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EXECUTIVE SUMMARY
Money isnt everything; but always remembers to make lot of if, before talking such non-sense... truly said by legendary investor 'Warren buffet'. In a world where things change at nano-second speed, the only thing which doesnt seem to change is the Growing importance of Money and To manage this most essential item is an art, science and requires prudence, wisdom and so much and so many. Well that's the reason - I chose treasury department for my final project so that I learn two most important things of life; viz 'Management of time' and 'Management of money'; needless to say they being prime requisites of a successful treasury. This report explains the various markets involved in an integrated treasury, namely Money Market, Debt Market, Forex market, Equity Market & Derivatives Market. It explains how excess cash of a bank is put to various uses there by generating decent returns out of idle cash. A treasury can be as a tool for managing Asset-Liability mismatches and a profit-making factory. It also explains how various macro-economic factors affect various markets and how an agile treasury can make profit out of it by taking advantage of these anomalies. The project also explains idea behind the centralized and integrated treasury. The basic purpose of integration is to improve portfolio risk insulation synergize banking assets with trading assets and utilization of fund properly, avoid the duplication of function across the multinational group. Thus in a nut-shell, the project tries to explain the Money market and Debt market and its different types of instrument , segment issuers and investors along with Yield curve and its interpretations. It also explains the Equity market and Forex market role in banking and factor affecting the Forex and Equity market. Forex, Derivatives & Equity how these markets interact in an Integrated Treasury to take various advantages for increasing the profitability of the treasury as well as of the bank

This project tries to explain the role of ALCO. The main job of ALCO is to potential source of fund should be balanced against the likely need for funds and management of asset and liability. This Project covers various Treasury Products in domestic Treasury as well as in foreign Exchange. It also explains the structure and working of integrated Treasury.

2. TREASURY MANAGEMENT IN BANKS - AN INTRODUCTION

In a Bank, treasury refers to the fund and revenue at the disposal of the bank and day- to- day management of the same. The treasury unit acts as the custodian of cash and other liquid assets. Traditionally, the role of treasury in Indian banks was limited to ensuring the maintenance of the RBI-stipulated norms for Cash Reserve Ratio (CRR) which mandates that a minimum portion of defined liabilities (currently 7.5% of Net demand and time deposits) be kept as deposit with the central bank and Statutory Liquid Ratio (SLR) which obliges banks to invest a specified percentage of liabilities (currently 25% of demand and time deposits) in notified securities issued by the Government of India and State Government or guaranteed by them. Activity in foreign exchange was confined to meeting merchants and customers' requirements for imports, exports, remittances and deposits . Furthermore, Indian Money market was characterized by imperfections arising from administered interest rates. The Money Market, therefore, hardly reflect the position of true liquidity in the system. Following the recommendations of the committee to review the working of Monetary system (1985: Chairman Shri Sukhamoy chakravarty) and the working Group on Money Market (1987: Chairman Shri n Vegul) RBI had initiated various measures to reform the money market and to develop the money market. Thus, Discount and Finance House of India was set up to provide to the market participants an institutional mechanism ( in the form of a market maker) to meet their liquidity requirements by dealing in short term money market instruments like treasury bills, bills rediscounting , etc .Further, steps such as increasing the number of instruments by introducing Commercial Paper (CPs) and Certificate of Deposits (CDs)greatly contributed to the development of money market .To enable Price discovery ,cap on call money interest rate was removed in stages , and completely withdrawn in May 1989. Non-banking institutions such as life Insurance Corporation, All India Financial Institution, Mutual Funds, etc, were over a period, allowed to enter the call money market for lending only. While the reported misuse of Ready-Forward (Repos) transactions by some of the market participants had

resulted in its partial ban for some time, the instrument was subsequently re-introduced with necessary safeguards to prevent its misuse and an improved SGL transfer procedure facilitated its effective monitoring. The introduction of delivery vs. Payment (DVP) system for securities settlement at public debt offices substantially reduced the counter party risk in security transfers and this also infused confidence in the introduction of repos and expansion of the list of repoable securities .All this has made Repo, currently an important instrument in the money market. The deregulation of financial markets began with the shift to market determined exchange rates and moved ahead with the freeing of bank deposits and lending rates. The RBI began using monetary intervention tools such as repos and Open Market Operations (OMO) to manage liquidity in the financial system and make the determination of interest rates on government securities more transparent and competitive by holding auctions. With the result, unlike earlier, their yields are aligned with those in the rest of market .In fact Government Securities effectively function as benchmark or reference yields on other securities. Post-liberalization deregulation and financial market reforms, a vibrant bond market has evolved in the country. This has enhanced the relative importance of investments and the investment portfolio in the balance sheet of the banks. Investments are now viewed has an alternative to credit (the historical source of profit to bank) but as tradable assets which offer both interest spread as well as capital appreciation. Just like equity prices and foreign exchange markets, interest rates (yields) on debt instruments are determined through their interplay of various economic, financial (liquidity, inflation, governments /RBI`s policies , growth, forex demand and supply , domestic interest rates vis a-vis global,etc) and political (local and international) factors and events. Given this, as in the case of the equities and forex rates, bond yields can (and do) vary from moment to moment. The reflection of these changes in spot interest rates has seen the fluctuations in the gilt prices as indeed those of all bonds whether government or non-government Similarly, the rupees exchange rate has become volatile. There is sufficient fluctuation both intra-day and inter-day prices enabling one to earn trading profits on buying and selling the currency. The forward market in India is another potential source of profits as more often than not; it deviates from the interest parity condition .Cross-

Currency (dollar/yen, sterling/dollar, dollar/Swiss franc) trading opportunities are, of course, are older and have come to life in Indian bank after liberalization The volatility in interest rates (yields) is at the heart of transformation of bank treasuries from mere CRR & SLR keepers to a profit center. Downward and upward movements in gilt yields offer excellent profit center. Downward and upward movements in gilt yields offer excellent scope and opportunity for the bank to trade in the underlying security and earn profits similar to trading in forex to take advantage of currency variations. An active treasury arbitrages by borrowing cheap (money market/forex market) and investing high in money, forex and bond markets. Bank treasuries deal with the customers enabling them to execute their transaction in the financial markets. Apart from trade execution, in such situations, the bank is, in effect, lending its balance sheet so that counterparty risk for both the customer and the deal counter-party is overcome. Another key (modern) function of the treasury is Asset-Liability management and hedging (i.e. insulating) the banks balance sheet from interest and exchange rate fluctuations. This involves reordering the maturity and interest rate pattern of assets and liabilities, either through direct portfolio actions or derivatives (e.g. Swaps and futures) to minimize and eliminate the risk arising from the mismatches between two sides of the balance sheet. The sources of profits of treasury are: a. Investment, Where the bank earns a higher yield than its cost of funds. an example is buying a corporate bond financed by deposits costing only 6% b. Spreads, between yields on money market assets and money market funding. The bank may, for instance, borrow short term for 5% and deploy in commercial paper with returns of 6% c. Arbitrage is buy/sell swap in the forex market, where the bank converts its rupee funds into a dollar deposit, earns LIBOR and gets back rupee on deposit maturity. yielding 7% and maturing in 3 years,

This generates a risk-free profit (arbitrage) if LIBOR plus the forward premium on dollar /rupee is more than the domestic interest rate. d. Relative value. This is a form of arbitrage in which the bank exploits the anomalies in market prices, the bank may have an AAA bond, which yields only 6% compared to another at the same rating and maturity, but of a different issuer, which offers 6.5%. It is worthwhile to sell the first bond and invest in the second and improve the yield by 50bps without any incremental risk, as both the bonds have the same credit quality. e. Proprietary Trading. In this focus is entirely on short-term, as opposed to investment, which is long term. The aim is to earn trading profits from movements in securities and forex prices during a day or a few days of trading. These are mostly directional trades, Under this ,a dealer may buy (say) 9081% Govt. of India security at rupees 116.50 at yields of 8.40% in anticipation of the yield falling to 7.70% on fundamental or technical ground. If this happens the bond appreciates and the bank exits the position with a profit. Forex trading is also directional, involving, for example, buying dollar/yen in the expectation that the dollar will appreciate or selling euro/dollar hoping that euro will decline f. Customer Services. Bank Treasuries offer their products and their services to customers/non-banking customers. The income of bank from these activities comprises fees for and/or margins on trade execution. Profits would be higher on structured (i.e. non-standard) transactions as compared to plain vanilla (e.g. straight forward buy sell USD/INR) deals. Treasuries are also involved in investment banking where their responsibilities cover trade execution on behalf of banks clients in the cash or derivatives markets. These may generate good margins, depending on the complexity and skills required to design and put through customized structures in the market

