Treasury Management & Operations

November 2022

Index
 Treasury Management – Components

 Treasury Organisation - Organisation

 Liability Management/ ALM/ Investment of Surpluses

 Interest Rate Risks- Bond Mechanics/IRS/VaR

 Forex Operations
 Risk Management
 Managing Volatility
 Lessons from previous crises & Understanding Risk
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 Background
Role of Treasury is decided by the type of Organisation

 Finance oriented
 Banks – Private, Foreign, Public sector, Co-Op
 NBFCs – Housing, Auto, Other Consumer financing
 Insurance Companies – General, Life – Public, Private
 Investment Entities – MFs. PE, VCF
 Finance Infrastructure – Exchanges, Credit Rating, Regulators
 Primary Dealers, Merchant bankers

 Non-Finance Corporate
 Conglomerates
 MNCs
 Other Manufacturing companies
 Other Service Sector – IT, ITES, Education, Healthcare etc

Treasury Management - Components

 Liability Management - Corporates/NBFCs

 Cash flow/ A-L Management/Money Mkt – Banks/NBFCs (FIs)

 Management of Surplus Funds/ Investments - All Treasuries

 Management of Market Risks - All Treasuries

 CRM for Treasuries – Corporates/NBFCs

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 Treasury - Organisation
BoD/ CEO/MD

ALCO Investment Committee Risk Mgt Com

Treasurer CFO

Money Forex Ops Fixed Income Other Risk

Research Middle
Mkt Ops Pcts Office; Risk
mgt
- Macro Economic - G-Secs - Equities
- Spot Ccys
- Commodities
- Fixed Income - Forwards , - Bonds/NCDs Back Office
Swaps & - Swaps Recon;
- Forex Accounting;
Options
Reporting
- Repo/ Reverse Repo
- Call money

Liability Management
Target : Diversified base of resources, Capital adequacy, Optimal Leverage,
Costs, Flexibility

 Capital Structure : Decisions /process on raising capital

 Working Capital Management

 Banking Channel - fund based and non-fund based
 ST market products such as CPs/ ICDs/ Mibor linked Bonds etc

 LT Resources :
 Corporate Bond Market : [Rating, Listing requirements]
 Multilateral agencies : IBRD, USAID, ADB & Kfw; [Conditionalities]
 Project Syndication for projects; [Lender Covenants]

 Cost efficiency & Arbitrage between Banking and Non-Banking Resources

 Cash Credit vs Other ST sources
 ECBs vs Domestic Bond Market
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 Asset-Liability Management
 Asset Liability Mismatches
 Funding/roll-over risks
 Interest rate sensitivity
 Embedded risks e.g. premature withdrawals/repayments

 Liquidity Risk
 Impact Costs on liquidation of assets
 Cash requirements against derivative exposures/hedges
 Stress-testing of cash-flows

 Operational Risks
 Systems; personnel related issues; IT etc
 Data aggregation issues for multi-location companies etc

Management of Surplus Funds/Investments

 The SLR Principle of management
 Safety: Minimum credit risk and lowest default risk
 Liquidity: Ability to sell when required, with low impact cost
 Return : The optimizing criteria after S&L taken care of

 Usually implies investment in

 Govt Securities
 High rated Corporate Bonds/ NCDs
 Fixed Deposits/CDs of Banks (Implied Govt G’tee in PSBs)
 CPs/ICDs of reputed corporates
 MF Products – Liquid Schemes; ST Income plans, FMPs
 Arbitrage (Cash-future) on the exchanges

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 Managing Market Risks- Approach
 Risk or Opportunity
 Risk is always present in any business activity; Emphasis will depend on the
type of activity
 Finance Intermediation is usually a
o Tenor arbitrage
o Credit arbitrage
o Spatial facilitation e.g. forex; Payment systems etc

 Market making and Volume trading – two-way quotes and how the market
moves

 Handling Risk – Approach

 Some risks remain whatever is the approach ; e.g., counter-party risk; Liquidity
risk; Cashflow risk
 Complete Hedge : costs money ….as there is no free lunch & unlikely to find an
exact matching counter-party requirement
 Arbitrage : between markets; products; spatial ….relative price risk
 Outright Price risk

Managing Market Risks/ Opportunities

 Interest Rate Risks : For a Financial Intermediary (FI) this is the biggest
risk since the whole business is in dealing with interest rates on both
sides of the B/S

 Forex Risks : Particularly for Corporates as FIs not seen taking

aggressive forex risks; Banks typically facilitate the transactions and in
the process seek spreads and/or fee-based income

