
The outright forward rate has to be
calculated by loading the forward margin
into the spot rate. For example US Dollar is
quoted as under in the inter-bank market on
a given day as under :
Spot
1 USD = Rs.44.1000/1300
Spot/November
0200/0500
Spot/December
1500/1800
TT Buying Rate
Problem
You would like to import machinery from USA worth
USD 100000
to be payable to the overseas supplier on 31st Oct
[a] Spot Rate
USD = Rs.45.8500/8600
Forward Premium
September 0.2950/3000
October 0.5400/5450
November 0.7600/7650
[b] exchange margin 0.125%
[c] Last two digits in multiples of nearest 25 paise
Calculate the rate to be quoted by the bank ?
Currency pair
GBP/USD
Bid
0.9891
Ask
0.9894
AUD/USD
1.2287
1.2289
Solution
This is an example Forward Sale Contract .
Inter Bank Spot Selling Rate Rs. 45.8600
Add Forward Margin
.5450
-------------46.4050
Add Exchange Margin
.0580
--------------Forward Rate
46.4630
Rounded Off to multiple of 25 paise
Rs.46.4625
Amount Payable to the bank
Rs.46,46,250
Swap
A swap agreement between two parties
commits each counterparty to exchange an
amount of funds, determined by a formula,
at regular intervals, until the swap expires.
In the case of a currency swap, there is an
initial exchange of currency and a reverse
exchange at maturity.
Mechanics
Firm A needs fixed rate loan AAA rated
Firm B needs floating rate
-A rated
Firm A enjoys an absolute advantage in
both credit markets.
Fixedrate
finance
Firm A
Firm B
9%
11%
Mechanics
STEP !
Firm A will borrow at Fixed rate 9%
Firm B will borrow at floating rate (LIBOR +1)%
STEP 2
Firm A will pay Floating rate [LIBOR] to Firm B
Firm B will Pay Fixed rate [9.5%] only
Gain
Net interest cost LIBOR- .5%
Net Interest cost 9+[ 1%+0.5%]=10.5%
Mechanics
Interest payments to each
other in years t 1 to t 7.
Gain
A
B
9.5%
Borrows at
9.0%
fixed
for 7 years
LIBOR
Borrows at
LIBOR + 1%
floating
for 7 years
Borrower- A Ltd
Borrower- B Ltd
Exposure
Rs.100 crore
Rs.100 crore
Maturity of
exposure(years)
Nature of exposure
Corporate
Corporate
Currency
USD
INR
Rating of Exposure
BBB
UNRATED
12%
25%
Value of collateral
after haircut
Rs.88crore
Rs75 crore
Risk weight
100%
100%
In the above case, the RWA for the net exposures of A & B under Basel II
A)Rs.24 crore and Rs 50 crore respectively********
B)Rs.172.50 crore and Rs.53 crore respectively
C)Rs.18 crore and Rs.12 crore respectively
D)Rs.150 crore and Rs.75 crore respectively
are ..
Bank A enters into a Overnight Indexed Swap (OIS) with XYZ Ltd whereby
Bank agrees to pay 7 days OIS at 6.25% for Rs.25 crores and receive
MIBOR Overnight Rate.
Actual MIBOR rates for 7 days are given below:
Day 1
6.15%
Day 2
6.05%
Day 3
6.10%
Day 4
6.15%
Day 5
6.05%
Day 6
6.05%
Day 7
6.10%
In the above case. the difference to be settled between the bank and
the XYZ Ltd amounts to..
a)Rs.7671*********
b)Rs.7692
c)Rs.8035
d)Rs.8074
ECGC Cover
50%
Realizable Value of
Security
Rs.1.50 lakhs
Balance
Rs.4 lakhs
The
total provision required in the above case is
Outstanding
.
a)Rs.1.25 lakh*****
b)Rs.2.50 lakh
c)Rs.0.50 lakh
d)Rs.2.00 Lakh
Example
Coupon of a floating rate bond is
a. modified whenever there is a change in the
benchmark rate.
b. modified at pre-set intervals with reference to a
benchmark rate.
c. modified for changes in benchmark rate beyond
agreed levels.
d. modified within a range, for changes in the
benchmark rate.
Ans: b.
Example
Which of the following is true about a
uniform price auction?
a. a.
An auction in which all successful bids are
made for the same price.
b. b.
An auction in which all bidders have bid a
uniform price.
c. c.
An auction in which all successful bidders
are allotted bonds at the same price.
d. d.
An auction in which the cut-off price is
derived as the weighted average of all successful
bids.
Answer: c
Example
A treasury bill maturing on 28-Jun-2008 is
trading in the market on 3-Jul-2007 at a
price of Rs. 92.8918. What is the discount
rate in this price?
Answer:
The yield is computed as:
= ((100-price)*365)/(Price * No of days to
maturity)
= ((100-92.8918)*365)/(92.8918*360)) =
7.7624%
Example
What is the price at which a treasury bill
maturing on 23rd March 2008 would be
valued on July 13, 2007 at a yield of
6.8204%?
Answer:
The price can be computed as
= 100/(1+(yield% * (No of days to
maturity/365))
= 100/(1+(6.8204%*(253/365)) =
Rs. 95.4858
Example
What is the day count convention in the treasury
bill markets?
a. 30/360
b. Actual/Actual
c. Actual/360
d. Actual/365
Answer: d
Example
Which of the following participants in the call
markets are allowed to lend as well as borrow?
a. Mutual Funds
b. Banks and Primary Dealers
c. Corporates
d. Financial Institutions
Answer: b
Repo
A 3-day repo is entered into on July 10, 2007, on an 11.99%
2009 security, maturing on April 7, 2009. The face value of
the transaction is Rs. 3, 00, 00, 000. The price of the security
is Rs. 116.42. If the repo rate is 7%, what is the settlement
amount on July 10, 2007?
Answer: Settlement amount on July 10, 2007 is the transaction
value for the securities plus accrued interest.
Transaction Value:
3, 00, 00, 000 * 116.42/100 =Rs. 3, 49, 26, 000
Accrued Interest:
The number of days is 93.
Accrued interest = 3, 00, 00, 000 * 11.99%* 93/360 = Rs. 9, 29,
225.00
Therefore, the settlement amount is: Rs. 3,49,26,000 + Rs.
9, 29, 225.00 = Rs. 3, 58, 55, 225.00
Example
Compute the Rupee value of an SGL transaction, with the following data:
Coupon Rate: 11.68%
Maturity date: August 6, 2008
Settlement Date: July 11, 2007
Price: Rs. 105.4025
Transaction amount: Rs. 50000000
Answer:
Value of the transaction = number of securities * trade price
= (50000000/100) * 105.4025
= Rs. 5,27,01,250
Accrued Interest for the period since the last coupon is
= days since the last coupon/360 * coupon rate * face value
= (155/360) * 0.1168 * 50000000
= Rs. 25,14,444
Settlement amount = Value of transaction + Accrued Interest
= Rs. 5,27,01,250 + 25,14,444
= Rs. 5,52,15,694
Forward rate is
a)Derived from spot rates b)spot rate
adjusted for premium/discount
c)The rate agreed for settlement on an
agreed date in future
d)All the above
An FCNR deposit received from an NRI in
us$ can be viewed by the bank as
a)Euro-rupee deposit b)Petro-dollar
deposit c)Rupee-dollar deposit
d)Euro-dollar deposit
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