Role of Treasury

Independent FX Role

Integrated Role

Independent investment role Funds manageme nt Liquidity & CRR /SLR Invstmetn Security treading

Merchant Dealing

ALM & Term money FCNR Swap Mat

Corporate FX Trading Proprietary Trading

Overseas Borrowings /investment Derivatives INR dealing

Derivatives (non INR Dealing)

Equities Trading

Thus, the art of managing, within an acceptable level of risk, the consolidated funds of the bank optimally and profitably is main objective of treasury management in banks

3. TREASURY OPERATIONS: THE GLOBAL SCENARIO

Prior to 1980s, national markets were largely independent of each other. During this period the foreign exchange market and the Euro market alone had the characteristic of being global in their operations. As against this, today there is a greater dependency of national market. The process of integration has been accelerated due to liberalization and deregulation of economics by various countries. The emergence of a global unified financial market resulted in the removal of the distinction between national markets and also between national and offshore markets. The Indian financial markets and also started between national and offshore market. The Indian financial markets also started showing sign signs of integration since 1991.Several measures have taken by Government of India and RBI to insure the integration of financial market. Some of the important measures taken are enumerated as below: a. Deregulation of interest rates; b. Liberalization of exchange control regulations relating to foreign investments in India c. Permission granted to Indian corporate to raise resources in international financial markets; d. Relaxation of control in the end use of funds raised abroad by issuance of global depository receipts (GDRs), foreign currency convertible bonds (FCCBs) or by way of external borrowings (ECBs) e. Permission accorded to banks to invest funds mobilized under FCNR (B), EEFC, RFC, etc in overseas markets. This can be termed as single most important step in integrating the markets; f. Permission given to corporate /bank to deal in derivative products for risk management; g. Introduction of Repo/Reverse repo in government and in certain other type of securities. This has facilitated in influencing call money rates; h. Permission granted to banks to initiate cross currency position overseas;

i. Allowing banks to invest /borrow funds in the overseas market to the extent of 25%of Tier 1 capital. In the case of borrowing, no restrictions were stipulated on the end use of funds and on repayment; j. Introduction of market determined exchange rates and the conscious decision of the government to borrow at market related interest rate; k. Permission accorded to borrow /lend foreign currencies among authorized dealers; l. Freedom to bands to fix open position limits an aggregate gap limits subject to approval of RBI; m. Removals of inter bank borrowing from the purview of CRR/SLR requirement. Bank can raise rupee resources by sale of foreign currencies for meeting their rupee requirement for lending to corporate provided such lending is profitable. Corporate have been permitted to borrow in INR and/ or in foreign currencies, and, also to alternate between INR loan and the Foreign Currency loan (FCL). Corporations will compare the cost of borrowings in INR and in foreign Currencies and decide to borrow in the currency on which the effective cost is less. This aspect has also contributed towards integration of forex and money markets. It should however be said here that the swap differentials of currencies may not reflect interest rate differential as the Indian markets are not totally free from regulation. The Indian financial market will also behave in the similar way as the global financial market when full convertibility in capital account is in introduced. The integration of various domestic financial markets and the domestic financial market with the global financial market will ensure massive cross border financial flows. Further; the investors will have to access to various financial markets in the world and have diversified asset portfolios. Apart from these, the other impacts of integration are: a) There will not be any distinction between the short term and the long-term interest rates, in the sense that Corporate can borrow long-term funds at short-term interest rate if they are raising funds on a floating rate basis. As a corollary to this, the distinction between short term and long term is also slowly getting reduced. b) There will be no difference between domestic financial markets vis--vis international financial markets.

c) The efficiency and competitiveness of the markets will be reflected in the narrow spread between the bid and ask prices; and because of the narrow spread, convergence of the markets will take place. d) The financial markets will be deeper and more liquid e) Innovations in financial products will take place to suit the requirements of various markets players f) Exchange rates as also interest rates will be determine d purely on the basis o demand and supply. g) Forward rates will be purely inflation interest rates differentials. The integration of carious international financial markets has achieved two objectives: Integration of domestic financial markets Supporting financial markets that are supranational. The foreign exchange market is the vehicle through which this is taking place. The cost of covering the proceeds of any international transaction in the money market and the forex market will be the same if these markets are in equilibrium. The Indian financial markets are not fully integrated because of restrictions in capital flows. However, RBI and the government of India have been taking numbers of measures to insure phased integration among the various financial markets and the markets will eventually integrate only when full capital account convertibility is permitted.

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4. KEY FACTORS IN TREASURY MANAGEMENT

4.1 Asset liability management ALM is a comprehensive risk management system, which primarily focuses on liquidity management, interest rate risk management and spread management. Thus, ALM provides the necessary framework to define measure, monitor, modify and manage risks, which is the need of the hour. Liquidity and market risk though different overlap in a variety of ways. Often, attempts to manage one of these risks also help to alleviate the other type, but sometimes they come into conflict. For this reason, the Asset and Liability management is concerned with overseeing both risks simultaneously. This process is best thought of as a series of balancing acts: potential sources of funds should be balanced against the likely need for funds; the interest-rate sensitivity of assets should be balanced against that of liabilities; and both of these concerns should be balanced against the banks profitability goals. 4.2 Asset Liability Management Committee The Asset and Liability Committees (ALCO) job is to devise broad strategies for handling a banks many competing needs over the long run and to monitor and manage its interrelated risk exposures on a daily basis. As a consequence, the Alco is the focal point for coordinating the banks many activities to accomplish its operating objectives. To help do this, and to help in its planning for the bank, the ALCO receives a wide variety of reports and analysis that bring together information on the banks asset/liability position, its capital level, its internal plans and current and projected external conditions. Some typical types of information and analyses the ALCO might receive include Information on current and projected national and local economic conditions and the outlook for interest rates Loan and deposit positions and forecasts, including any concentrations in either.

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The current and projected liquidity position for the bank. An analysis of the potential effects of interest rate risk on the banks income and capital position

When making decisions about asset and liability management, ALCO must remember the following Potential sources of funds should be balanced against the likely need for funds. The interest-rate sensitivity of assets should be balanced against that of liabilities. Both of these concerns should be balanced against the banks profitability goals.

A typical scenario explaining the role of Asset Liability committee would be as follows, Bank derives much of their earnings from the typical spread between short-and long term interest rates. By borrowing short and lending long they are able to tale advantage of the fact that long-term rates typically exceed short-term rates by at least a percentage point or so. However, the values of long-term instruments are much more sensitive to interest-rate changes than the values of short-term instruments, setting up a tradeoff between the expected return and interest-rate risk. In practice, evaluating market and liquidity risk involves the consideration of different possible scenarios going forward .for example: What if the bank experiences an unexpectedly large volume of deposit withdrawals? What if loan payments occur faster than anticipated? What happens if interest rates suddenly rise by 100 basis points (or one percent)? 12

Thus, ALCOs challenge is to assess the probability that these events will occur and position the bank to handle the most likely scenarios with a minimum of deterioration in performance and condition. More specifically, it is the job of the ALCO to: Assess the probability of various liquidity. Shocks interest-rate scenarios. Position the bank to handle the most likely of these scenarios at minimum cost (impact on earnings and capital) while still achieving a reasonable level of profitability. Allocate the banks remaining assets and liabilities to meet risk and profitability objectives. 4.3 Treasury Management Skills The surge of activity in the money and forex markets requires constant monitoring and managing. Hence to succeed in these areas, every treasury professional should possess the following skills. o Mathematical Aptitude o Computer skills o Ability to withstand pressure o Agile, dynamic &patient o Zeal to win the race of competition

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5. OBJECTIVES OF TREASURY
Treasury of a commercial bank undertakes various operations in fulfillment of the following objective: To take advantage of the attractive trading and arbitrage opportunities in the bond and forex markets. To deploy and invest the deposits liabilities, internal generation and cash flows from maturing assets for maximum return on a current and forward basis consistent with the banks risks policies/appetite. To fund the balance sheet on current and forward basis as cheaply as possible talking into account the marginal impact of these actions. To effectively mange the forex assets and liabilities of the bank To mange and contain the treasury risks of the bank within the approved and prudential norms of the bank and regulatory authorities. To assess, advice and mange the financial risk associated with the non- treasury assets and the liabilities of the bank To adopt the vest practices in dealing, clearing, settlement and risk management in treasury operations. To maintain statutory CRR&SLR as mandated by the RBI on current planning basis To deploy profitably and without compromising liquidity the clearing surpluses of the bank.

