Module 3: Treasury Management

I. Objectives:
a. Enumerate the different criteria treasurer should consider in investing
surplus funds.
b. Develop investment strategies that is appropriate to the company.
c. Enumerate different types of treasury products and their accounting.

II. Discussion:
Investment Criteria
- Safety of the Principal – companies would not invest company funds in
a risky investment in order to earn extraordinarily high returns if there is a
chance that any portion of the principal will be lost. A company policy
should limit investments to a specific low-risk investment types.
- Maturity and marketability – investment should be easily converted to
cash on a short notice; make investments where there is a robust market
available for their immediate resale.
- Yield – pick the investment with highest yield

Investment Options
- Bankers’ acceptances. Banks sometimes guarantee (or accept)
corporate debt, usually when they issue a loan to a corporate customer,
and then sell the debt to investors. Because of the bank guarantee, they
are viewed as obligations of the bank.
- Bonds near maturity dates. A corporate bond may not mature for many
years, but one can always purchase a bond that is close to its maturity
date. There tends to be a minimal risk of loss (or gain) on the principal
amount of this investment, since there is a low risk that interest rates will
change so much in the short time period left before the maturity date
of the bond that it will impact its value.
- Certificate of deposit (CD). These certificates are essentially term bank
deposits, typically having durations of up to two years. They usually pay
a fixed interest rate upon maturity, though some variable–rate CDs are
 available. There is a perception that they are more secure than
commercial paper, since CDs are issued by banks, which are more
closely regulated than companies.
- Commercial paper. Larger corporations issue short - term notes that
carry higher yields than on government debt issuances. There is also an
active secondary market for them, so there is usually no problem with
liquidity. Commercial paper is generally not secured; however, staying
with the commercial paper issued by “blue chip” organizations
minimizes the risk of default.
- Money market fund. This is a package of government instruments,
usually composed of Treasury bills, notes, and bonds, that is assembled
by a fund management company. The investment is highly liquid, with
many investors putting in funds for as little as a day.
- Repurchase agreement. This is a package of securities (frequently
government debt) that an investor buys from a financial institution,
under the agreement that the institution will buy it back at a specific
price on a specific date. It is most commonly used for the overnight
investment of excess cash from a company’s cash concentration
account, which can be automatically handled by the company’s
primary bank.
- PH Treasury issuances. The United States government issues a variety of
notes with maturity dates that range from less than a year (PH Treasury
certificates) through several years (notes) to more than five years
(bonds). The wide range of maturity dates gives one a broad range of
investment options.

When any of the preceding investments are initially issued to an investor or

dealer, this is considered a primary market transaction. It is quite likely that
many of these investments will be subsequently resold to a series of investors,
depending on the duration of the investment. These subsequent transactions
are considered to be trading in the secondary market.
Investment Comparisons
Investment Strategies
1. Earnings Credit Strategy
o Minimal level of investment strategy wherein the treasurer can do
nothing and leave idle balances in the corporate bank
accounts.
o Ideal for companies with minimal bank balances.
o Earnings from the idle balances can be offset to banks’ service
fees.
2. Matching Strategy
o Matches the maturity date of the investment to the cash flow
availability dates listed in the cash forecast.
o More concerned with short-term liquidity than return on
investment and is most commonly used by firms having minimal
excess funds.
3. Laddering Strategy
o Involves creating a set of investments that have a series of
consecutive maturity dates.
o Improves liquidity while still taking advantage of longer-term
interest rates.
4. Tranched-cash Flow Strategy
o requires the treasurer to determine what cash is available for
short, medium, and long-term investment, and to then adopt
different investment criteria for each of these investment
tranches.
The short-term tranche is treated as cash that may be
needed for operational requirements on a moment’s
notice. This means that cash flows into and out of this
tranche can be strongly positive or negative. Thus, return
on investment is not a key criterion – instead, the treasurer
focuses on very high levels of liquidity. The return should be
the lowest of the three tranches but should also be
relatively steady.
 The medium - term tranche includes cash that may be
required for use within the next 3 to 12 months, and usually
only for highly predictable events, such as periodic tax or
dividend payments, or capital expenditures that can be
planned well in advance. Given the much higher level of
predictability in this tranche, the treasurer can accept
longer - term maturities with moderate levels of volatility
that have somewhat higher returns on investment.
The long - term tranche includes cash for which there is no
planned operational use, and which the treasurer feels
can be safely invested for at least one year. The priority for
this tranche shifts more in favor of a higher return on
investment, with an attendant potential for higher levels of
volatility and perhaps short - term capital loss, with a
reduction in the level of liquidity.
o the treasurer should regularly review the cash forecast and adjust
the amounts of cash needed in each of the three tranches.
Inattention to these adjustments could result in an unanticipated
cash requirement when the cash in the company’s long-term
tranche is tied up in excessively long-term, illiquid investments.
5. Riding the yield curve
o strategy of buying longer-term securities and selling them prior to
their maturity dates. This strategy works when interest rates on
short-term securities are lower than the rates on longer-term
securities, which is normally the case.
o The longer-term securities with higher interest rates that are held
by the company will increase in value over time.
6. Credit rating strategy
o treasurer buys the debt of a company that may be on the verge
of having its credit rating upgraded. By doing so, the investment
ends up earning a higher interest rate than would other
investments with a comparable credit rating.
For all of the investment strategies noted here, the treasurer must closely
monitor the credit rating of the debt issuer. A credit downgrade can result in a
substantially lower return to the company if the treasurer needs to sell the debt
prior to its maturity date.

