ASSIGNMENT

SUBJECT CODE & NAME

MF0016 TREASURY MANAGEMENT

Q1 Give the meaning of treasury management. Explain the need for specialized handling of
treasury and benefits of treasury.
Ans Treasury Management Treasury management is the planning, organising and control of funds
required by a corporate entity. Funds come in several forms: cash, bonds, currencies, financial
derivatives like futures and options etc. Treasury management covers all these and the intricacies of
choosing the right mix. According to Teigen Lee E, “Treasury is the place of deposit reserved for
storing treasures and disbursement of collected funds”. Treasury management is one of the key
responsibilities of the Chief Financial Officer (CFO) of a company.

Need for specialised handling of treasury

 Treasury management should be practised as a distinct domain within the Finance function of
an organisation for the following reasons:
 One of the most consistent demands on the CFO of a company is that money must be
available when needed, and this becomes a 24/7 task. The cost of money raised for the
business is probably the most crucial metric in a company for many of its investment and
operational decisions. Hence cost of funds has to be tracked diligently.
 Internal financial management in a multi-national corporate entity requires monitoring of
several global currencies.
 Globalisation of business has thrown up an unbelievable basket of opportunities for the CFO
to optimise the utilisation of funds and minimise its costs. This requires expert handling.
 Globalisation has also brought in unexpected risks that are not visible to the untrained eye
but can even destroy a business. Who would have thought that the crash of Lehman Brothers
could impact business houses in interior India? But that was what happened in 2009.
 With increasing financial risk shareholders have become jittery about their holdings and need
reassurance often. For a company the Treasurer is probably the best spokes person to allay
the concerns of stockholders and other interested parties
Benefits
Managing treasury as an expert subject has many benefits:
 Valuable strategic inputs relating to investment and funding decisions
 Close monitoring and quick effective action on likely cash surpluses and deficits
 Systematic checks and balances that give early warning signals of likely liquidity issues
 Significant favourable impact on the bottom line for global corporations through effective
management of exchange fluctuation
  Better compliance with the increasingly complicated accounting and reporting standards on
cash and cash equivalents

Q2 Explain foreign exchange market. Write about all the types of foreign exchange markets.
Explain the participants in foreign exchange markets.
Ans Foreign Exchange Market Foreign Exchange market (forex market) deals with purchase and sale
of foreign currencies. The bulk of the market is “over the counter” (OTC) i.e. not through an exchange
which is well regulated. International trade and investment essentially requires foreign markets.
Banks act as intermediaries and perform currency exchange transactions by quoting purchase and
selling prices. In India the Foreign Exchange Management Act (FEMA) 1999 is the law relating to
forex transactions and its aim is to develop, liberalise and promote forex market and its effective
utilisation.
Types of foreign exchange market

Spot market – Spot market is a market in which a currency is bought or sold for
immediate delivery or delivery in the very near future. The rate quoted is called as
‘spot rate’, the date of settlement known as ‘value date’ and the transactions called
‘spot transactions’.

The forward market involves contracts for delivery of foreign exchange at a specified
future date beyond the spot date and the transaction is called a ‘forward transaction.’
The rate that is quoted at the time of the agreement is called the forward rate and it is
normally quoted for value dates of one, two, three, six or twelve months.

Unified and dual markets – Unified markets are found where there is only one market
for foreign exchange transactions in a country. They have greater liquidity, increased
price discovery, lower short-run exchange rate volatility and reliable access to foreign
exchange. In contrast, dual markets are found in countries with multiple exchange
markets

Offshore and onshore markets – During the earlier stages of financial development,
forex market operated onshore i.e. within India. But after liberalisation of the
economy, offshore markets have developed and instruments based on foreign
currencies issued by Indian firms are traded in foreign markets.