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 To identify and borrow on the best terms from the market to meet the clearing deficits of the bank. To offer comprehensive value-assed treasury and related services to the bank customers. To act as profit centers to the bank

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6. TASKS BEFORE TREASURY

6.1 Balance sheet management: The ongoing reforms have provided the banks freedom to price most of their assets and liabilities although there exits a broad band specified by the RBI. The pricing of the treasury assets and liabilities which form a critical mass of the balance sheet, is therefore, very crucial to the balance sheet management. Thus the balance sheet management ids a dynamic proactive process. It requires continuous monitoring, analysis of market changes and controls. Demand and supply forces will impact the optimal balance sheet size and its growth rate. 61.1 Liquidity Management An important aspect of balance sheet management is liquidity management liquidity essentially means ability to meet all contractual obligations as and when they arise, as well as the ability to satisfy funds requirement to meet new business opportunities. Liquidity planning involves an analysis of all measure cash flows that arise in the banks as a result of change sin assets and liability and projecting these cash flows over the future. Ideally balance sheet projection should be prepared over a 12-month period or monthly basis. This would be in the nature of a monthly rolling forecast. This will enable the treasury manager to identify any potential liquidity problems that may arise in future, such that corrective action can then be taken to maintain adequate liquidity. Liquidity analysis involves a study of the maturity profile of existing assets and liabilities over, which is, superimposed the impact of transactions that are planned for the future Effective liquidity management requires careful attention to the balance structure and growth. A balance sheet that is growing rapidly needs careful scrutiny to determine whether the liquidity of the bank is being adversely affected. Very often banks put up excessive assets in the form of cash credit loans or investments in securities without having matching source of funds of similar tenure. This mismatch in the maturities of the assets and liabilities may result in the bank being subjected to liquidity risk, because the bank starts depending chronically and excessively on the most easily accessible source of 16

funds, i.e. the inter bank call money market . Thus, the bank may end up funding long term assets by overnight borrowings on an ongoing basis .it should be borne in mind that the dependence on the call market may not be advisable due to sharp fluctuation in market rates as well as volatility in the availability of funds in the market. 6.1.2 Funds Management Funds management by the treasury involves providing a balanced and welldiversified liability base to fund the various assets in the balance sheet of the bank. Diversified liabilities imply raising funds from a variety of tenures. Customer deposits are often the most suitable source of funds for the bank, due to actuarial and behavioral reasons. At the other end of the spectrum are the funds obtained from the interbank money, which are very short term in tenure and volatile as regards rate as well as availability. The treasury has to decide an optimal mix of funds from various sources to ensure that there is no excessive dependence on any single category, it is also advisable that the maturity profile of the assets conformed broadly to that of the liabilities, so that there is no large structural mismatch in the balance sheet that can lead to liquidity problems The treasury has also the responsibility for setting targets for balance sheet size and key ratios, in consultation with all business groups. Asset and liability levels need to be monitored and managed out periodically to iron out any structural imbalances. The ALCO should meet every month for this aspect of strategic business planning. The size of the balance sheet is a matter of great importance for a bank, in light of capital adequacy guideline. A bank cannot afford to be driven just by volume goals which aim at certain percentage growth will call for additional capital in accordance with BIS guidelines, and capital is increasingly scarce. Therefore, the focus has now to shift on quality of assets, with return on assets being a key criterion for measuring the efficiency of deployment of funds

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6.2 Reserve Management and Investments In the Indian banking scenario, a large asset base of a bank consists of investments on account of statutory reserves. Since such large proportions are deployed in such reserves, management of this reserve is very important factor in overall profitability of the bank. It should ideally take into account both liquidity as well as yield consideration. Even though longer maturity securities offer the highest yields, they are the most susceptible to fall in price due changes in yield curve on the other hand, shot dated have low price risks but they also give lower returns therefore the choice of appropriate mix of maturity patterns in the SLR portfolio is a very important function of the treasury manager. Along with this the market risk of the portfolio in terms of its price sensitivity to interest rate changes needs to be quantified and periodically monitored by means of analytical tools such as duration analysis this will give a measure of the precise risk profile of the security holding and in able the portfolio manager to initiate suitable corrective action in line with treasurys overall investment strategy and risk return parameter. Along with investment for statutory reserves, the treasury also makes investments in various other kinds of instruments such as CDs, CPs, PSU bonds, corporate debts etc. these investments decisions depends on factors such as liquidity position, money market condition, tenure of funding available, market liquidity in various instruments ,yield and tax planning requirements treasury may hold investment in these in these instruments till there maturity or it can trade them to advantage of market opportunities. 6.3 Cash Management Treasury is to ensure that the funds of the bank are deployed optimally, without sacrificing yield or liquidity. A treasury unit has an idea of the banks overall funding needs as well as direct access to various markets (like money market, capital market, forex market, credit market). Hence, ideally treasury should provide benchmark rates, after assuming market risk, to various business group, & product categories about the correct business strategy to adopt.

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6.4 Risk Management Integrated treasury manages all market risk associated with banks liabilities and assets, the other important risks it has to manage are liquidity risk and price risk in addition to counterparty risk and issuer risk, the market risk of liabilities pertains to floating interest rate risks and assets and liability mismatches. The market risks for assets can arise from Un favorable change in interest rates Increase in levels of disintermediation Securitization of assets Emergence of credit derivates, etc,

While the credit risks assessment continues to rest with credit department, the treasury would monitor the cash inflows impact from changes in asset prices due interest rate changes by adhering to prudential exposure limit

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7. WHY A CENTRALIZED TREASURY?

Idea behind decentralization Sales are local so why not collect the cash locally? Salaries are local so why not pay them from a local bank account? Exchange risks are known locally so why not hedge them locally? The knowledge about future investment projects is known locally so why not finance them locally? But the problem with this approach is that it will create a lot of duplications of functions across a multinational group. It will also lead to different subsidiaries taking opposite positions in the market. Some will hedge a long dollar position while others will hedge a short dollar position. At the same time, some will have spare cash while other subsidiaries will go to market and finance themselves with loans. Thus, international banks face huge challenges in managing payment, cash and treasury transactions across multiple locations and time zones while at the same time working with multiple externals banks and stakeholders. Thus centralization makes a lot of sense. If one looks at the spreads that are lost due to taking the opposite market position it is not difficult to build a business case for implementing a centralized cash management and treasury operation. If one also centralizes the payment processes you can get a better cash flow forecast and save on the number of bank interfaces you need to build. On top of the savings made by running centralized payments, cash management and treasury operations, it will also be possible for the central treasury to hire better people and so give a better service to the group. To secure around-the clock support for the company, one may decide to have regional centers in different time zones. But it will still be a central treasury with a centralized implementation of system support.

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A centralized cash management structure with centralized bank accounts management and few (or no) local bank accounts have many advantages: o You can pool cash more easily and internally offset balances. o Fewer bank accounts mean fewer inter faces. o Group-wide bank account management gives better bargaining power with the banks. o The cash management processes can be carried out more efficiently and can be scaled more easily.

