Collateralised Borrowing and Lending Obligations (CBLO)

Collateralised Borrowing and Lending Obligations (CBLO) is a product in the money market launched in 2003 by Clearing Corporation of India Limited (CCIL). Collateral is a physical security given as a guarantee by a borrower for participation in the transaction. CBLO provides liquidity to non-banking entities that have been phased out of call money market or have restrictions on borrowing/lending transactions in call money market. It is a tripartite repo in which the borrower deposits his securities with a third party acceptable to the lender. CBLO is a repo used in international markets. The third party guarantees the return of funds from the borrower on the specified date. The third party sells the securities in the market to repay the funds to lender. In most of the repo transactions, both the borrower and lender cant unwind the deal before the due date. In certain cases even if the liquidity condition of the borrowers improves before the specified date, they cannot unwind repo deal. Similarly, even the lenders cannot get back their funds until the maturity date of the repo deal. When lenders need funds, they have to enter into a new repo deal or borrow funds. To resolve this problem, CCIL designed the CBLO to lend or borrow at various maturities. RBI has prescribed the mode of operations in the CBLO segment. The minimum order for auction market is ` 50 lakh and in multiples of ` 5 lakh. In 2002 RBI permitted CBLOs developed by Clearing Corporation of India (CCIL) without any restriction on denomination or lock-in period. There is a facility to unwind lending and borrowing at prices depending on the market situation. Since the lenders and borrowers have the flexibility to unwind the deal at their will, they may have to bear risk of buying CBLOs with longer maturity period. In auction market, the borrowers will submit their offers and the lenders will give their bids, specifying the discount rate and maturity period. The bids and offers are screened from 9.45 am to 1.30 pm on working days. In normal market, the minimum order lot is fixed at ` 5 lakh and in multiplies of ` 5 lakh. The members will place their buy/sell orders on the screen which is opened from 9:30 am to 3.30 pm on all working days. The orders are selected based on best quotations and negotiations are also allowed. The borrowers issue the debt instruments under the guarantee of CCIL. CCIL identifies lenders and borrowers to promote CBLO. It, provides guarantee, manages the instrument, and acts as a clearing house for settlement between the purchaser and seller through clearing operations. In a demanding situation, it also acts as a buyer or seller. The CBLO members are required to maintain a cash margin with CCIL as a cover for the exposure obligations during the course of borrowing. The borrowing members retain the ownership of the securities as the securities are not transferrable to the lenders. The participants in CBLO transactions are the members of Negotiated Dealing System (NDS) such as banks, financial institutions, cooperative banks mutual funds and primary dealers. The Non-NDS members like cooperative banks, corporates, Non-banking Financial Companies (NBFCs), pension/provident funds and trusts can participate by registering themselves as associate members to CBLO

segment. The associate members can participate in normal market to borrow and lend funds, but not in auction market. The CCIL designates a bank and the associate members are required to open a current account for settlement of funds.

2. Definition of commodities markets Commodities market is the market in which commodities like oil, gold, and agricultural products are traded. It operates on agreements for buying and selling commodities at agreed prices on a specific date. The main commodities markets are in London, New York and Chicago. In India, commodities market facilitates multi-commodity exchange within and outside the country based on requirements. The Indian commodity market has grown tremendously after the liberalisation of the economy. The demand for commodities in the Indian domestic and global market is estimated to grow four times in the next five years. 4.8.2 Regulators of commodities markets Regulation of commodity market is done by governmental commissions that process the trading. In India Forward Market Commission (FMC) acts as the regulator. Head quartered in Mumbai, FMC is overseen by the Ministry of Company Affairs. FMC helps introduce new instruments like options, benefiting the stakeholders including farmers who benefit from price discovery and price risk management. 4.8.3 Commodity exchanges Commodity exchange refers to commodity purchases and trading contracts for future delivery. These exchanges facilitate trading in physical goods like corn, timber or oil. Most commodity exchanges trade in a single commodity product like oil or rice. A few commodity exchanges work with spot market for providing immediate delivery. This paves way for traders to purchase products in spot market and use or store them for later use. Other products include futures, where an agreement is made for trading at a given price in future. These markets help people make investments that hedge the risk. Some of the commodity exchanges work over the counter (OTC) and have no central place for sharing price quotes or set terms. Instead the traders and brokers deal among themselves. This advantage is a certain amount of certainty and clarity of process and terms, but the disadvantage is limited liquidity and relatively low prices for commodities. The three commodity exchanges set up in India in the year 2003 are National Commodity and Derivatives Exchange, Multi-commodity Exchange, and National Multi-commodity Exchange. 4.8.4 Players in commodity market Hedgers and arbitrageurs The group includes production, processing or merchandising of a commodity. Commercials do the bulk of trading in commodity markets. Large speculators group of investors pooling their money to reduce risk and increase gain. Large speculators consist of money managers

