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Reasury Rash Ourse: by Jawwad Ahmed Farid
Reasury Rash Ourse: by Jawwad Ahmed Farid
CONTENTS
WHAT IS A TREASURY?................................................................................................................................
Treasury.....................................................................................................................................................
The Money Market desk.................................................................................................................................
The FX Desk.....................................................................................................................................................
The Equity Desk...............................................................................................................................................
The Specialized Desks.....................................................................................................................................
What do treasuries really do?.....................................................................................................................
How is a corporate treasury different from a bank treasury?.......................................................................
THE TREASURY FUNCTION............................................................................................................................
1. Trade Flows (FX desk)...........................................................................................................................
2. The Treasury Function Operations........................................................................................................
i. Introduction.........................................................................................................................................
ii. Front Office Function...........................................................................................................................
a. User Roles.................................................................................................................................
b. Money Market Desk Activities.................................................................................................
c. Foreign Exchange Desk Activities.............................................................................................
d. Capital Market (CM) Desk Activities.........................................................................................
iii. Middle Office Function........................................................................................................................
a. User Roles.................................................................................................................................
b. Activities...................................................................................................................................
iv. Back Office Function............................................................................................................................
a. User Roles.................................................................................................................................
b. Activities...................................................................................................................................
c. Basic Treasury Back Office Tasks..............................................................................................
3. Related Terminologies.........................................................................................................................
i. Four eyes.............................................................................................................................................
a. Ticket Approval.........................................................................................................................
b. Ticket Verification....................................................................................................................
c. Ticket Authorization.................................................................................................................
ii. Confirmation........................................................................................................................................
a. Society for Worldwide Interbank Financial Telecommunication (SWIFT)...............................
iii. Settlement...........................................................................................................................................
a. Delivery versus payment (DVP)................................................................................................
iv. Reconciliation......................................................................................................................................
a. Broker Reconciliation...............................................................................................................
b. Securities Reconciliation..........................................................................................................
v. Accounting...........................................................................................................................................
vi. Price discovery.....................................................................................................................................
vii. Proprietary Trading..............................................................................................................................
viii. Treasury Risks......................................................................................................................................
a. Credit Risk.................................................................................................................................
b. Market Risk...............................................................................................................................
c. Operational Risk.......................................................................................................................
4. Treasury Markets.................................................................................................................................
i. Foreign Exchange Market....................................................................................................................
a. FX Ready/ Forward/ Split.........................................................................................................
b. FX Swap....................................................................................................................................
c. FX Placements/ Borrowings.....................................................................................................
d. FX Miscellaneous......................................................................................................................
e. FX TMU – Import/ Export/ Remittance/ Encashment..............................................................
TREASURY CRASH COURSE
PRODUCT VARIATIONS................................................................................................................................
1. Options................................................................................................................................................
i. Stock Options.......................................................................................................................................
ii. Foreign Currency Options....................................................................................................................
iii. Index Options.......................................................................................................................................
iv. Futures Options...................................................................................................................................
v. Warrants..............................................................................................................................................
vi. Employee Stock Options......................................................................................................................
vii. Convertibles.........................................................................................................................................
viii. Interest Rate Options..........................................................................................................................
a. Bond Options............................................................................................................................
b. Interest Rate Caps/ Floors/ Collars..........................................................................................
c. European Swap Options...........................................................................................................
ix. Exotic Options......................................................................................................................................
a. Bermuda Option.......................................................................................................................
b. Quanto Option.........................................................................................................................
c. Composite Option....................................................................................................................
d. Digital or Binary or “All or nothing” options............................................................................
e. Barrier Options.........................................................................................................................
f. Asian Options...........................................................................................................................
g. Average Strike Options.............................................................................................................
h. Look back Options....................................................................................................................
i. Compound Options..................................................................................................................
j. Chooser (As you like it) Options...............................................................................................
k. Exchange Options.....................................................................................................................
l. Forward Start Options..............................................................................................................
m. Basket Options.........................................................................................................................
n. Shout Options...........................................................................................................................
2. Forwards..............................................................................................................................................
i. Synthetic Forward Contract.................................................................................................................
ii. Forward Rate Agreement (FRA)..........................................................................................................
3. Futures................................................................................................................................................
i. Stock Index Futures.............................................................................................................................
ii. Futures Contracts on Currencies.........................................................................................................
iii. Futures Contracts on Commodities.....................................................................................................
iv. Interest Rate Futures...........................................................................................................................
a. Treasury Bond Futures.............................................................................................................
b. Treasury Note Futures..............................................................................................................
c. 5-year Treasury Note Futures..................................................................................................
d. Treasury Bill Futures.................................................................................................................
e. Eurodollar Futures....................................................................................................................