To get from a de-centralized to a centralized treasury operations there are many issues to consider: o Legal restrictions in some countries. o Tax issues. o What should the centralized processes look like? o How does it an affect my system landscape? o Loss of local knowledge. o Local resistance to the change.

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8. WHY AN INTEGRATED TREASURY

Traditionally, the forex dealing room of a bank managed the foreign exchange dealings mainly arising out of merchant transactions (FX buying from & selling to customers) and consequent cover operations in interbank market. The domestic treasury/ investment operations were independent of foreign dealings of a bank. Treasury operations were treated as cost center, specifically devoted to reserve management (CRR & SLR) and consequent fund management. Treasury also undertook investment in government and non-government securities. The need for integration of forex dealings and domestic treasury operations has arisen in the backdrop of interest rate deregulations, liberalization of exchange control, Development of forex market, introduction of derivative products and technological advancements in settlement and dealing environment The basics purpose of integration is to improve portfolio profitability, risk insulation and also to synergize banking assets with trading assets. Banking assets are held basically for client relationship /steady income/ statutory obligations and are generally held till maturity whereas trading assets are held primarily for generating profits on short term differences in prices/yields. The purpose is achieved through efficient utilization of funds, cost effective sourcing of liability, proper transfer pricing, availing arbitrage opportunities, online and offline exchange of information between the money and forex dealers , single window service to customers, effective MIS, improved internal control, minimization of risks and better regulatory compliance. An integrated treasury acts as a center of arbitrage and hedging activities. It seeks to maximize its currency portfolio and free transfer of funds from one currency to another in currency portfolio and free transfer of funds from one currency to another in order to remain a proactive profit center. With phased liberalization on capital account convertibility, there will be a scope

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for banks with integrated treasury to structure multi-currency balance sheets and take advantage of strategic position Transfer pricing: treasury is to ensure that the funds of the bank are deployed optimally, without sacrificing yield or liquidity. An integrated treasury unit has an idea of the banks overall funding needs as will as direct access to various markets (like money market, capital market, forex market, credit market). Hence, ideally treasury should provide benchmark rates, after assuming market risk, to various business groups & product categories about the correct business strategy to adopt Thus the main advantage of integrating a treasury is that the members of the dealing room can interact among themselves to exploit the best risk- return opportunity so as to make the best utilization of funds. The other benefits include Arbitrage benefit of integration The price differentials between different markets on the same asset category. Gives rise to arbitrage opportunities Derivative products: Treasury can develop interest rate swap (IRS) & other rupee based/cross currency derivative product for hedging banks owned exposures and also sell such products to customers / other banks. Capital Adequacy: this function focuses on quality of assets, with return on assets (ROA) being a key criterion for measuring the efficiency of deploying funds. An integrated treasury is the major profit center. It has its own P&L measurement. It undertakes exposures through training (deals done to makes out of movements in market interest/exchange rates) that may not required from general banking.

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9. VARIOUS MARKET IN INTEGRATED TREASURY

MONEY MONEY MARKET MARKET

MARKET MARKET INTEGRATED INTEGRATED TREASURY TREASURY

FOREX FOREX

DEBT DEBT MARKET MARKET

DERIVATIVES DERIVATIVES MARKET MARKET

EQUITY EQUITY MARKET MARKET

Thus, as shown in the figure above the major components of integrated treasury are Money Market, Debt Market, Equity Market, Forex Market, and Derivatives Market.

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Now let me give brief view on the working of these markets.

10. MONEY MARKETS

Money market is a place to meet the short-term fund requirements of the participants in the market. The interest rates in Money Markets are deregulated and exclusively determined by demand and supply The money markets serve the following objectives: It provides an equilibrating mechanism for evening short-term surpluses and deficits. It provides a focal point for bank intervention for influencing liquidity in the economy It helps in meeting the requirement of the participants at a reasonable price Depending upon the term for which the money is lent, the transaction may be termed as Call Money, Notice Money and Term Money. CALL MONEY is the borrowing/lending done .for overnight tenure. It is used by market participants for daily funding mismatches and to comply with CRR stipulations. NOTICE MONEY is 14days. TERM MONEY refers to those borrowings/lending transactions between inter-bank participants, which have tenors greater than 14 days To control the money supply and liquidity in the economy, RBI uses the Liquidity Adjustment Facility (LAF) window and open Market operation (OMOs) 25 borrowing / lending transactions for tenors between 1-

in Treasury bill and government securities markets. A notable feature of the money market is that trading takes place through both over-the counter market as well through an organized exchange CBLO

10.1. MONEY MARKET INSTRUMENT

CALL/NOTICE/TERM MONEY: Call money market is that part of the national money market where the day-to-day surplus of funds, of banks and primary dealers, are traded in. Call/ Notice/ term money market ranges between one day to 15 days borrowing and considered as highly liquid. Other key feature is that the borrowings are unsecured and the interest rates are very volatile depending on the demand and supply of the short-term surplus/ deficiency amongst the interbank players. The average daily turnover in the call money market is around Rs. 12000-13000 cry every day and the market is active between 9.30 to 2.30 every working day and 9.30to 12.30 every Saturday REPO / REVERSE REPO: . It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date in future at a predetermined price. Such a transaction is called a Repo when viewed from the prospective of the seller of securities (the party acquiring fund) and Reverse Repo when described from the point of view of the supplier of funds. Thus, whether a given agreement is termed as Repo or a Reverse Repo depends on which party initiated the transaction. The lender or buyer in a Repo is entitled to receive compensation for use of funds provided to the counterparty. Effectively the seller of the security borrows money for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate. The Repo rate is negotiated by the counterparties independently of

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the coupon rate or rates of the underlying securities and is influenced by overall money market conditions. The Repo/Reverse Repo transaction can only be done at Mumbai between parties approved by RBI and in securities as approved by RBI (Treasury Bills, Central/State Got securities). The RBI not permits the co-op bank to do Reverse Repot. INTER CORPORATE DEPOSITE: For short-term cash management of the rich corporate, the company offers to borrow through Inter corporate deposits. The company has P1+ credit rating (Highest Rating in its category) for an amount of Rs. 250 crores. The company offers two variables of the Inter Corporate Deposits: Fixed Rate ICD: the quantum/ rates/ term to maturity of the ICD are negotiated by the two parties at the beginning of the contract and remain same for the entire term of the ICD. As per the RBI guidelines the minimum period of the ICD is 7 days and can be extended to period of 1 year. The rates are generally linked to Interbank Call Money Market Rates. Floating Rate ICD: Corporate interested in using the daily volatility of the call money market are offered Floating Rate ICD which may be benchmarked/ linked to either NSE Overnight Call/ Reuters Overnight Call rates. The corporate are also given Put/ Call option after 7 days for managing their funds in the event of uncertainty of availability of idle funds COMMERCIAL PAPER: It is a short term money market instrument comprising of unsecured, negotiable, short term usance promissory note with fixed maturity, issued at a discount to face value. CPs is issued by corporate to mpart flexibility in raising working capital resources at market determined rates. CPs are actively traded in the secondary market since they are issued in the form of Promissory Notes and are freely transferable in demat form.

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CERTIFCATE OF DEPOSITE: Certificates of Deposit (CD) were introduced in 1989 following the acceptance of the Vague Working Group of Money Market. These are also usance promissory notes issued at a discount to the face value and transferable in demat form. They attract stamp duty. CDs are issued by scheduled commercial banks and it offers them an opportunity to mobilize bulk resources for better fund management. To the investors they offer better cash management opportunity with market related yield and high safety. BILL REDISCOUNTING: The bills rediscounting scheme was introduced by RBI in November 1970 under which all licensed scheduled commercial banks were eligible to rediscount with RBI genuine trade bills arising out of sale/ purchase of goods. In November 1981 RBI stopped rediscounting bills but permitted banks to rediscount the bills with one another as well as with approved financial institutions. To augment facilities for this activity and also make a larger pool of resources available, RBI has been progressively enlarging the number of institutions eligible for bills rediscounting including primary dealers.

