TREASURY MANAGEMENT

• Definition
• Treasury management is the management of an organization’s
liquidity to ensure that the right amount of cash resources area
available at right time in right currency and right place in a way to
maximize the return on surplus funds and minimize cost , control
interest rate and currency exposure to an acceptable level.
• In short it is efficient management of financial risk and liquidity of
business
• Objectives
• - To meet problems arising out of growth in money , capital and
forex markets which has become volatile in nature
• - Use of Information Technology for analysis, receipt and
transmission of information on Economic indicators affecting Banks
and various inflows and outflows from Banks resoureces
• - To reduce funding cost to manage liquidity and allocate resources
efficiently
 TREASURY MANAGEMENT
• - To Optimize profitability in investment by increasing overall
average return on the portfolio , through trading in securities and to
earn moderate capital gain
• - To control and minimize the situation araising out of market risk
and credit risk
• - To comply with requirements of the regulatory authorities like RBI
(Reserve Bank of India, SEBI etc).
• - Adhere to internal policy guidelines on money market operations
and investments
• -For all the above clear POLICY GUIDELINES should be layed
down
• -Set specific and goals
• -Set policies for managing various risks
• -Set clear guidelines for IT and analytical capabilites
• -Assign clear organizational and decision making roles
 TREASURY MANAGEMENT
• Avoid deficiencies VIZ:
• - undue reliance on Maturity Gap alone as the sole indicator of
interest rate sensitivity
• - Insufficient knowledge on part of Asset Liability Committee
Members
• -Over estimation of quality of internal data
• - Too much reliance on computer to provide solutions
 TREASURY MANAGEMENT

• Organizational structure
• Three distinct functions –Dealings, Back office , Accounts
Head Treasury

Head of Research and

Chief Dealer Head Back Office
Analysis
Funds Manager

Back Office
Dealer Dealer
Operations Officer Officer Officer
Money Market Corporate Dealer Forex
Accounts Debts Equity Forex
Operation Bonds and shares
Planning

Officer Officer
Settlement Security Accounts

Officer
Security
Custody and
Interest
Collection
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• Note
• Fund Manager takes care of
• A) Liquidity Position
• B) Fund Flows
• C) Maintains Reserve Requirement
• When Volumes are more – Risk Managers are also posted who
take care of
• A) Evaluation of scenarios
• B) Independent review of Line /Limit excess
• C) Review of transactions to ensure compliance with regulatory
norms
• D) Moniter risk factors – Credit, Liquidity, Interest rate , Performance
risks
 TREASURY MANAGEMENT
• Functions of Treasury
• - Maintain CRR, SLR at required level
• - Deploy surplus money in Short term / Long term depending on maturity
profile of resources and market opportunities
• - Drawals of refinance from RBI
• Maximize returns through trading and retailing in securities
• CRR- Cash Reserve Ratio
• - Cash Balances which are maintained with RBI in the account are
considered for CRR
• - To be maintained over a 14 day period on a daily average basis
• - Maintain a minimum level of 85 % of the CRR balance required to be
maintained in each of the first 13 days of the reporting fortnight
• -Actual figure should be - % of NDTL on the reporting Friday preceeding
to CRR fortnight
• - Penalty for shortfall
• A) Not allowed to access to refinance / rediscount facility and pay 3 % on
portion of accomodation already obtained by them from RBI
• B) Interest will not be paid by RBI
 TREASURY MANAGEMENT