 Equity Market Risks – Risk of adverse price movement

 Commodity Markets- Risk of adverse price movement

 Liquidity/Cashflow/Counter-party Risk : overlaps all product based

exposures

 Arbitrage Opportunities in Markets : Spread trades, Convergence issue

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 A Sample Balance Sheet of a Bank
Summary Balance Sheet - SBI Mar-22 Mar-21
Rs Mn % to total Rs Mn % to total
Total ShareHolders Funds 2,80,088 5.62 2,53,875 5.60
Deposits 40,51,534 81.23 36,81,277 81.19
Borrowings 4,26,043 8.54 4,17,298 9.20
Other Liabilities and Provisions 2,29,932 4.61 1,81,980 4.01
Total Capital and Liabilities 49,87,597 45,34,430

Cash and Balances with RBI 2,57,859 5.17 2,13,202 4.70

Bank Balances Money at Call and Short Notice 1,36,693 2.74 1,29,837 2.86
Investments 14,81,445 29.70 13,51,705 29.81
Advances 27,33,967 54.82 24,49,498 54.02
Fixed Assets 37,708 0.76 38,419 0.85
Other Assets 3,39,925 6.82 3,51,769 7.76
Total Assets 49,87,597 45,34,430
source: moneycontrol.com

Interest Rate Risks

 For floating rate instruments, the PV or Price is by definition Par or 100% at
the interest reset date
 For fixed rate instruments/products
 Outright Price risk on any investment
 Reinvestment and Gap risks : Mismatch between asset and liability maturities => either need
to reinvest or renew the funding => can result in loss/gain
 Basis Risks : e.g. fixed vs floating; different benchmarks for floating or different tenors
 Measurement of interest rate risk => Value/ Price of the product
 Calculation is same as the IRR

 PV of a fixed annual interest stream = ∑ + where c is coupon, F is the

maturity value, r is the market yield and n is the number of years
 PV of bond/debenture, is the Price and r is the YTM – implicit as market deals in price terms
 YTM (r) calculations assume that the reinvestment of interim cashflows (viz., C above) are
reinvested at YTM
 It can be seen that the Price and YTM are inversely related
 Bond Conventions : 30/360; actual/365

 P …..semi-annual = ∑ or in general ∑ where k is the

/ ^ / ^
compounding frequency
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 Interest Rate Risks…2
 Duration or Macaulay Duration is a popular measure of interest risk
=∑ 𝑡𝑖 /P.V. where 𝑡𝑖 is the index of the period of the CF and k is the
/ ^
compounding frequency e.g., for a 2 year semi-annual coupon bond 𝑡𝑖 = 0.5,1,1.5,2 and k = 2

 Can be seen as a weighted average of maturities of EACH cashflow; the PVs of

each CF being the weights => the result is in no. of years

 A more sophisticated version is the Modified Duration which is the first

derivative of the Bond-Price equation w.r.t. YTM or r
 Modified Duration = - ( )∑ 𝑡𝑖 /P.V.
/ / ^

 MD shows the sensitivity of price with respect to yield/YTM

 An example : 6% bond ; 3 year maturity ; FV=Maturity Value=100; semi-

annual payment; What can we make of different scenarios
 What is the MD/ Mac D/Sensitivity
 What is the MD/Mac D when yields are 9% and 2%
 What is the MD/Mac D when coupon is 9% or 2%

Interest Rate Risks….3

Cashflow 3 3 3 3 3 103 r

Period (ti) 0.5 1 1.5 2 2.5 3 0.06

Df (r=0.06) 0.9709 0.9426 0.9151 0.8885 0.8626 0.8375 Sum

CF/ Df 2.91 2.83 2.75 2.67 2.59 86.26 100.00

ti*DCFi 1.46 2.83 4.12 5.33 6.47 258.78 278.99

Mac D= (ti*DCFi)/P 0.01 0.03 0.04 0.05 0.06 2.59 2.79 yrs

MD 0.0141 0.027 0.03998 0.0518 0.06281 2.5125 2.71 %

 Longer the maturity/MacD, higher the MD/sensitivity

 Behaviour of MD/Mac D at different level of absolute rates – Higher sensitivity
at relatively low rates => long recovery rates
 Behaviour of MD/Mac D at different level of coupon rates – Lower sensitivity at
higher coupons => Convexity or second order movement of P w.r.t. YTM
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 Interest Rate Risks…4
 Some related measures