4. Swaps..................................................................................................................................................
i. Fixed for fixed currency swap..............................................................................................................
ii. Floating for floating currency swap.....................................................................................................
iii. Cross-currency interest rate swap.......................................................................................................
iv. Step-up Swaps.....................................................................................................................................
v. Amortizing Swaps................................................................................................................................
vi. Basis Rate Swap...................................................................................................................................
vii. Forward or Deferred Swaps.................................................................................................................
viii. Compounding Swaps...........................................................................................................................
ix. LIBOR-in- Arrears Swap........................................................................................................................
x. Constant Maturity Swap......................................................................................................................
xi. Constant Maturity Treasury Swap.......................................................................................................
xii. Differential Swap or Quanto................................................................................................................
TREASURY CRASH COURSE
vii. Pre Settlement Risk (PSR) and Potential Future Exposure (PFE) Limits..............................................
viii. Hierarchy of Limits...............................................................................................................................
2. A More Detailed Look at Limits.............................................................................................................
i. Capital Loss and Stop Loss Limits........................................................................................................
ii. Value-at-Risk Limits.............................................................................................................................
iii. Regulatory Approach Limits................................................................................................................
iv. Other Limits.........................................................................................................................................
a. Duration Limits.........................................................................................................................
b. Convexity Limits.......................................................................................................................
c. PVBP Limits...............................................................................................................................
v. Credit Risk Limits.................................................................................................................................
a. PSR Limits.................................................................................................................................
b. Settlement Risk Limits..............................................................................................................
c. Financial Institution (FI)/ Counterparty Limits.........................................................................
d. Regulatory Limits......................................................................................................................
e. Internal / Concentration Limits................................................................................................
vi. Application to Products.......................................................................................................................
vii. Setting Limits for Liquidity Risk............................................................................................................
a. Cash flow mismatch or gap limits............................................................................................
b. Maturity Limits.........................................................................................................................
c. Target Liquid Reserves.............................................................................................................
d. Concentration Limits................................................................................................................
e. Contingent liability limit...........................................................................................................
f. Review......................................................................................................................................
ix. Setting Limits for Interest Rate Risk....................................................................................................
Repricing limits....................................................................................................................................
x. Limit Breach, Exception processing, Action Plan for Trigger Zones....................................................
a. Exception Handling...................................................................................................................
b. Example of an Action Plan for Trigger Zones...........................................................................
TREASURY PROFITABILITY.............................................................................................................................
1. Treasury Profitability - Foreign Exchange Desk......................................................................................
2. Treasury Profitability – Capital Market (Equity (EQ)) Desk.....................................................................
ANNEXURE A- CALCULATING VALUE AT RISK....................................................................................................
1. Introduction.........................................................................................................................................
2. VaR Methods.......................................................................................................................................
a. Variance Covariance Approach...........................................................................................................
b. Historical Simulation Method..............................................................................................................
c. Monte Carlo Simulation.......................................................................................................................
d. Quick Review.......................................................................................................................................
e. Implementing VaR...............................................................................................................................
2. Methodology.......................................................................................................................................
i. Setting the Scene.................................................................................................................................
Sample Portfolio..................................................................................................................................
ii. Preliminary steps.................................................................................................................................
iii. VaR Approach Specific Steps...............................................................................................................
a. Variance-Covariance (VCV) VaR...............................................................................................
b. Determining Historical Simulation daily VaR...........................................................................
iv. Scaling of the daily VaR.......................................................................................................................
2. Caveats, Qualifications, Limitations and Issues.....................................................................................
ANNEXURE B: BUILDING MATURITY & LIQUIDITY PROFILES FOR DEPOSITS AND ADVANCES FOR ALCO, LIQUIDITY COVERAGE
& ICAAP REPORTING..................................................................................................................................
Lesson Zero: Introduction and Course Overview.........................................................................................
Bank Deposit & Asset Maturity profiles for ALM - Objectives........................................................................
TREASURY CRASH COURSE
Advances and Deposits Maturity & Liquidity Profile - Methodology & Sample output.................................
Step 1: The Core Banking Dump..........................................................................................................
Step 2: Pre-processing the data and adding intelligence for the purpose of building a pivot table. .