• SLR – Statutory Liquidity Ratio

• It is for safeguarding the interest of the depositors and money
supply in the economy .
• It is % of the NDTL (Net of Demand and Time Liabilities)
• Components of SLR –
• A) Cash in Hand ( Excluding foreign currency)
• B) Excess cash with RBI over statutory CRR
• C) Net Balance in Current Account with SBI / Nationalised Banks
• D) Investment in Government securities
 TREASURY MANAGEMENT
• A treasury Manager may also be termed as CFO ( Chief Financial
Officer )
• As a CFO he is responsible for all crucial financial decisions. He is
also a member of TOP Management and may be called as VP,
Director ( Finance), GM ( Finance ) or any other name
• He is involved in the formulation of policies and decision making and
thus performs the functions of both the controller and the treasurer
• Responsibilities as a Controller :
• Recording transactions in Books of Accounts like GL, accounts
receivable , payables etc.
• Track short term investments
• Act as a planning director
• Prepare pay rolls
• Other types of reporting and assistance to the top management
 TREASURY MANAGEMENT
• His responsibilities as a Treasurer – deals with liquid assets
and custodian of cash
• Funding – Both long term and short term cash requirements.
Considers debt structures of organization , Debt portfolio
management etc.
• Working capital Management – Balancing of current assets and
current liabilities
• Better Investor relationship
• Good Banking relationship
• Short term investment – Decision making and implementation
• Risk ( Hedging) and Foreign exchange management
• Establishing company policy
• Capital structure formulation
• Insurance and Tax Planning
• Internal Treasury controls
 TREASURY MANAGEMENT

• Financing decisions – relates to mobilization of funds

• How to mobilize – amount , from internal generation or external
sources
• Where and whom to mobilize from
• Procure at what cost
• When to mobilize
• Investment decisions
• Funds generated i.e. internal generation needs to be used to give a
proper Return on the Investments which can be both long term
assets / Short term
• Long term assets – Known as Capital Budgeting
• Short term assets – Known as working capital management
 TREASURY MANAGEMENT
• Financial Markets- Overview
• Place where people and organizations wanting to borrow money are bought
together with those having surplus funds is called financial market .
• Functions of Financial Markets
• Intermediary functions which consist of
• -Transfer of resources – resources from lenders to ultimate borrowers
• - Enhancing Income – allows lenders to earn interest/ dividend on their surplus
investible funds , thus contributing to the enhancement of the individual and
national income
• - Productive usage – Funds are productively used enhancing the income and the
gross national production
• - Capital formation – channel through which new savings flow to aid capital
formation
• -Price determination – Price determined through interaction of buyers and sellers
They provide a signal for the allocation of funds in the economy based on the
demand and supply through the mechanism called ‘ Price discovery process’.
• -Sale Mechanism – Provides for sale of assets by investors so as to offer benefits
of marketibility and liquidity of assets
• - Information – The activities generate dissemination of information to various
segments to reduce cost of transaction
 TREASURY MANAGEMENT

• Financial Functions
• Provide borrowers with funds so as to enable to carry out their
investment plan
• Provide lender with earning assets so as to enable earn wealth by
deploying in productive ventures
• Provide liquidity in market to facilitate trading
 TREASURY MANAGEMENT

Primary
Market
Non
Secondary
Depository
C Market
Market

O
N
S Depository Money
Market Market
T
Financial
I Market
T Constituents
Financial
U Service Capital
E Market Market

N
T
Equity Debt
S Market Market
Euro Bond
Market
 TREASURY MANAGEMENT
• Money Market- Characteristics
• Short term funds borrowed and lent
• No fixed place for conduct of operations
• Dealings may be conducted with or without help of brokers
• Short term financial assets dealt in are Close substitutes for money ,
financial assets being converted in money with ease, speed, with minimum
transaction cost
• Funds are traded for a maximum period of 1 year
• Presence of large number of sub markets such as Interbank call money
market, bill rediscounting, T Bills etc.
• Objectives
• -Provide an equilibrium mechanism for ironing out short term surplus and
deficits
• - Provides a focal point for Central Bank intervention for influencing liquidity
in the economy
• - Providing access to uses of short term money to meet their requirement at
a reasonable price
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M
O
N
E
Y Call Money
Market
M
A
R
Collateral
K Discount
Loan
Market
E Market
Money Market
T Segmants
S
E
G
M
Acceptance Bill
E Market Market
N
T
S
 TREASURY MANAGEMENT
• Call Money Market – It deals in money at call and short notice. This
market deals with extremely short period loans. Funds are available
for being borrowed and lent for extremely short period ranging from
day, overnight or upto a maximum of 7 days.
• The money invested by banks in call money market provides high
liquidity with limited profitability. It takes the form of inter – bank call
money market wherein the bank with surplus lends to needy banks.
• Banks usually borrow to meet the statutory obligations. Rate of
interest is highly volatile and sensitive to changes in demand and
supply. It is looked upon as the barometer of the money market.
• Collateral Loan market – A market for collateral funds. Money
made available against the collateral of securities such as Stocks,
bonds etc. This is a specialized sector of money market. Loans are
granted against the securities . The borrowers are mostly brokers
and dealers in the stocks and shares. Collateral loans are mostly
advanced by commercial banks to a private parties in the market.
 TREASURY MANAGEMENT