 BPV01/PV01 : Basis point value or delta Present Value 01

o Change in the value of a Bond/portfolio for one basis point
change in yield

 Duration Gap
o Volume weighted average duration of Assets vs Liabilities

 Rate Sensitive Assets vs Rate Sensitive Liabilities

 Value at Risk
 Based on expected portfolio valuation
 Typically applied to trading portfolios and other
products/assets as well

Interest Rate Swaps (IRS)- Backdrop

 Term Structure of rates and Forward interest rates are building blocks for swaps
 Indian markets do not have a term money market but some products managed
to develop. Lets assume there is a term structure like this
Month Bid Ask

1 5.00 5.05

3 5.25 5.30

6 5.50 5.55

9 5.60 5.65

12 5.75 5.80
FFIR & FRA : important concepts to understand IRS
 Forward-forward interest rate (FFIR) is a forward rate for a transaction starting
at a later time ; say 3 month lending/borrowing rate starting 3 months from now
 Forward Rate Agreement (FRA) is a derivative on FFIR for a pre-specified
notional amount. The above would be a 3X6 FRA
 Given the above term structure and no credit spreads what would be a two-way
quote for a 3X9 FRA ? •16
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 Forward Rate Agreement
 Buying a 3X9 FRA = effectively borrow for 6 months at the end of 3
months from now (@5.65%)
 For a market-maker it means effectively lend for 6 months at the
end of 3 months from now (@5.65%)
 How can they do it given the above term structure
 Buyer of FRA effectively borrows for 9 months and lends for 3
months & Market maker effectively does the reverse

 => {[1+(0.0565*9/12)]/[1+(0.0525*3/12)]-1}*200 = 5.775%

 For the reverse, the market maker would charge 5.675%

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 Hence the 3X9 FRA rate is: 5.675% -5.775 %

FRA Settlement
 Since it is a derivative, there is no actual borrowing or lending
 The settlement is on the basis of differences between the agreed rate and the
market rate (of the underlying variable) prevailing on the settlement date ; The
3X9 FRA at say 5.775 % Mibor would gain from the contract if 3 months later
the 6 mth Mibor is >5.775 % and vice versa
 If the 6mth rate after 3 mths is say 6.775% then seller would pay net difference
of 0.4839% on the notional amount (to be decided upfront)
 If this rate was 4.775%, then buyer would pay 0.4885% to the seller on the
notional amount contracted
 This can be seen as buyer paying fixed rate of 5.775% to the seller and
receiving the variable rate (Mibor in this case)
 Exchanging differences allows the buyer/seller to neutralise (hedge) actual
borrowing/lending if there were one
 Say, now one wants this structure not for 6 mths but for 5 years….=>IRS
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 Interest Rate Swaps in India
 Interest Rate Swap is a series of FRAs on an agreed interest rate. The parties
will exchange two sets of cash flows (usually one leg fixed) at periodic intervals
on a Notional amount for the agreed tenor
 The floating rates that are popular in the Indian context are MIBOR, MIFOR and
INBMK
 Market lot Rs 250 mn ; Swap start date is usually T+1 basis ; Liquid markets upto
5 years; some cases 10 years
 Dealt in OTC market. Credit risk between counter parties; Subjected to ISDA
agreements; Credit Support Clauses becoming common
 Swap rates typically driven by factors driving G-sec (treasury)/ Corporate Bond
Yields; Generally the direction is the same, but not the quantum of movement;
Spreads to treasury or corporate bonds could be volatile. So as risk mitigation,
they are reasonable but basis risks remain
 The hedge (or risk) is through paying fixed rate in a scenario of higher rate
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expectations, and receiving fixed rate in a lower rate expectation

IRS …2
 A look at the Mibor swap – Overnight Interest Swap
 Typical transaction structure : Assume company A wants to protect against a
raising interest rate scenario (Examples of when and why it wants this??)
 They want to do this through a “pay fixed rate” OIS for a notional amount of Rs 1
bn. The 5 year quote of B is say 5.75-6.00
 The transaction will entail A to pay at 6% semi-annually (Rs 15mn) and receive
Mibor for previous six months, compounded daily

interest payment 6% semi-annually on Rs 1 bn

Party A Party B
interest payment Mibor daily compounded semi-annually on Rs 1 bn

 Mibor has a direct relation to the policy rate (Repo/ReverseRepo) and hence
generally moves with other rates. The OIS curve is a good representation of the
policy expectations
 The risk in the swap can be estimated similar to that of a G-sec; PV01 or MD •20
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 Value at Risk