Participants
The participants in forex market are the RBI at the apex, authorised dealers
(ADs) licensed by the central bank, corporates and individuals engaged in
exports and imports.
 Corporates – Corporates operate in the forex market when they have
import, export of goods and services and borrowing or lending in foreign
currency.
 Commercial banks –Banks trade in currencies for their clients, but much
larger volume of transactions come from banks dealing directly among
themselves.
 RBI – RBI intervenes in forex market to ensure reasonable stability of
exchange rates, as forex rates impact, and in turn are impacted, by
various macro-economic indicators like inflation and growth.
 Exchange brokers – They facilitate trade between banks by linking the
buyers and sellers. Banks provide opportunities to brokers in order to
increase or decrease their selling rate and buying rate for foreign
currencies

Q3 Write an overview of risk mitigation. Explain the processes of risk containment. Write
about the tools available for managing risks.
Ans Mitigation of Risks
It is important that an organisation is not only aware of the risks before it impacts their bottom
line, but has well-laid action plans to meet the risks and mitigate its adverse impact.
Risk Mitigation – An Overview Here is a bird’s-eye view of risk mitigation methods and processes
that will help you to appreciate the details of the subject that you will be studying in this and the 4
units that follow this unit.
Risk mitigation can be handed in four ways:
a) Risk avoidance: We can withdraw from an activity perceived to be risky, and elect not to go
through with it.
b) Risk transfer: We can insure ourselves against the risk and transfer it to another party called
the insurer.
c) Risk sharing: We can disperse the risk element in an activity and reduce its impact, by the use
of derivative instruments,
d) Risk acceptance: We can build our competence and capability to deal with the risk by detailed
study, research and methods developed specifically for the concerned activity and its risk
component.
Processes for risk containment
The basic steps in a typical risk containment process are:
 Establishing the context i.e. analysing the strategic and organisational context in which
risks occur
 Identifying risks i.e. defining the risks associated with business, to have a fundamental
understanding of the activities causing risk of loss
 Quantifying risks i.e. measuring the probability, frequency and hence the value of the risks,
besides listing non-quantifiable effects of the risks
 Formulating policy i.e. providing a framework to handle risks, which lays down standard
levels of exposure and policy guidelines for each level
 Evaluating risk i.e. ranking the risks based on priority, and aligning action and cost thereof
with the rank
Tools available for managing risks
Risk management tools do analysis and implementation of methods for mitigating
risks. The major tools available for risk are:
 Failure Mode Effects Analysis (FMEA): This tool is used for identifying the cost
of potential failures in business. This method can be applied during analysis
and design phases of new business to identify the risk of failure.
 Fault Tree Analysis (FTA): The tool is used as a deductive technique to
analyse reliability and safety of an organisation.
 Process Decision Program Chart (PDPC): The tool identifies the different levels
of risk and the countermeasure tasks. The process of planning is essential
before the tool is used for measuring risks.

Q4 What is Interest Rate Risk Management (IRRM)? Write the components

and features of IRRM. Explain the macro and micro factors affecting interest
rate.
Ans Interest Rate Risk Management (IRRM)
Interest Rate Risk is the risk
 to the earnings from an asset portfolio caused by interest rate changes
 to the economic value of interest-bearing assets because of changes in interest
rates
 to costs of fixed-rate debt securities from falling bank rates
 to impact of interest rates on cost of capital used by the firm as hurdle rate for
capital investment
Components of IRRM
IRRM can be broken into three parts: term structure risk, basis risk and options risk.
Term structure risk also called yield curve risk is the risk of loss on account of
mismatch between the tenures of interest-bearing monetary assets and liabilities.
Basis risk is the risk of the spread between interest earned and interest paid getting
narrower. Options risk is the term risk on fixed income options i.e. options based on
fixed income instruments.
Features of IRRM
Following are the features of corporate IRRM process:
 Clarifying the policy with regard to interest rate risk
 Constant watch on market rate fluctuations and studying its relevance to the
firm’s cost of capital
 Fixing the band beyond which interest rate changes should trigger corrective
action
 Special attention to long-term fixed exposures in investments as well as funding
decisions
 Effective, unambiguous and timely reporting on IRRM to the CEO and the Board
Factors Affecting Interest Rate
Interest is usually a significant component of the company’s cost of capital unless the
company is funded entirely by equity. It is important to learn the factors that impact
interest rates.
Macro factors
Cost of living index: Increases in price levels of goods and services over a period of
time reduce real value of the rupee and push interest rates up.
 Monetary policy changes: RBI works with monetary policy to balance the twin
objectives of economic growth and price stability for a developing economy like ours,
and interest rate is automatically affected with increase and decrease of money supply
by RBI using repo rates. Condition of economy: Whether the economy is rapidly
growing or its growth rate is declining can make a difference.
Global liquidity: Global economic environment and availability of funds across the
world does have an impact.
Foreign exchange market activity: Foreign investor demand for debt securities
influences the interest rate.
Micro factors
Micro factors, meaning factors specific to the borrower, which play a role in the
interest rate, are:
 Individual credit and payment track record, credit rating
 Industry in which the business is operating
 Extent of leveraging of the company viz. debt-equity ratio
 Quality of prime security and collateral
 Loan amount