Outsourced Investment Management

Under this arrangement, the outside firm invests the cash under the terms of a
customized investment agreement with the company. The company can
choose from a variety of possible investment strategies, as well as restrict
investments to certain classes of assets. This approach gives the company
access to an experienced group of investment managers that presumably
uses strong systems of control when initiating and tracking transactions. The
fees a company incurs through an outsourcing arrangement can be quite
competitive in comparison to the cost of maintaining a similarly experienced
in - house staff.

Risk Reduction Strategies

1. A simple risk-reduction strategy is to avoid investments in the securities of
any single entity, in favor of investments solely in one or more money market
funds.
2. The PDIC insures a bank customer’s deposits at the bank against the failure
of the bank, up to a maximum reimbursement of P500,000.
3. Create a sweep account, where funds are automatically swept out of the
concentration account at the end of each business day and moved into
an interest-earning account.
Accounting for Investments
A company will normally invest in marketable securities, so that it can more
easily liquidate its investments. Marketable securities are investments that can
be easily liquidated through an organized exchange, such as the Philippine
Stock Exchange. For accounting purposes, marketable securities must be
grouped into one of the following three categories at the time of purchase
and reevaluated periodically to see if they still belong in the designated
categories:
1. Financial Assets at Fair Value Through Profit or Loss (FVTPL)
o Measured at initial recognition and at each reporting date at fair
value. Transaction costs do not form part of initial cost and are
charged to expense.
o At reporting date, the investment shall be adjusted to fair value.
Any change in fair values is taken as income or loss in profit or
loss.
o The determination of the gain or loss on the sale of securities is
based on the difference between the net proceeds from sale
and the carrying amount of the investment.
2. Financial Assets at Other Comprehensive Income (FVOCI)
o Investment shall be recorded upon acquisition at purchase price
(presumably the fair value) plus directly attributable transaction
costs.
o Any change in fair value of the investment during the period is
taken to other comprehensive income in the statement of
comprehensive income.
o At the date of sale, the investment account shall be adjusted to
fair value, presumably the selling price, through other
comprehensive income.
o The cumulative balance of unrealized gain or loss in equity shall
remain in equity and is not subsequently reversed in profit or loss.
However, the entity may transfer the cumulative gain or loss
within equity (based on B5.12, IFRS 9). The amount transferred to
 retained earnings is the difference between the net selling price
and the initial cost of the investment.
3. Financial Assets at Held to Collect (Amortized Cost)

Classification of Financial Instruments

Investment Reporting
It is useful to have a summary-level report itemizing the investment, current
market value and return on investment for each investment made. This
approach yields a quick view of a company’s overall level of investment and
the results thereof. If the investment portfolio includes debt, then the report
could be expanded to include either individual or average maturity dates.
Investment Management Controls
In addition to the basic process flow just noted, the following controls are also
useful for ensuring that the documented investments were actually obtained
and stored:
- Periodically match the approved cash forecast, quote sheets, and
investment authorization to actual investments completed.
- Assign securities custody to independent party.

Investment Management Policies

An investment policy is used to defi ne the level of risk that a company is willing
to tolerate and defines the exact types of investment vehicles to be used (or
not used).
- Liquidity - the policy should severely restrict the use of any investments
that cannot be liquidated within a short period of time, since this gives
a company maximum use of the money in case of special opportunities
(such as an acquisition) or emergencies (such as a natural disaster
destroying a facility).
o the policy could state that 75 percent of all investments must be
capable of immediate liquidation (which rules out real estate
holdings)
o that any investments over a base level of $50 million can be
invested in less liquid instruments.
- Risk
o Putting all excess cash to government securities
o Attempt to derive a significant proportion of investment income
by putting cash to highly risk investment
- Return on Investment

Notes:
1. The investment policy should be closely aligned with the investment
strategy.
2. There are a multitude of possible investment policies that a treasury can
adopt; some are designed to restrict its choices of possible investments,
while others are needed to account for investments.
The following policy possibilities are sorted into the categories for funds
investment, designations of types of investments, and investment accounting.

Funds Investment
1. At least P___ shall be invested in overnight investments and in
negotiable marketable obligations of major U.S. issuers.
2. No more than ___ percent of the total portfolio shall be invested in time
deposits or other investments with a lack of liquidity.
3. The average maturity of the investment portfolio shall be limited to ___
years.
4. Investments in foreign commercial paper shall be limited to those
unconditionally guaranteed by a prime PH issuer and fully hedged.
5. Investments in commercial paper shall be limited to those of companies
having long - term senior debt ratings of A or better.
6. Investments in bank certificates of deposit shall be limited to those banks
with capital accounts exceeding P10 billion.
7. Investments shall only be made in investments backed by PH
government debt obligations.
8. Securities physically held by the company shall be stored with an
accredited third party.
9. If an employee is responsible for the physical security of securities held
by the company, then this person cannot also be responsible for
recording the securities in the accounting records.