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10.2 COLLATERALIZED BORROWING AND LENDING OBLIGATION (CBLO)

CBLO is a product developed by Clearing Corporation of India Limited (CCIL) in January, 2003 for the benefit of the entities who have either been phased out of inter-bank call money market or have been restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market. CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety days (can be made available unto one year as per RBI guidelines). In order to enable the market participants to borrow and lend funds, CCIL provides the Dealing system through Indian Financial Network (INFINET), a closed user group to the members of the Negotiated Dealing System (NDS) who maintain Current account with RBI CBLO is a borrowing arrangement, against those securities (Central Government securities and Treasury Bills) which are placed with the Clearing corporation of India either as margin or otherwise. 10.2.2 INTERBANK MARKET In this market the only banks participate to borrow /lend money to meet their requirements. The rate for borrowing money in this market are usually higher than in CBLO market for the fact that this is an Over the counter market and it is clean /unsecured. In this market, a bank may classify other bank as preferred counter parities and assign limits; i.e. the maximum amount which they will lend, as per the internal guidelines of the bank.

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11. DEBT MARKETS

10.1 Structure of the Indian Debt Market MARKET SEGMENT ISSUERS INSTRUMENTS INVESTORS

Bonds, debentures, cps, CDs

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THE SOVEREIGN ISSUER

CENTRAL GOVT.

STATE GOVT.

GOI dated securities, Treasury bill, state government securities, Index bond, Zero coupon bonds

RBI

DFIs

Govt. Agency& state bodies THE PUBLIC SECTOR PSUs Comm. Bank/ DFIs

Govt. Guaranteed Bonds/ Debenture

Bank Pension fund

PSU Bonds, debenture, CP CD, Debentures, bonds

FIIs

Corporate

Individuals Corporate THE PRIVATE SECTOR Bonds, Debentures, Commercial paper (CP), SPNs, Floating Rate Notes FCDs, PCDs, ZCBs

Provident fund

Pvt. Sect. Banks

Insurance cos, Trusts, Mutual funds

11.2 Yield Curve and its Interpretations Understanding and forecasting Interest Rate Movements is of at most importantance in the Bond Markets. A comprehensive understanding of Pattern of interest rate movements

31

or Yield Curves can help optimize portfolio returns. Thus Yield Curve plays an instrumental role in bond market A Yield Curve may be defined as, The graphical depiction of the relationship between the interest rates (or yields) on bonds of the same credit quality and different maturities is known as the yield curve. In other words, the yield curve is a depiction of debt market interest rates across maturities, with time being plotted on the X-axis and yields on the Y-axis. The curve graphically demonstrates the rate at which market participants are willing to transact debt capital for short term, medium-term and long-term periods. Types of Yield Curves 1. Steep yield curve d

steep curve can occur when the small percentage gap between the shortest maturity bonds (i.e. three-month T-bills) and the longest maturity bonds (i.e. 30-year Treasury bonds) widens because some economic force causes the short-term rates to drop more than longterm ones. A steep curve often forecasts a faster-growing economy because lower shortterm rates make it easier for companies to borrow money to expand their operations.

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2. Flat Yield Curve

Flat curve indicates that the bond investors are resistant for financing long term projects because they do not see adequate returns or doubt the sustainability of the project or they have better short term opportunities. Flat curves do not necessarily guarantee an economic slowdown, but the odds can still be pretty goods. It is important that only bonds of similar risk are plotted on the same yield curve. The most common type of yield curve plots Treasury securities because they are considered risk-free and are thus a benchmark for determining the yield on other types of debt

3. Inverted Yield Curve

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Typically, they are caused by short-term monetary imbalances in the economy whereas the long-term conditions are expected to normalize. In the past, such curves have been experienced during times when banks have raised short-term rates to ward off speculative pressures on currency, etc. But as a word of caution, many a times an inverted yield curve has been a signal of coming recession as there is no motivation for longer separation from money. 4. Normal Yield Curve

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Normal yield curve slopes gently upward reflecting higher future rates. In the absence of economic disruptions, investors who risk their money for linger periods expect higher yields than those who risk their money for shorter-time periods. The underlying reasoning is that investors have a grater liquidity preference and, therefore they attach lesser risk to shorter- term securities, as they are closer to cash. Therefore, as maturities lengthen, interest rates get progressively higher and the curve goes up.

11.2.3 Yield Price Relationship

Four factors determine a bonds price volatility to changing interests rates 1. Par value 2. Coupon 3. Years to maturity 4. Prevailing level of market interest rate Alkyls five bond relationships: 1. Bond price move inversely to bond yields (interest rates). 2. For a given change in yields, longer maturity bonds post larger price changes, thus bond price volatility is directly related to maturity. 3. Price volatility increases at a diminishing rate as term to maturity increases. 4. Price movements resulting form equal absolute increases or decreases in yield are not symmetrical. 5. Higher coupon issues show smaller percentage price fluctuation for a given change in yield, thus bond price volatility is inversely related to coupon.

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11.2.4Bond valuation Like other financial assets, the value of a bond is the present value of its expected future cash flows: Pm = (Ci/2)/ (1+Ym/2) ^t +Pp/ (1/Ym/2) ^2n This is the present value model where: Pm is the current market price of the bond N is the number of years to maturity C I is the annual coupon payment Ym is the yield to maturity of the bond Pp is the par value of the bond 11.2.5 Trading Books and Valuation The RBI stipulates that the entire investment portfolio of the bank be classified under the following three categories. The bank should decide the category of the security at the time of its acquisition. Held Till Maturity (HTM): The securities acquired by the banks with the intention to them till maturity will be classified a Held till Maturity. The redemption value is less than acquisition cost, than the difference must be amortized over the remaining periods to maturity. HTM investments need not be market to market ad should not exceed 25 percent of the total investment portfolio. Held For Trading (HFT) : The securities acquired by the banks with an intention to trade by taking advantage of the short term price/interest rate movement, etc. will be classified as Held for Trading. Individual securities in the HFT category have to be marked to market and cannot be held for more than 90 days. Appreciation will be ignored while depreciation will flow directly to the profit and

36

loss account and book value of these will not change. Valuation should be done monthly or at more frequent intervals. Available For Sale: securities which cannot be classified in above two categories are classified as Available for sale. AFS will also be marked-to-market but at quarterly intervals. Depreciation will flow to the profit and loss account. The bank can shift investments from AFS to HTM category with the approval of BOD /ALCO only once in a year. Such shifting is normally allowed only at the beginning of the year

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12. EQUITY MARKET.

Well, it is said Equity markets are a reflection of any economy or it is a comprehensive picture of a nation as a whole and I agree with this because it shows the confidence of the investors in the Corporate of the country. Today every bank has dreams they can achieve higher profit by investing their excess money .however, the question that arises is that, should you leave your money tucked away in the bank or plough it into the stock market where the potential for higher returns is greater but the chances of losing money is higher/ deciding where to invest depends on bank attitude towards risk (bank capacity to take risk and bank tolerance towards risk) and institute investment horizon. However, today, we are faced with a rising cost of living, and non availability of guaranteed-return investment products. In such a scenario, investing in equity, which offers returns that are higher than the inflation rate, helps you build wealth and improve your standard of living. The risk involved with investing in equity can be moderated by careful stock selection and close monitoring. What is equity? Simply put, acquiring equity shares of a company signifies ownership in that company to the extent of shares that you have acquired. For instance, if you hold 500 shares of ABC Company, which has totally, issued 10 lakh shares. Your ownership in ABC Company is 0.05 per cent (500 shares/ 10 lakh shares *100). Risks involved Systematic risk This implies risk in the system this risk applies to the entire market and includes risks such as interest rate risk, inflation risk, exchange rate risk, political risk, etc. some of the important systemic risks are indicated below. 1. Interest risk. Interest rate risk can affect the overall market. Interest is the cost of borrowing money. As interest rates rise, money become more expensive to 38

borrow, and companies that have lined up expansion plans may postpone their plans due to the high interest cost they have to bear. Moreover, for consumers high interest rate can alter their plans for purchasing a home or car due to high monthly installments. These results in lower consumption and reduced economic activity. 2. Inflation risk. Inflation risk can influence all asset classes. Inflation is nothing but the steady increase in prices of goods and services. With rising inflation, manufactures of goods incur higher raw material costs and see profit declines. Such a risk is detrimental to the stock market and the overall economy. 3. Exchange rate risk. Exchange rate risk is the risk of an investments value changing due changes in currency exchange rates. This risk usually affects businesses that export and/or import but can also affect the overall economy. For example, if the rupee depreciates against the dollar then Indian exporters will benefit since they will be able to get more rupees for every dollar. An appreciating rupee against the dollar has the opposite effect. However, a continuously falling currency does not always augur well for our capital markets. FIIs are one of the main investors in our capital markets. If our currency continuously depreciates, it will result in lower investment values when FII sell their holdings and convert the sale proceeds back into the original currency. 4. Political risk. Political risk implies political instability, which can affect the general economy. A stable and progressive government can influence the investment climate in a country and have an affect on the overall market further, war, riots, will have a similar affect on the economy. 5. Non systematic risk This is risk that is very specific to a particular stock or an industry. Some of the important non-systemic risks are indicated below. 1. Industry risk. Industry risk implies risk that directly impacts a sector or industry. For example, the tobacco industry is penalized with high duties due to the adverse health factors associated with this sector.