Q5 Explain the contents of working capital. Write down the need for working capital
Ans Contents of working capital
 A trading business for instance may have to purchase and store products to be
sold, paying for them before they can be sold and cashed. A factory that
produces and sells products has to store raw materials and finished goods,
besides having some unfinished materials under process.
 A company may also need to allow the customers to pay later instead of
insisting on cash at the point of delivery.
 Payments in advance may be required for certain expenses like annual
insurance, deposit for renting the office, foreign currency and tickets for
foreign travel or advance fees/deposits for statutory registrations.
 And finally the business must have some idle cash and bank balances for
making spot payments.
Need for working capital
Can a business run without the need to invest in working assets like trade receivables
and inventories? Let us study the following case.
 Pachai is a vendor of pani-puris in a makeshift stall of his own at the end of the
street in which he lives.
 Every morning he goes to the market and buys the ingredients to make pani-
puris for the day, estimating the quantity based on anticipated sales. He buys
more in the weekends, naturally.
 He does not pay for the material as he buys on credit.
 Through the day he does the processing of the pani-puris to the stage needed,
and at 4 pm sets up the stall and runs it till 8 30 p.m.
 As he sells the pani-puris he collects cash, and at 8.30 or earlier,depending
upon the demand, he sells his day’s produce completely.
 He goes across to the vendor from whom he bought the ingredients and pays
for the supply, and returns home with the balance money, which is his profit.
 The cycle is repeated day after day.
Here is a businessman who, you might say, does not require working capital at all: no
idle cash, no deposits, no receivables and no inventories. But this is an extreme case
under ideal conditions.

Q6 Explain the concepts and benefits of integrated treasury. Explain the advantages and
disadvantages of operating treasury as a profit center.
Ans Concept and Benefits of Integrated Treasury The concept of integrated treasury works on the
principle that Treasury can be a single unifying force of a company’s activities in the money
market, capital market and forex market; and can help the company derive synergy. Synergy is a
powerful advantage in business because it brings together two or more activity domains and
achieves a total effect that is greater than the sum of all the individual domains. Thus a decision
related to money market instruments, for example, is taken after reviewing possible forex actions
that could enhance the benefit of the decision. The Indian rupee is freely convertible on current
account and partially convertible on capital account. This has made it possible to take a combined
approach to a treasury issue.
The major functions of integrated treasury are as follows:
 Ensuring liquidity reserve
 Deploying surplus funds in securities with low risk and moderate profits
 Managing multi-currency operations
 Exploring opportunities for profitable placements in money market, securities market and
forex market
 Managing the sum total of treasury risks with some balancing actions as between the three
markets
The benefits of integrated treasury are:
 Improved cash planning and better monitoring of the cash position
 Constant watch on the impact of treasury activities on the balance sheet
 Greater financial control by integrating budgetary control and financial information

Treasury products – Banks sell risk management products and structure loans to business
organisations along with forex services In order to reduce the interest rate or exchange risk. These
can be bought by large organisations. Example – ABC Company buys a forward rate agreement
from the treasury and fixes the interest rate on a commercial paper and they plan to issue this
commercial paper after three months. In order to reduce the interest cost of the company, the
treasury offers currency swap for rupee credit loan into USD loan.

The advantages of operating treasury as a profit center than as a cost center are:

 Individual business units can be charged a market rate for the service provided, thereby
making their operating costs more realistic.
 The treasurer is motivated to provide services as economically as possible to make profits at
the market rate.
The disadvantages of operating treasury are:

 The profit concept is a temptation to speculate. For example, the treasurer might swap
funds from the currencies that are expected to depreciate and risk the company cash
values.
 Management time could be wasted in arguments between Treasury and business units
over the charges for services, distracting the latter from their main operations.

 The additional administrative costs may be excessive.

THE END