• Bill Market –Market that deals in the purchase and sale of various
types of commercial bills. Commercial bills are 2 types bills of
exchange and treasury bills.
• Whereas commercial bills are drawn in evidence of commercial
transactions and are between two parties, the Treasury bills is a
short term government security having a maturity ranging from a few
days to few months. The instrument is sold by central bank on
behalf of the govt. and does not guarantee any fixed rate of interest
to the holder. The T Bills are generally sold by auction to the
Highest bidder. There is no default risk and are so very secure for
loans.
• Acceptance market – A market that deals with Banker’s
acceptances are known as ‘Acceptance market’. A Banker’s
acceptance constitutes a draft issued by a bank ( drawn by a
business firm on a bank) and accepting/ undertaking to make the
payment of the money specified on the draft on demand. Banker’s
acceptances arise out of commercial transactions both within the
country and abroad.
 TREASURY MANAGEMENT
• Discount market – The market where bankers acceptances are
discounted is the discount market. Since Bankers acceptance bears
the signature of the Bank, they are easily discounted with less
charges. This offers the advantage of temporary funds to the
traders.
• Institutions that operate in money market are :
• Commercial Banks – They constitute the most important segment
in the money market. They use short term deposits for providing
short term funds to trade and commerce. They also invest funds for
discounting the commercial and treasury bills. Liquidity and
profitability are the tow cardinal principles that are kept in mind while
carrying out lending operation by commercial banks.
• NBFC- Non Banking financing companies like insurance
companies, leasing companies etc. They lend to business
corporations. They make a decisive impact on the money market
operations through their variety of activities.
 TREASURY MANAGEMENT

• Acceptance Houses – Institutions that specialize in task of

acceptance of commercial bills are called ‘Acceptance houses’.
They accept exchange bills on behalf of their customers. The
discounting of such bills is done by Discount Houses.
• Central Bank – They are important constituent in the money
market. They have many important functions. The central bank
works for the integrated development of the various segments in the
banking and financial system of the country. The efficiency of the
measures like credit control measures is largely determined by the
efficiency and sensitivity of the money markets.
• RBI took several measures for setting institutions to hasten growth
and development of money market by establishing DFHI to deepen
the money market operations. Similarly SEBI, CRISIL, ICRA were all
brought in to develop a strong system in the money market and to
regulate the dealings.
 TREASURY MANAGEMENT

• Instruments in the money market.