39

2. Risk of employee strike. Employee agitations result in stoppage of production, which, in turn, results in lower profitability of the company. 3. Technology risk. This risk is applicable to a company that does not adapt to new technology, which could significantly improve its business functioning and prospects. Equity versus other investment avenues

18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

2000-2005 1995-2005

BANK

KISAN VIKAS PATRA

S&P CNX

Statistics have proven that in the Indian financial markets, equities have surpassed other traditional forms of investments such as gold and fixed deposits .as per the above graph; equity has been the best performing investment when the holding period is 5 years. For instance, during the period 2000-2005. Whilst equity delivered a return of 17.74 per cent per annum, bank fixed deposits gave a return of 6.49 per cent per annum.

40

Understanding Equity markets and the role of the bank in equity market: There are two premier stock exchanges in this country- national stock exchange (NSE) Also called as NIFTY / Bombay stock exchange (BSE) also called as SENSEX. The name nifty comes from the fact that it is composed of 50 stocks (NSE -fifty) and sensitive index is composed of in equity markets, the stocks /shares are classified into three categories 1. Forntline / Large cap stocks 2. Middcap stocks 3. Small cap stock These stocks are classified into the corresponding categories depending on their market capitalization (i.e. no. of shares* market price of the share) All the stocks except the once which have futures stocks available in the future markets have Circuit Filters. The circuit filters are 2%, 5%, 10%, 20% depending on the market capitalization and the volatility of the stock and is decided by the exchange form time to time. Settlement of funds is on T+2 bases in Cash/ spot market and on T+1 basis in the Derivatives segments. Today banks are not able to take full advantage of Equity markets because of some restrictions imposed by the RBI and SEBI. Some of these rules are Bank cannot short sell Banks cannot hedge or trade in derivatives markets. They cannot place positions on their own in the market and cannot route more that 5% of their business through any of the broker. With further deepening of the financial markets, there is a wide possibility that the banks will soon be allowed to take advantage of derivatives markets and other opportunities.

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13. FOREX MARKET

12.1 Basic definitions and exchange rate quotations in foreign exchange markets A few definitions in respect of the often repeated terms in FX markets are furnished below: Exchange rate refers to the price of one currency against another currency. Spot transaction refers to the transaction wherein the settlement takes place two working days after the date of transaction. This is the standard basis on which majority of FX transactions are concluded Where the transaction and the settlement take place on the same day of the date of the transaction itself, then such transaction is said to have taken place on cash or today value basis. TOM transaction refers to the transaction wherein the settlement takes place one working day after the date of the transaction. The term TOM stands for value tomorrow. Any transaction in respect of which the settlement takes place beyond the spot date is a forward transaction. An outright transaction is one in which a particular currency is bought against another currency that is being sold for a given value date at a mutually agreed exchange Swap transaction refers to purchase and sale of a given pair of currencies against each other for different maturity/ value dates. In effect, it is a combination of two outright deals of varying maturity dates. Cross rate is the process of arriving at a value of a given currency through the medium of two different pairs of currencies, in which there is a common currency in both the pairs. For instance, in order to arrive at EUR/INR price, market uses EUR/USD price and USD/INR price

42

 Direct quotations refer to the quoting of a price wherein a given unit of foreign currency is kept constant and the home currency is expressed as a variable. Direct quotations are regarded as easy to understand. User-friendly and more transparent. Indirect quotations refer to the quoting of as price wherein the home currency is kept constant for a given unit and the foreign currency is expressed as variable Since FX is akin to a commodity, there would be invariably a price differential between the buying and selling price which is called the bid/offer spread When the forward price of a currency is higher than the spot price of that currency, the currency is said to be at a premium. When the forward price of a currency is lower than the spot price of that currency, the currency is said to be at a discount. Proprietary trading refers to the trading in FX markets on the banks own account. Merchant trading refers to the entering of a particular transaction in the books of the bank on behalf of a client. The banks normally undertake immediate cover operations in respect of such deals so that they are insulated from any risks arising out of adverse exchange rate movements against the quotes already offered to the client.

13.2 Factors affecting Exchange Rates The movements of exchange rates are indeed fascinating, thus it is very important that one understands the factors influencing exchange rate: a few of which are listed below: Demand and supply for the individual currency Relative strengths of the economies for a given pair of currencies Trade-surplus /deficit vis--vis the currencies of the countries concerned A host of economic factors like gross national product, fiscal deficit, balance of payments position, industrial production data, employment data etc. Monetary policies of the government/central bank political and security climate Inflation rate differentials

43

 Interest rate differentials

13.3 Role of a bank in Forex Markets: Only authorized dealers (ADs) licensed by the RBI can participate directly in the FX market. Customers approach Ads to get the best value for their FX requirements. Usually the AD quoting the best FX rate will get the deal from the customer. Factors like customer relationship, execution capability and post trade service quality will also have a bearing on which AD gets the deal. To offer a competitive quote to a customer an AD has to have the ability to get the best quotes from the market. This in turn would depend on how active that AD is in the inter-bank FX market. An exporter would sell foreign currency to an overbought or over sold position in a foreign currency VisaVis INR. The exchange rate quoted to the customer would usually be at a spread to the prevailing inter-bank exchange rate. To realize this spread the AD would look to offload its position in the inter-bank market. Depending on the actual rate at which the AD manages to square its position in the market, the spread earned would be higher, lover or same as the earlier envisaged spread. Having concluded an FX transaction with the customer, the AD may have an overbought or oversold position in a foreign currency vis--vis INR. The exchange rate quoted to the customer would usually be at a spread to the prevailing inter-bank exchange rate. To realize this spread the AD would look to offload its position in the inter-bank market. Depending on the actual rate at which the AD manages to square its position in the market, the spread earned would be higher, lower or same as the earlier envisaged spread. Apart from merchant transactions Ads also take proprietary positions i.e. positions on their own account. These positions could be taken by the AD on the back of a customer transaction or could be initiated in the inter-bank market. These positions are subject to daylight and overnight limits. The net overnight position which is termed as the net overnight open position limit (NOOPL) is approved by the RBI for each AD after the latters board of directors has approved the same.

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14. DERIVATIVES MARKETS

A Derivative is an instrument whose value depends on the value of other more basic underlying variables. The underlying variables. The underlying variables could be Stock price Exchange rates Interest rate These underlying variables are called as cash market variables. Characteristics of derivates: Derivatives have the characteristic of leveraging or gearing. Pricing and trading in derivatives is complex and thorough understanding of the price behavior and product structure. Derivatives by themselves have no independent value. Derivatives improve the liquidity/depth of the underlying instrument. They perform the economic function of price discovery. Users of derivatives Hedgers, traders and speculators use derivatives for different purposes. Hedgers use derivatives to protect their assets / positions from erosion in value due to market volatility. It also helps them avoid liquidity risk & locking-in the downside Traders look for enhancing their income by making a two-way price for other market participants. Speculators set their eyes on making quick money by taking advantage of the volatile price movements.