 Estimate of maximum Potential loss in the Value of the Portfolio ;

assumed worst case scenario

 Over a specified time period

 At a specified confidence level

 Typically assumes joint normal distributions for a Portfolio

 Uses assumed, historical or implied volatility

 Uses MC simulations for the rates for the respective periods and
takes the left tailed values for the estimation of maximum losses

Value at Risk…2
 Methods :
 Historical Return Profile : Take the historical daily returns of say one year; Order them in
terms of low to high; The point at which the left tail data crosses 5% is the value which we
can expect as maximum loss for a single day, at a confidence level of 95%

 Parametric: Assume that our data is normally distributed; then the mean and the SD describe
the data well. Hence we look at the 95%/99% confidence level for the left tail (1.65/2.33SD)

 Monte Carlo Simulation : Using a simulation obtain the VaR levels and average over them

 Can be aggregated over different securities and different trading portfolios

 Can be used to compare different types of portfolios

 Gives an idea for the Treasurer/ Top management, Risk Managers and
Regulators an extent of the risk embedded in different portfolios and at an
aggregated level. Larger the VaR, larger the risk

 Does not specify what happens beyond the confidence level; of around 2.33
S.D. for 99%. => No estimate of amount of loss if the level exceed

 This is an estimate ! No guarantees 11

 Risk Management

Measurement & Mitigation

 Exposure as absolute limits

 Dealer-wise Position/ Stop-loss limits
 Exposure as % of Networth
 Limit on Portfolio VaR
 Stress Testing of Portfolio/ Worst Case scenario
 Mandatory Stop Losses
 S/L Review Triggers
 General Review Triggers (e.g. event-based)
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ALM - revisited
 Banking Vs Trading book & off B/S exposures
 OTC vs Market ; Products like securitization tend to bridge the gap
 Held to maturity vs held for trading - accounting and valuation
 New accounting norms
 Interest rate risk straddles both, though it is more for trading book ; Hence
need for ALCO beyond Treasury
 ALCO : Top operational unit for overall risk assessment, measurement and
management. In the process it

 Provides B/S planning for the Board/CEO:

 Funding mix – domestic vs fgn ccy; ST vs LT ; retail vs wholesale; Tier II capital
 Profit planning and growth projections

 Product pricing directions to various units– fixed vs floating; Interest

margin/spread; desired maturity profiles

 Provides overall Risk measurement, assessment and guidelines for risk mgt
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 ALM …2
Type of Risk Measurement Control

Trading Outright
book price risk PV01, MD, VaR Limits on
Individual trading
Yield Curve Risk Portfolio size
Basis /Repricing Risk Portfolio MD/PV01
Stop-Loss limits
Management Counter trading

Liquidity Spreads and Limits on securities with low

Risk Volumes trading
Forex Risk Limits on trading, stop-loss
Fx Swaps

ALM …3
Banking Type of Risk Measurement Control
Duration/Maturity Reduce/Increase portfolio
Book Gap/Mismatch gaps duration
Basis /Reinvestt
Risks Income gap Reduce/Increase RSA vs RSL
Interest Rate Swaps
Liquidity Risk ST mismatch Cash/Liquid asset coverage
Credit/default risk Downgrade/Default H.O./R.O. oversight
NPA recognition and mgt
Premature
Embedded option repayments Differentiated Pricing
/withdrawals Absorbing in the Spreads
Robust systems, periodic
Systems Risk checks/audit
Robust systems, periodic
Operations Risk checks/audit
HR risks Strong HR policies 13
 Treasury Products in India
 Ready Delivery Products - Buy/sell for current/immediate date
 Cash/spot markets – OTC (currencies, G-secs, Bonds/NCDs)
 Cash/spot markets – Exchange-based (Equities & commodities)

 Future Delivery Products – Buy/Sell for forward date - Interest cost for carrying
the product
 Forwards – OTC (Currencies, G-sec repos)
 Futures markets - Exchange based (Currencies, Commodities, Interest rates)
(delivery vs non-deliverable)
 Series of Future Payments (series of forwards) – OTC product
 Loan vs Interest Rate Swap
 Fgn Ccy Loan vs Currency Swap

 Optional Delivery Products [Buy/Sell contract for right to buy/sell]

 Exchange based – Equities, Currencies
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 OTC – Currencies

Thank You

ramgopal.kundurthi@gipe.ac.in
+91 98200 70086

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