• T – Bills , Money at call and short notice, Bill rediscounting scheme (BRS),
CD, CP , REPO IBPC, Securitised debt, Options, Futures, FRAs , Swaps
etc.
• General features of the instruments are :
• Short maturity – Maximum period is upto 1 years. Call money deals in
funds for period ranging from 1 to 7 days. T Bills have 91 days and 364
days duration, CP and CD are also short term. Thus short duration is the
hall mark of the instruments.
• High Liquidity – They have high liquidity. Being in the nature of ‘near
money’ they can be easily and quickly converted into cash at low
transaction cost with loss. Rediscounting facility is available with RBI and
DFHI.
• High Safety – Money market instrument enjoy government guarantee. In
addition they are issued by institutions of sound financial standing (T bills
by RBI), Banks (BRs and CD), highly rated corporate in (CP and securitized
debt). This gives high safety with near Zero risk of default.
 TREASURY MANAGEMENT
• Limited participants – The instruments are dealt by RBI, DFHI ,
STCI at the apex level and by Banks , select financial institutions,
and corporate at the operating level. Banks can indulge in both
buying and selling of instruments without any restrictions only
lending facility with the fulfillment of certain conditions is available
for selected public financial institutions and corporate entities.
• High Volume – Volumes are high and the minimum is also high for
example TBIlls – 1 lakh , CD or CP 25 laks. Minimum rediscounting
amount for a single commercial bill and call loan is Rs. 10 crore.
• Interest rate deregulation – There is no regulation and the rates
are market determined.
 TREASURY MANAGEMENT
• Yields in money market instruments
• Call Money –The rate is called the ‘call money rate’. They are found
to have seasonal and daily variations requiring intervention by RBI
and other institutions . Thus they have a high volatility with varying
fluctuations which has many factors . Some of them are :
• CRR Requirement – Important tool with RBI which is often used for
influencing liquidity in the financial system. Heavy rush on reporting
fridays cause rise in demand resulting in rise in rates. Also where
Banks make huge demand for liquid resources for meeting
structural disequilibria in their inflows and outflows of funds.
• Institutional selling – Rates go up when institutional lenders start
selling securities for meeting their loan repayment or maturity of
their instruments or other business needs. This causes a sudden
spurt in demand for call funds.
• Corporate demand.- Particular part of years when tax burden falls
on corporate there is huge demand causing a spurt in rates.
 TREASURY MANAGEMENT
• Bank deposits – Where banks are flush with more deposit funds, the
supply increases causing fall in rates. And vice versa.
• Stock Market – Stock market conditions largely causes wide
fluctuations for instance When stock market is buoyant call rates go
up and vice versa. Industrial and commercial boon also make call
rates move up as against a period of depression.
• GSM Vagaries . Government securities market also influence call
rates. When subscription to govt. loans opens , the demand for call
loan goes up thus spurting call rates. And vice versa . A jump in the
liquidity resources of banks due to interest payments on central and
state government securities in the months of April, May, October
and November has an effect on call rates.
• Alternative sources – Alternative sources of short term funds are
available. This can have an effect. For instance , where it is
possible for banks to avail liberal access to rediscounting finance
from RBI at cheaper rates, the demand demand for call funds
decrease and call rates decline.
 TREASURY MANAGEMENT
• Cyclical fluctuations – During busy season from October to March
there is greater demand for call loans and less in slack season from
April to september
• Other causes – Some other factors viz.
• A) Absence of adequate number of big lenders causing liquidity
crunch and enhanced call rates
• B) Lack of sophisticated techniques for forecasting, resulting in over
reaction to changes.
• C) Highly telephone dependent nature of market – absence of
perfect communication network in some areas
• Commercial Paper
• The rates vary greatly which is influenced by various factors such as
• Credit rating of the instrument, economic phase, the prevailing rate
of interest in CP market, Call rates, the position of foreign exchange
market. There is no bench mark for this interest rate.
 TREASURY MANAGEMENT
• Certificate of deposit
• CD rates are higher than time deposit rates . Many factors influence
this. They are :
• A) Urgency of requirement of funds
• B) Alternative opportunities for investment of funds mobilized
• The CD are issued at a discount to face value and the effective rate
of interest is higher than the quoted discount rate. To calculate the
same we have the formule
• ERR = [ (1+ QDR/100 x N/M) N/M -1] x 100
• ERR – Effective rate of interest
• QDR- Quoted discount rate
• N – Total period in a year , say 12 months or 365 days
• M – Maturity period in months or days as case may be.
 TREASURY MANAGEMENT
• T Bills – The discount rate at which the RBI sells is known as TB
rate. The effective yield on TB depends upon such factors as rate of
discount, difference between the issue price and the redemption
value and time period of their maturity.
• TB Rate : computed as follows ;
• Y = [{(FV-IP) /IP} x {364 /MP}] x100
• Govt. securities – Issue through auction on Yield basis or Price
basis.
• Yield basis – The Yield percent per annum or the price expressed
upto 2 decimal places should be stated in the application.
Depending upon the bids received the maximum rate of yield or the
minimum offer price is determined.
• Price basis – Where the auction is held on ‘Uniform price method’
competitive bids offered with rates upto and including maximum rate
of yield or the pries upto and including the minimum offer price as
determined by RBI will be accepted at the maximum rate of yield or
minimum offer price is determined . Bids quoted higher than the
maximum rate of yield or lower than the minimum price as
determined by RBI will be rejected.
 TREASURY MANAGEMENT
• Where an auction is held on “Multiple price “ method competitive bids at the
maximum rate of yield or the minimum offer price as determined by RBI will
be accepted.
• REPOs- Being collateralized loans, repos help reduce counter party risk
and therefore fetch a low interest rate.
• A treasury manager can use this instrument to his advantage. As low risk
and flexible short term instruments, repos are used to finance securities
held in trading besides meeting specific customer needs. They offer low
cost investment opportunities with combination of yield and liquidity.
• They are used as fund management / SLR management devices used by
banks.
• Liquidity adjustment facility – RBI undertakes the management of short
term liquidity by standing ready to infuse or siphon out liquidity from the
banking system by undertaking repos/ reverse repos for short tenors ( as
short as one day) in government securities. This combined operation which
is addressed to the system ( not to the individual market participent) is
known as Liquidity adjustment facility.
• The Reverse repo rate represents interest rate at which RBI is prepared to
infuse liquidity and repo to siphon out .
 TREASURY MANAGEMENT