45

Derivatives can be classified as forwards, futures, swaps and options. 14.1 Forwards A forward contract is a customized contract between two entities, where settlement take place on a specific date in the future at todays pre agreed price. 14.2 Futures: A futures contract is an agreement between tow parties to buy or sell an asset at certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange- traded contracts. Futures are similar to forwards except for the differences listed below: Futures are standardized exchange traded contracts. Future contract need not necessarily culminate in the delivery of the underlying Settlement is on a daily basis on all outstanding contracts. 14.3 Options An option is a contract, which gives the buyer the right, but not the obligation, to buy or sell specified quantity of the underlying asset, at a specified (strike) price on or before a specified time (expiration date). OPTIONS

CALL

PUT

A Call option is the right to buy an asset for a certain price whereas a put option is the right to sell an asset for a certain price. 14.4 Warrants:

46

Options generally have lives of up to one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over the counter.

14.5 LEAPS: The acronym LEAPS means long-term Equity anticipation Securities. These are options having a maturity of up to three year. 14.6 BASKETS: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. 14.7 SWAPS: Swaps are private agreements between two parties to exchange cash fbws in the future according to a prearranged formula. They can be regarded as portfolios forward contracts. The two commonly used swaps are Interest rate swaps: these entail swapping only the interest related cash fbws between the parties in the same currency. Currency swaps: these entail swapping both principal and interest between the parties, with the cashfbws in one direction being in a different currency then those in the opposite direction 14.8 Swaptions: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver fixed and pay fbating. A payer swaptions is options to pay fixed and receive fbating.

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15. BANKS TREASURY PRODUCTS

1. Domestic Treasury A. Assets products/ instruments Call/notice money lending Term money lending / inter-bank deposits Investment in CDs Commercial paper Inter bank participation certificates Derivate usance promissory notes/bankers or corporate acceptances Reverse Repos / CBLO-Backed lending through CCIL SLR bonds (notified as such by the RBI) a. Issued by govt. of India as securities and T-bills b. Issued by state Govt. c. Guaranteed by Govt. of India d. Guaranteed by state Govt. Non SLR bonds (issued by) a. Financial institutions b. Banks/ NBFS (Tier ll capital) c. Corporate d. State level Enterprises e. Infrastructure projects Asset backed securities (PTCs) Private placements 48

Floating rate bonds Tax free bonds Preference shares Listed/unlisted equity Mutual funds

B. Liabilities products / instruments Call/ notice money borrowing Tem money borrowing CDs issues Interbank participation certificates Repos/ CBLO- backed borrowing through CCIL Refinance (RBI ,SIDBI,NABARD, EXIM bank, NHB) Tier II bonds (issued by bank)

2. Foreign Exchange A. Inter bank Spot currencies Cash Tom Forward and forward forward (simultaneous purchase and sale of a currency for two different forward maturities) Foreign currency placements, investments and borrowings (in accordance with RBI guidelines) B. MERCHANT TREASURY) Preshipment foreign credit (PCFC) Foreign currency bills purchased (FCBP) Foreign currency loans (FCLs/FCNR(B)) 49 (INITIATED IN BRANCHES, ARRANGED BY FOREX

Post shipment foreign credit (PSFC) External commercial borrowing (ECB)

3. Derivatives Interest rate swaps (IRSs) Forward rate agreements (FRAs) Interest rate Futures Interest rate options Currency options

Certain corporate assets such as investments in subsidiaries and joint ventures are reckoned as treasury assets although in nature they are not traded and are permanent.

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16. ORGANIZATIONAL STRUCTURE OF INTEGRATED TREASURY

Organizational structure of a commercial bank treasury should facilitate the handling of all market operations, from dealing to settlement, custody and accounting, in both the domestic and foreign exchange markets. In view of the voluminous and complex nature of transactions handled by the treasury, various functions are segregated and explained as under. o Front-office: dealing Risk Taking o Mid office: Risk Management and Management information. o Back-office: confirmations, settlement, Accounting and Reconciliation It is important that the above three functions are distinct and work in water-tight compartments. The dealers are not supposed to handle settlements or accounts. The back-office should not perform dealing and should perform only accounting and settlements. 16.1 Front office The front office constitutes of dealers and traders. In the course of their buying and selling transactions, they are the first point of interface with the other participants in the market (dealers of other banks, brokers and customers). They report to their departmental heds. Attributes of good front office dealer A successful treasury personnel /trader have the following attributes.

51

Is properly capitalized-enough money to trade and survive Treats trading as a business. Has a low tolerance for risk. Trades only when the market provides an opportunity. Can control his emotions. Has a trading plan. Has a risk management plan. Is incredibly disciplined. Is focused. Has back tested his trading methodology

16.2 Mid-office A mid office set-up, independent of treasury unit ,acts as a unit responsible for risk monitoring, measurement and analysis and reports directly to the top management for control. This unit provides risk assessment to asset-liability committee (ALCO) and is responsible for daily tracking of risk exposures, individually as well as collectively. The main objective of the mid office is to have an independent robust system to achieve the following goals for market risk:

1. Measurement of market risk a suggesting measures to mitigate the risk. 2. Independent monitoring of compliance of banks investment policy 3. Monitoring of compliance of regulatory guidelines on regular basis 4. Review of overall portfolio performance FUNCTIONS OF MID-OFFICE Various activities performed /to be performed in Mid-office are as under: A) Formulating Investment /Treasury policy for the bank

52

B) Measurement of risk 1. Documentation of VaR (Value and risk) calculation methodology. 2. Generation of VaR reports using KVaR 3. Document market view on short-term interest rates, exchange rates, equity prices. 4. Risk analysis for derivative instruments C) Monitoring 1. Onsite monitoring of Rates/Prices. 2. Monitoring of realized and unrealized gains /losses. 3. Monitoring of VaR limits. 4. Monitoring business routed through brokers 5. Monitoring of stop-loss and take-profit limits. 6. Limit setting and monitoring and reporting to treasury Branch head the cases of violation of set limits. 7. Regulation monitoring of the progress of NOSTRO reconciliation to mange the exchange fluctuations risks. 8. Rate scanning on on-gong basis & monitoring of off-market Quotes to ensure that the rules applied by the dealers for trading as will as reporting by branches, are in accordance with the market movements and prescribed limits by competent authorities. Any deviation noticed by Mid-office to be reported to the concerned authority. 9. Periodic generation of Back-testing and Stress-testing reports using KVaR D) Portfolio performance 1. Portfolio management from risk perspective and suggesting hedging strategies. 2. Risk vs. Return analysis 3. Performance analysis of various portfolios including monitoring of interest income, dividend income, and yield earned at various folder-level. 4. Analysis of profits earned from merchant transactions in foreign exchange dealing.

53

E) Others 1. Interaction with risk management department on liquidity and market risk. 2. Submission of fortnightly reports on excesses over limits and outstanding under credit limit, settlement limit, country exposure limit etc. to the concerned authority (GM-risk management). 3. Daily reconciliation of currency positions (between front office and back office) 4. Follow-up of confirmation proposals being submitted to competent authorities seeking confirmation of action for exceeding the prescribed limits during the course of day to day functions of the treasury branch. 5. Scrutiny of amended & cancelled deals and reporting the same to the head of treasury branch, to ensure that reasons for the same are duly recorded 6. Password control and other IT operations relating to Risk Management. 7. Regular monitoring of compliance of Regulatory Guidelines and Banks guidelines contained in banks investment policy and other guidelines issued from time to time and reporting of breaches/deviations to GM (Risk Management), GM (Treasury). 16.3 BACK OFFICE It is that part of the treasury organization that administers and supports the trading activates of the treasury front office. The back offices main functions are to process, confirm, verify, settle, reconcile and record financial market transactions. The back office is also responsible for ensuring that the organizations treasury management policy and controls are followed as well as ensuring general compliance with rules and regulations. In a more general sense, the term refers to all administrative functions that support an organization and includes areas such as payroll and expenses, accounts payable. Accounts receivable an accounting.