making investment decisions for overall investors group Small speculators group of individual commodity traders trading on their own account or through brokers.

3 . Types of Foreign Exchange Risks

The different risks associated with foreign exchange can be classified as follows: Transaction risk Settlement or credit risks Mismatch or liquidity risk Sovereign risk Position risk Cross-country risk Of the above position risk and cross-country risk arise only for licensed forex traders, and we need not discuss these. The other risks are faced by all entities engaged in foreign exchange. 11.3.1 Transaction risk Transaction risk is the in-built risk in foreign exchange transactions including invoiced export receivables, import payables, other foreign currency receipts and payments, and foreign currency loan transactions. This is the risk of adverse exchange rate movement occurring between the date of recording the transaction in the books of accounts and the actual realization or payment being made subsequently during the course of the transaction. 11.3.2 Settlement or credit risk Settlement risk is the risk of a counterparty failing to meet the obligations in a financial deal. Settlement risk arises depending upon the way settlement is structured. There are two factors which could cause this risk: Different time zones Different time zones implies that there is a risk that the bank paying rupees to the counterparty in India during Indian business hours may not get payment from the counterparty in the United States when the US banks open. Alternatively the company may make payment to bank but the foreign counterparty may not get the proceeds for the same reason. Cable-in factors Cable-in factors occur mainly in countries such as the United States where cables reaching up to 12 noon only are accepted and acted upon. In some countries like West Germany messages have to be delivered on the day previous to the settlement day. A good amount of settlement risk has now been eliminated as a result of Society for Worldwide Interbank Financial Telecommunication (SWIFT). The SWIFT messaging system does not enable funds transfer but sends payment orders to be settled by correspondent accounts that the institutions have with each other. SWIFT messaging centres share realtime information with each other so that if one of them runs into a problem the other centre can take over the operations of the entire network. SWIFT conducts most of its messaging services in areas such as payments and cash management, treasury, securities and trade services. 11.3.3 Mismatch or liquidity risk

In the foreign exchange dealings it is not possible that sales and purchases are always matched in value terms. There can be substantial periodic mismatches mainly in banks. Large-scale global businesses also experience this risk. Sovereign risk Sovereign risk is based on the government of a country. Although an importer agrees to pay for his imports the central bank of the country may not allow the importer to do so. This has happened in a number of African and South American countries on account of economic volatility and political uncertainties. 4. Types of interest rate risk Volatility risk The volatility or likelihood of adverse change in option value on account of changes in the price of underlying asset Rate level risk The change in interest rates according to the period of investment, during which restructuring of interest rate levels might take place Reinvestment risk The risk of having to reinvest cash flows from an investment at lower rates of interest Price risk Variations in market price of securities or commodities on which trading has taken place Call/put risk The risk of swings in interest rates in reverse direction to the option offered (call or put) Real interest rate risk The risk of inflation and consequent fall in the purchasing power of the rupee causing a dent in the real interest earned vis--vis the nominal interest rate.