Investment in Debt Securities Accounting

1. The unrecognized amount of gains or losses on held-to-maturity
securities shall be regularly reported to the board of directors.
2. Debt securities shall not be classified as held to maturity unless sufficient
investments are already on hand to cover all budgeted short-term cash
requirements.

Marketable Equity Securities Accounting

1. All securities purchases shall be designated as FVTPL securities at the
time of purchase.
2. All losses on securities designated as FVOCI shall be considered
permanent
3. FVOCI securities shall not be sold solely to recognize related gains in their
fair market value.
Investment Procedure
Procedure Statement Retrieval No.: TREASURY – 04
Subject: Determination of investment amount and type, and investment
execution

1. PURPOSE AND SCOPE

This procedure is used by the treasury staff to invest funds in accordance
with the corporate investment policy.
2. PROCEDURES
2.1 Create a Cash Forecast (Treasury Staff)
2.1.1 Create a cash forecast covering the next __ weeks, including
standard cash inflows and outflows, and also incorporating
expected capital expenditures and special adjustments.
 2.1.2 Compare the new forecast to the forecast developed for the
preceding week to see if there are any large variances in the
weekly cash results; investigate and adjust as necessary.
2.2 Record Proposed Investment on Cash Forecast (Treasury Staff)
2.2.1 Based on the amount of excess funds projected to be available,
note below each week on the forecast the proposed amount of
funds to invest, the type of investment, and the duration of each
proposed investment. The type of investment should be based on
the approved corporate investment policy.
2.2.2 Create a copy of the forecast and file it.
2.2.3 Send the original cash forecast to the Treasurer.
2.3 Approve Investment Recommendation (Treasurer)
2.3.1 Upon receipt of the cash forecast, review it in general for errors
and omissions. Have the financial analyst revise the forecast as
necessary.
2.3.2 Compare the proposed types of investments to the approved
corporate investment policy to ensure that they are acceptable.
2.3.3 Verify that the proposed investment duration does not exceed
the approved corporate investment duration policy.
2.3.4 Sign and date the forecast in the approval block.
2.3.5 Forward the cash forecast to the treasury staff.
2.4 Obtain Investment Quotes (Treasury Staff)
2.4.1 Upon receipt of the latest approved cash forecast, print the
latest. Request for Interest Rate Quotations form.
2.4.2 Verify that the banks listed on the form are approved for
investments by the company.
2.4.3 Contact the banks for rate quotes on the investment type,
duration, and amount noted on the cash forecast, and enter the
quotes on the form.
2.4.4 Sign in the “Quotes compiled by” fi eld in the “Approvals” block
of the form.
 2.4.5 Review the quotes with the treasurer and enter the actual
investment to be made in the “Final Investment” block of the
form.
2.4.6 The treasurer signs in the “Approved by” field in the “Approvals”
block of the form.
2.4.7 Forward the form to the Investment Manager for investment
placement.
2.4.8 File the cash forecast.
2.5 Issue Investment Authorization Form (Investment Manager)
2.5.1 Extract a copy of the investment form from the forms cabinet and
fill it out, entering the investment type, amount, and duration
noted in the “Final Investment” block of the Request for Interest
Rate Quotations form.
2.5.2 Sign the investment form.
2.5.3 Fax the form to the bank quoting the highest rate on the Interest
Rate Quotations form.
2.5.4 Call the firm to verify receipt of the fax.
2.5.5 Sign in the “Investment placed by” field in the “Approvals” block
of the Request for Interest Rate Quotations form.
2.5.6 Create two copies of the Request for Interest Rate Quotations
form and investment form, and file both copies.
2.5.7 Forward the original versions of both the Request for Interest Rate
Quotations form and investment form to the Treasury Clerk.
2.6 Match Authorization to Transaction Report (Treasury Staff)
2.6.1 Upon receipt of an investment transaction report from the bank,
match its terms to those listed on the investment form and
Request for Interest Rate Quotations form. If there are
discrepancies, contact the bank to determine why, and forward
this information to the Treasurer.
2.7 Forward Records to Accounting (Treasury Staff)
2.7.1 Assemble the cash forecast, Request for Interest Rate Quotations,
investment form, and investment transaction report into a single
packet.
2.7.2 Create a copy of the packet and fi le it by date.
2.7.3 Forward the original version of the packet to the general ledger
accountant, to be recorded in the accounting system.
2.8 Record Investment Transaction (Accounting Staff)
2.8.1 Upon receipt of the approved investment packet, record a credit
to the cash account and a debit to the investments account.
2.8.2 If the investment is into bonds, update the Bond Ledger Report.
2.8.3 If the investment is into stocks, update the Stock Ledger Report.
2.8.4 Stamp the investment packet as having been entered, and file
the packet.