Step 3: Creating the ivot Table and Generating Presentation Graphs using Pivot Charts..................
Lesson One: Preparing the Core Banking Dataset........................................................................................
Extracting Relevant Data.................................................................................................................................
The DTM (Days to Maturity) formula.............................................................................................................
Lesson Two: Adding Intelligence for the Pivot Table....................................................................................
Deposit Size Bracket........................................................................................................................................
Maturity Bucket Bracket.................................................................................................................................
Cost of Deposits Bracket.................................................................................................................................
Lesson Three: Creating the Pivot Table.......................................................................................................
Lesson Four: Reading the PivotTable and PivotChart...................................................................................
Lesson Five: Quick Review & Extending the framework...............................................................................
Lesson Six: Pivot Shoot Out- Pivot Tables and Pivot Charts Galore...............................................................
Lesson Seven: The Pivot Chart Shoot out for Advances................................................................................
Maturity Profile Bucket...................................................................................................................................
Advances Size Bucket......................................................................................................................................
Pivot Table and Chart Variations....................................................................................................................
Lesson 8: Wrap up and building the ALM profile for the banking book........................................................
BIBLIOGRAPHY...........................................................................................................................................9
LIST OF FIGURES.........................................................................................................................................10
DISCLAIMER..............................................................................................................................................
TREASURY CRASH COURSE
B IBLIOGRAPHY
Options, Futures and Other Derivatives, John C. Hull, 7th Edition, Prentice Hall, 2009
The Handbook of Fixed Income Securities, Frank J. Fabozzi, 7th Edition, McGraw-Hill,
2005
Risk Management and Financial Institutions, John C. Hull, Low Price Edition, Pearson
Education, Inc., 2007
Exotic Equity Derivatives Manual, Salomon Smith Barney, August 1998
Understanding Market, Credit and Operational Risk- The Value at Risk Approach, Linda
Allen, Jacob Boudoukh and Anthony Saunders,Blackwell Publishing, 2004
Beyond Value at Risk, The New Science of Risk Management, Kevin Dowd, John Wiley &
Sons, 1998
Higher-Order Simulations: Strategic Investment Under Model-Induced Price Patterns,
Gilbert Peffer and Bàrbara Llacay, Journal of Artificial Societies and Social Simulation vol. 10, no. 2,
6 <http://jasss.soc.surrey.ac.uk/10/2/6.html>, 2007
VaR Applications: Setting VaR-based Limits, Carlos Blanco and Sally Blomstrom, Financial
Engineering Associates, Inc., May 1999
Commonly Used Market Risk Limits, Guidelines on Risk Management of Derivatives and
other traded instruments, Annex D
Quantitative Finance, Second Edition, Paul Wilmott, John Wiley&Sons, Ltd., 2006
Liquidity Risk Management, Leonard M. Martz, 2007
Back Office and Beyond- A guide to procedures, settlements and risk in financial
markets, Mervin J. King, Harriman House Ltd., 1999
Mastering Treasury Office Operations- Denis Nolan & Gordon Amos, FT Prentice Hall,
2001
L IST OF F IGURES
Figure 1: Treasury Desks........................................................................................................................................................................................................
Figure 2: Money Market Desk...............................................................................................................................................................................................
Figure 3: FX Desk....................................................................................................................................................................................................................
Figure 4: Equity Desk.............................................................................................................................................................................................................
Figure 5: Specialized Desks....................................................................................................................................................................................................
Figure 6: Flow chart for Treasury Function............................................................................................................................................................................
Figure 7: Foreign Currency Asset and Liability balances import functionality on a Treasury system...................................................................................
Figure 8: Foreign Currency Asset and Liability balances input screen on a Treasury system...............................................................................................
Figure 9: Day Start and End functionality on a Treasury system..........................................................................................................................................
Figure 10: Five core themes for approaching TMU customers.............................................................................................................................................
Figure 11: WTI price graph....................................................................................................................................................................................................
Figure 12: Price and trailing volatility for WTI.......................................................................................................................................................................
Figure 13: Gold Price Model – Actual and Simulated Prices.................................................................................................................................................
Figure 14: Gold WTI Ratio......................................................................................................................................................................................................
Figure 15: Gold-WTI with USD/CHF.......................................................................................................................................................................................
Figure 16: Product wise payoffs.............................................................................................................................................................................................
Figure 17: Potential Future Exposure over life of contract...................................................................................................................................................
Figure 18: Core Treasury Products and Exposure Estimation...............................................................................................................................................