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17. REGULATIONS, SUPERVISION AND COMPLIANCE OF TREASURY OPERATIONS

Banks perform the role of intermediation in the financial sector. Thus the deposits and the other liabilities of various maturities, and sizes and prices (interest rates) are deployed by the bank in the assets of differing maturities, sizes and prices. This role is facilitated by the status and confidence of depositors that the banks enjoy as good managers of financial risks, particularly credit risk. It is easy to see that in this process of intermediation, there can always be some time lag between the acceptance of liabilities and the creation of assets that match with the liabilities. Thus, banks at times carry surplus funds (surplus in liquidity) and other times facing funds crunch (deficit in liquidity). While there is need to park the surplus funds as early as possible in some short term, secure and earning assets before being invested in more stable assets, deficit has to be made good by borrowing short term initially before a more stable resource is tied up. Under such conditions, only such of the surplus fund, which is capable of being transferred easily to counterparty, is of consequence. In other words, balances with RBI in excess of the statutory reserves required to be maintained by the banks and balances maintained by the financial institutions with RBI could represent approximately the liquidity available in the system. Money market is the place where such monies and assets, typically short term in nature, are priced and traded. Thus, it acts has a equilibrating mechanism for evening out short-term liquidity surpluses and deficits. It has the important role of providing a 'medium' through which he monetary policy signals of the bank (RBI) aimed at managing short term

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liquidity in the system are transmitted. Obviously, in order to successfully fulfill its role, money market has to be very liquid where short-term instruments are traded in high volumes. It is also important that the money markets should have systems to ensure limitation of counter-party risk to protect the participants. RBI is concerned about the functioning of money market on sound lines as problems into money markets cam escalate into Systemic risk and result in huge losses in the absence of the
proper supervision and risk management. RBI regulates the money market, and all money market instruments come rider its regulatory preview. Government on India has delegated powers to RBI. Under the Section 16 of the Securities contracts (Regulation) act, 1956, for regulating contracts in Government securities, money market securities, gold elated securities, and derivatives based on these securities. RBI has already announced its intention to make call money market a pure interbank market with banks and primary dealers as members. The lending by non- banks in the call money market is being phased out. The money market which typically used to be a telephone market has seen dramatic improvements in market infrastructure and the introduction of Negotiated Dealing System, Clearing Corporation of India and the Real Time 3ross Settlement System (RTGS), the payment and settlement infrastructure is caching to international standards thus facilitating better turnover and price discovery in the money markets besides addressing the systemic risk. In the not too distant future money market will be totally screen and systems driven. For any segment of the financial market to develop on healthy lines, it is Necessary that self-regulation be accorded priority. Accordingly in the Indian foreign Exchange Market, Foreign Exchange Dealers' Association (FEDAI) is he Self Regulatory Organization (SRO) for the foreign exchange segment. Fixed income Money Market and Derivatives Association (FIMMDA) is an SRO for his money market. FIMMDA has taken initiatives to frame the code of conduct and ensure adherence to the code by the market participants. It has also developed standard Master Agreements for the various types of money market transactions to promote their use in the market. Along with an effective SRO, a strong central bank to support and supervise the money market, integration with

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Rest of the markets in the financial system, existence of risk management systems, adherence to various risk control procedures, norms for disclosures and transparency in the balance sheets of the banks are some of the prerequisites for the sound working of the money market. These prerequisites are almost fully prevalent in the money markets.

17.1 Reserve bank guidelines Organizational Set Up Management of market risk should be the primary concern to the top management of banks. The boards should clearly articulate market risk management policies, procedures, prudential risk limits, review mechanisms and reporting and auditing systems. The policies should address the bank's exposure on a consolidated basis, and clearly articulate the risk management systems that capture all material resources of market risk and assess the effects on the bank. The operating prudential limits and the accountability of line management should be clearly defined. The Assets-Liability Management committee (ALCO) should function as the top operational unit for managing the balance sheet within the performance/ risk parameters laid down by the board. Ideally, the organizational structure for the Market Risk Management should be as under: a. The Board of Directors b. The Asset-Liability Management committee c. The ALM Support groups/Market Risk Groups d. The Risk Management Committee 17.2 The dealing room principles The Treasury Dealing Room within a bank is the clearinghouse for the matching, managing and controlling the market risks. It may provide funding, liquidity and investment support for the assets and liabilities generated by the regular business of the bank. The Dealing Room is responsible for the proper management and control of market risks in accordance with the authority granted to it by the bank's Risk Management Committee. The Dealing Room is also responsible for meeting the needs of the business units in pricing market risks for the application to its products and services .the dealing Room acts as the banks interface to international and domestic financial markets and generally bears

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responsibility for managing market risks in accordance with instruction received from the banks risk management committee. The risk management committee may also allocate a discretionary limit within which the dealing Room may take market risk on a proprietary basis. For these reasons, effective control and supervision of banks dealing Room activities is critical to its effectiveness in managing and controlling market risks. Critical to a Dealing Rooms effective functioning is a comprehensive Dealing Room Manual covering all aspects of their day-to-day activities and ensuring that all dealers have access to it. All dealers active in day to day trading activities must acknowledge familiarity with and provide in undertaking in writing to adhere to the banks Dealing guidelines ad procedures. The Dealing Room Procedures Manual should be comprehensive in nature covering operating procedures for all bankss trading activities in which the Dealing Room is involved and in particular it must cover the banks requirements in:

Code of Conduct Adherence to internal limits Adherence to RBI limits and guidelines Dealings with brokers Dealings hours Security and confidentiality Staff Rotation and Leave requirements.

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18. CONCLUSION
There is famous line which we keep on hearing "Change is the only thing that is constant in this world" and this is doubly true when it comes to managing Treasuries. Treasuries have to attain so many things keeping so many things in mind. An Integrated Treasury has to run all the individual markets (Money markets, Debt markets, Forex Markets, Equity Markets, Derivative markets) efficiently as well as integrate them effectively to achieve the best Risk-Return trade-off. With growing influence of global markets on Indian markets, Indian markets are becoming nimble and complex every nano-second and to keep up with this pace treasuries are turning into "learning centers" along with the traditional "Business centers". Thus to conclude, I would say that "Cooperation is the key to everything" and Integration is nothing but Cooperation between different departments to achieve the best for treasury as well as for the bank.

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19. SUGGESTIONS
Post liberalization only a few banks have been able to keep pace with the dynamic and the complex nature of the Indian economy. Thus, in today's agile markets, treasury has arisen as a niche area requiring extremely competent and skilled people than ever before. Thus, as the need of the hour, I propose 1, A dedicated "RESEARCH DEPARTMENT", the advantages of which would be as follows:

It will supplement the traders with insights on short views for trading.
It will offload the burden of the trader, as now he will not have to worry about taking long-term views. The trader will now concentrate on only short term trading activities focusing on move and more on short term (trading) profits. The research department with its specialized people will have its own published reports and journals; free from any bias (since now we will not have to be dependent on broking houses, investment banks for advises)

It will also help the bank in offering "Portfolio Management Services" to its customers. It will improve the market perception of the Saraswat co-op Bank and in long run will help bank in improving its clientele base,

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THE

PROPOSED

STRUCTRURE

OF

THE

RESERCH

DEPARTMENT IS AS FOLLOW:

RESEERCH HEAD

DEBT & MONEY MARKET ECONOMIST

TECHNICL ANALYIST ECONOMICIST

ECHNICL ANALYIST

FOREX MARKET

ECONOMIST

TECONOMICIST ECHNICL ANALYIST

EQUITY MARLET

ECONOMIST

TECHNICL ANALYIST

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Such a prototype will also help the bank in taking it is treasury operations to the next level thereby taking a step further in its endeavor to remain ahead in the race of competition.

20. BIBLIOGRAPHY
Books 1. Theory and practice of Treasury and Risk Management in banks- S.S Mundra (BOB) 2. Foreign Exchange and Money Market- USB Investment bank 3. Foreign Exchange Handbook H P Bhardwaj 4. Options, Futures and other Derivatives John C Hull Web site 1. www.gtnews.com 2. www.google.com 3. www.investopedia.com 4. www.forex.com 5. www.rbi.gov.in 6. www.ccil.com 7. www.economist.com

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