• The accounting guidelines for REPOs are :

• Contract price – The first leg should be at the prevailing market
rates Accrued interest received / paid in a repo / reverse repo
transaction and the clean price ( i.e. total cash consideration less
accrued interest) should be accounted for seperately.
• Entry and exit – Securities will exit and enter the investment
account of the seller at the book value.
• Market making – The buyer of securities will ‘mark to market’ the
securities acquired under reverse repo transactions as per the
investment classification of the security.
• Coupon – While the buyer will book the coupon during the period of
repo , the coupon will not accrue to the seller during the period of
repo.
 TREASURY MANAGEMENT

• Bill Market-
• RBI grants advances against the security of Usance promissory notes
under section 17(4) ( c ) of RBI Act. The advances takes the form of
demand loan. Introduced in 1952 and discontinued in 1971.
• In 1970 another scheme was started and revised in 1981 . Now as per
this the eligible banks can rediscount the bills with another bank.
• Under this scheme all commercial banks, selected urban cooperative
banks, EXIM Bank, LIC Mutual Fund, SIDBI etc were alloweed to use
this marker.
• The Eligible bills were : a) Bills arising out of genuine trade
transactions. Bills under Letter of credit Bills arising out of sale of good
to govt. departments and bills of exchange drawn on and accepted by
ICICI on behalf of it purchaser constituents.
• The Banks seeking rediscounting facility were authorized to keep with
them on behalf of their discounting institutions individual bills upto Rs.
10 lacs.
• The banks can take delivery of the bills lodged with the discounting
institution 3 days before the date of maturity.
• Eligible maturity – For export bills period was 180 days
• - For other bills period was 90 days
 TREASURY MANAGEMENT
• The following measures were introduced to revitalize the scheme.
• Interest rate – To attract market players with surplus funds such as
LIC, UTI etc the interest rate was increased to 12.5 %
• To do away with the stamp duty, an innovative derivative promissory
note was introduced in 1988 wherein banks were permitted to issue
derivative usance promissory notes for a period not exceeding 90
days .
• Inter relationships
• We see that there is a inter relationship in the types of instruments
on account of their structure which are short term, on account of the
yield which are market determined and thus an influencing factor in
the decision making for the treasury manager in the areas of choice
of instruments to be used, maturity and yield depending upon the
requirement.
 TREASURY MANAGEMENT
• FOREIGN EXCHANGE MARKET
• Characteristics of Market :-
• This does not have a physical place. Done electronically by linked networks
of banks, foreign exchange brokers, and dealers whose function is to bring
together buyers and seller in the market.
• The market has geographical dispersal since it is available in many centres
in the world. Viz. London, New york, Paris, Zurich, Amsterdam, Tokyo,
Hongkong, Toronto, Frankfurt, Milan etc.
• Transfer of purchasing power – Market aims at permitting transfer of
purchasing power denominated in one currency to another
• Volume – Out of the total trading transaction taking place in foreign
exchange market around 95 % takes the form of cross border purchase and
sale of assets, that is international capital outflows. Only around 5 % relates
to export import activities.
• Provision of credit – Market provides credit through specialized instruments
such as ‘Bankers acceptances’ and letter of credit.
• Minimizing risks – Risk of trade is minimized. Done through ‘hedging’
facilities
 TREASURY MANAGEMENT
• Constituents-
• Interbank market – It is the wholesale market through which most
of the currency transactions are channeled. It is used for trading
amongst bankers. About 20 major banks dominate the market.
• There are 3 constituents of interbank market. They are :
• Spot Market- Account for 60 % of transactions
• Forward Market – Account for 10 % of transactions
• Swap Market – Account for 30 % of transactions
• SWIFT – It is an international bank communication network that
links electronically all brokers and traders in foreign exchange. It is
an important mode for trading.
• Participants- Bank, Non bank foreign exchange dealers, Individuals
and firms conducting commercial and investment transactions,
speculators and arbitragers, Central Banks and treasuries and
foreign exchange brokers
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• Transactions
• Spot transactions – The rate is spot rate, date of settlement is
known as value date
• Forward transactions – one currency exchanged for another at a
future date but the rate is fixed at the time of agreement. Quoted for
value dates of 1, 2, 3, 6 or 12 months.
• Swap transactions – Simultaneous sale and purchase of a given
amount of foreign exchange for different value dates with the same
counterparty. Two types Spot against forward and forward against
forward.
• Rates and quotations – Interbank quotations are normally direct
quotations. The trading principle is ‘buy low and sell high’Cross
rates are rates between two currencies not related to the trading
countries currency.
 TREASURY MANAGEMENT
• Factors influencing Exchange rates :
• Demand and supply
• Relative strength of economies for a given pair of currencies
• Trade surplus /deficit vis-à-vis the currencies of the countries
concerned.
• GDP, Fiscal deficit, Balance of Payment position, Industrial
production data, Employment data etc.
• Monetary policy of government/ central bank
• Political and security climate
• Inflation rate differentials
• Interest rate differentials
 TREASURY MANAGEMENT
• Exchange rates are 2 types a) Merchant rate B) Inter bank rate
• Transaction cost – These are fixed and charged to the member banks by
FEDAI . In foreign countries these are negotiated between banks and their
clinets.
• Nominal, Real and effective exchange rates
• Nominal – It is presented in an index form . It is also called the notional rate
• Real rate – The exchange rate that measures the purchasing power of the
currency and gives and idea whether the exchange rate is competitive . It is
obtained by adjusting the nominal rate for relative pries between countries
under consideration and can be calculated as follows
• RE = [ NE x DP] / FP
• Index of real exchange rate = nominal exchange rate index x domestic price
level index divided by foreign price level index
• Effective Exchange rate – Measure of appreciation or depreciation of a
currency against the weighted basket of currencies with whom the country
trades. REER changes without any change in exchange rate. It can
appreciate by the reduction of non tariff barriers that makes import cheaper
and rate can depreciate by import liberalization.
 TREASURY MANAGEMENT