Figure 19: Difference between FX Forward Sale and Purchase contract and Bill Discounting.............................................................................................
Figure 20: TMU customer reactions......................................................................................................................................................................................
Figure 21: Payoff Profile Tool.................................................................................................................................................................................................
Figure 22: Pay off profile for a long forward contract...........................................................................................................................................................
Figure 23: Payoff profile for a long call option......................................................................................................................................................................
Figure 24: Treasury strategies and structures.......................................................................................................................................................................
Figure 25: Pay off profile for a short call option....................................................................................................................................................................
Figure 26: Payoff profile for a combination of a short call and long call...............................................................................................................................
Figure 27: Payoff profiles for forwards & futures contracts..................................................................................................................................................
Figure 28: Payoff profiles for option contracts......................................................................................................................................................................
Figure 29: Quadrant IV - Payoff profiles for a long forward contract...................................................................................................................................
Figure 30: Payoff profile for a long forward contract............................................................................................................................................................
Figure 31: Payoff profile for underlying security...................................................................................................................................................................
Figure 32: Payoff profile for the holder of a call option........................................................................................................................................................
Figure 33: Payoff profile for the writer of a call option.........................................................................................................................................................
Figure 34: Payoff profile for the holder of a put option........................................................................................................................................................
Figure 35: Payoff profile for the writer of a put option.........................................................................................................................................................
Figure 36: Building blocks for synthetic configurations.........................................................................................................................................................
Figure 37: Synthetic forward contract creations...................................................................................................................................................................
Figure 38: Comparative payoff profiles for calls & forwards.................................................................................................................................................
Figure 39: Comparative payoff profiles for calls, puts & forwards........................................................................................................................................
Figure 40: Payoff profile for a synthetic long forward...........................................................................................................................................................
Figure 41: Revised payoff profile for a synthetic long forward.............................................................................................................................................
Figure 42: Template for evaluating derivatives.....................................................................................................................................................................
Figure 43: Comparative look at derivatives...........................................................................................................................................................................
Figure 44: Payoff to the buyer & seller of a call option.........................................................................................................................................................
Figure 45: Payoff to the buyer & seller of a put option.........................................................................................................................................................
Figure 46: Binomial tree - prices of the underlying asset......................................................................................................................................................
Figure 47: Using a Binomial tree to calculate the price of an American Call Option............................................................................................................
Figure 48: Payoffs for the buyer & seller of a forward contract...........................................................................................................................................
Figure 49: Plain Vanilla Interest Rate Swap...........................................................................................................................................................................
Figure 50: Interest Rate Cap .................................................................................................................................................................................................
Figure 51: Interest Rate Floor................................................................................................................................................................................................
Figure 52: Sample trade ticket for a Cap/ Floor....................................................................................................................................................................
Figure 53: Sample term sheet for a double barrier...............................................................................................................................................................
Figure 54: Sample term sheet for a look back swap..............................................................................................................................................................
Figure 55: Sample term sheet for a basket option................................................................................................................................................................
Figure 56: Payoffs for the buyer of a call & seller of a put i.e. of a synthetic forward contract...........................................................................................
Figure 57: Sample term sheet for an amortizing swap.........................................................................................................................................................
Figure 58: Sample term sheet for a variance swap...............................................................................................................................................................
Figure 59: Term sheet for an Equity Linked Note..................................................................................................................................................................
Figure 60: Key elements of a Capital Protected Note term sheet.........................................................................................................................................
Figure 61: Term sheet for a Commodity Linked Note...........................................................................................................................................................
Figure 62: Term sheet for a Range Accrual Option...............................................................................................................................................................
Figure 63: Sample Trade Tickets for Switchables..................................................................................................................................................................
Figure 64: Sample Trade Ticket for an IRD swap...................................................................................................................................................................
Figure 65: Sample Trade Ticket for an IRD note....................................................................................................................................................................
Figure 66: Sample Trade Ticket for a Quanto........................................................................................................................................................................
Figure 67: Sample Term Sheet for a Cumulative Cap............................................................................................................................................................
Figure 68: Sample Trade Tickets for Steepener Notes..........................................................................................................................................................
Figure 69: Sample Trade Ticket for an inverted curve instrument........................................................................................................................................
Figure 70: Sample Trade Ticket for a single range step up....................................................................................................................................................
Figure 71: Sample Trade Ticket for a tiered range................................................................................................................................................................
TREASURY CRASH COURSE