5. The role of Treasury in working capital

The Treasury function of a company plays a key role in working capital. The interface between treasury and working capital management can be seen in the following aspects. 1. Cash balance, a significant component of working capital, is entirely in the hands of Treasury. As we have seen above, deciding the optimum cash balance and maintaining the actual balance at that level is a key requirement of good working capital management. Especially when cash is held in foreign currencies this becomes a technical matter and needs a treasury managers expertise. 2. Treasury highlights hidden problems in working assets like pipeline funds. For instance, a customer payment may take a week to get into the bank and become usable. This will not be apparent from a balance sheet but will be brought up by Treasury and can be resolved. Banks, acting as the Treasury arm of corporate India, has played a major role in reducing pipeline cash through cash management systems that make cash available almost in real time though it is collected in a different place, even a different country. 3. Foreseeing spikes and troughs in working asset balances and planning for the same is an integral part of Treasury function. This calls for special skills and precise information management. Particularly in seasonal businesses, the variations are prominent and can cause great liquidity

hardships. Treasury assists managements in such situations to monitor the ups and downs of assets like inventories and receivables, and identify which part of the variation is acceptable and which has to be attacked and resolved. 4. Current assets and liabilities in foreign currency pose a challenge to the Treasury Head in terms of protection against adverse changes. Monetary assets in foreign currency viz. cash and bank balances, receivables and investments, as well as monetary liabilities viz. import payables, foreign currency loans and other liabilities to be repaid in forex pose a threat to the bottom line in view of the volatility of the currencies. Treasury helps in defining the risk more precisely and suggesting action that can be taken to cope with the risk.

6. Treasury Products Treasury products are the products in the market available to the treasury for raising and deploying funds for investment, and trading in securities and forex markets. Treasury products yield returns and manage the mismatches in the liquidity position. 14.6.1 Forex services Forex is a market where currencies of various countries are traded. It is the most liquid market as free currencies such as USD, EURO and other currencies are instantly bought and sold. Free currencies refer to the currencies of developed countries. Partially convertible currencies have limited demand. Some forex products are: Spot trades Spot refers to payment and receipt of funds in foreign currencies two working days from the transaction date. Currencies of various countries are traded in spot centre. Companies typically are buyers of spot trades. Forwards Forwards are sales and purchases of a currency at a specified future date at a rate fixed on a given day. Treasury enters into forward contracts with banks based on import/export exposure. The customers enter into forward contract with their respective banks to cover currency risk. The main purpose of treasury in forward contracts is to cover the currency risk, but for banks it is a big opportunity to make profits. Swaps Swaps refers to an agreement between two parties to exchange currencies at a certain exchange rate and at a certain time in future. Swaps are a combination of spot and forward transaction. Swap is used for funding requirements, limiting risks, overcoming restrictions in certain markets and balancing portfolios. It also provides financial profit. Example ABC Company has USD funds, but it is in need of rupees to invest in commercial papers for three months. The company may enter into USD/Rupee swap and it sells USD at spot rate .It converts USD funds into rupee and buys back the USD after 3 months at forward rate. Money products Money market is a short-term market with maturity period less than one year. The funds are borrowed or lent for a short-term. The money market products are Treasury Bills (T-bills), Commercial Paper (CPs), Certificate of

Deposit (CDs), repo and bill rediscounting. Almost all these are relevant for banks and banking companies. Treasuries of companies can float CPs and make very short-term investment in other instruments. Rediscounting and repo are purely between banks. 14.6.3 Securities Securities products form an integral part of integrated treasury. In securities market investors can buy and sell the products available in the securities market. Some of the securities products available are: Government securities (G-sec) are debt instruments auctioned by RBI on behalf of the Government of India. Study the FAQ section of RBI website (http://www.rbi.org.in/scripts/FAQView.aspx?Id=79#3) to know more on RBIs view on government securities. Corporate debt issued by other corporates: Since the corporate debt security paper is issued in demat form and have a credit rating they are active in the secondary market. Global rating is necessary if the debt paper is issued in international markets. Treasuries invest on corporate debt paper because the yields on these bonds are higher than from government securities. It can invest in Foreign Currency Non-Resident (FCNR) funds and foreign currency surplus in the global market as per guidelines approved by the organisation. Debentures and bonds issued by corporates of private sector: The interest is received at regular intervals and the principal amount repaid on maturity. Debentures and bonds are issued in different structures to enhance the marketability and to reduce the cost of the issue. Convertible bonds which give option to the bondholder to convert bonds to common stocks or shares of the issuing company.