• Relationship with Money market operations

• Banks as AD provide support to international trade. They maintain
foreign currency positions in different convertible currencies. They
offer various exchange rates. Forex market is organised and banks
are important players.
• The signs of mature market contribute to lower arbitrage
opportunities . The recommendations of Capital account
convertibility aims at providing competitive capital/resources.
However , currently, on account of the inherent imperfections in
Forex and domestic money markets, distortions and consequent
arbitrage opportunities arise. Integration of markets in the light of
CAC recommendation envisage freedom to convert Rupee portfolio
into Foreign currency portfolio and vice versa.
• RBI has thus permitted two way conversion of rupees into FC and
FC to Rupee subject to a ceiling of 15 % of the unimpaired Tier I
capital of the Bank concerned.
 TREASURY MANAGEMENT
• In respect of Cash / Spot premium of USD/INR which is essentially a two
day money should be ideally correspond to the call money rates. However,
on account of existing imperfections, the cash/spot premium do not at all
times move in tandem with the call money rates for an arbitrage opportunity.
• Similarly on account of inflation and interest rate differentials , USD normally
commands a premium. By utilising rupee resources subject to 15 % Tier I
cap and the Gap limit compliance requirements, it should be possible for
Banks to buy spot USD only to be sold later.
• Conversly Bank can also choose to borrow to the specified extent in FC
terms and create temporary liquidity by swapping the FC funds for rupees ,
in case it is facing funds constraints in the local markets or when the cost of
domestic funds shoot up.
• Arbitrate opportunities would vanish or be lower with the progress towards
full convertibility.
• Therefore, coordinated working of FX treasury and domestic money market
will be good for the economy and this is what is the link between the FX
market and money market.