Copyright anbirts1 Treasury Management Policy Process and Performance.

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Treasury Management

Policy Process and

Performance

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Why Manage Risk?

Objective of the Organisation

Maximise Shareholder Wealth

How? Cash Flow = Value

Discount Rate - Reduce Volatility - Reduce Risk - Reduce Cost of Capital

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Should We Manage Risk?

• Efficient Markets

• Parity

• Portfolio Theory

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Should We Manage Risk?Efficient Markets

• Basically current prices reflect all known information and the next price will be a random walk

• What Does Random Walk Theory Mean?The theory that price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement.

• So we cannot beat the market over time and there are costs in hedging e.g. wider spreads on the forward, management time

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Should We Manage Risk?Parity

• Expected change in Movement in spot exchange rate expected inflation

Expectations International Fisher effect FisherTheory effect

Difference between covered Interest rate parity Movement inspot and forward interest ratesFrom Alpha Dhanani

Purchasing Power Parity

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Should We Manage Risk?

• So maybe we should manage risk due to:

1. Even if the parity theories work long term we might, with large movements, be bankrupt short term

2. There is some value in certainty, e.g. planning liquidity even if hedging does not reduce volatility

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Should We Manage Risk?Portfolio Theory

• If hedging makes sense there is still the question as to whom should undertake the hedging, Managers or Shareholders?

• Portfolio theory

• Asymetric information

• Internal hedging

• Asymetric tax effect

• Access to markets

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Foreign Exchange Policy Issues

Define Exposures to Be Managed– Economic– Translation– Transaction

Objective:Minimise FX losses and Maximise FX Gains Commensurate with a defined level of Risk

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• Which exposures are important• Time Period

– Start Date• Price List, Forecast, Order Date

– End Date• Year end or beyond, invoiced or expected date

• Policy Alternatives• Cover Everything• Leave Open• Selective Cover• Hybrid

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• Instruments– Define proportions in each– Options – write covered or uncovered, buy

• Set Limits– Overall limits– Individual limits

• Treasury Procedures


Value at Risk (VAR)

VAR estimates the potential pre-tax loss resulting from an adverse movement in market prices over a defined holding period.

• Equities• Commodities• FX• Interest Rates


VAR Correlation Approach

• Historic Data• Normal Distribution• 68% of changes

within one Standard Deviation (SD)

• 95% of changes within two SD’s

• 99% of changes within three SD’s

10 million (GBP equivalent)

long position in USD

SD .15%

Want 95% confidence

Max loss =

10,000,000 x .0015 x 2 = 30,000

Example: Single Asset


VAR Two Assets

[(VAR1)2 + (VAR2)2]

Example: Two Unrelated Assets10,000,000 (GBP equivalent) long in USD SD .15%10,000,000,Long (GBP equivalent) in Euro SD.20%95% Confidence

VAR = [(10,000,000 x .0015 x 2)2 + (10,000,000 x .002 x 2)2]

VAR = (30,000)2 + (40,000)2

VAR = 900,000,000 + 1,600,000,000 = 2,500,000,000

= 50,000


VAR Correlation (Related Movements)

VAR = [(VAR1)2 + (VAR2)2 + 2 x VAR1 x VAR2 x R]

ExampleSame as above but Correlation Coefficient .6

VAR = (30,000)2 + (40,000)2 + 2 x 30,000 x 40,000 x .6]

VAR = 62,769


VARAdvantages

– Reasonably simple concept to communicate– Used to aggregate risks– Can correlate Profits to Risk (Performance Measurement)

Disadvantages– Based on major assumptions (normal distribution, history

repeats itself)– Complex mathematics– Sudden shifts of volatility– Appears scientific


Setting Limits: An ApproachCo Net Worth GBP 10,000,000

Prepared to Lose 2,000,000

Currency Exposure USD

Annual Volatility 20% and Monthly Volatility 20 x

Maximum Exposure Period: 6 months12

M

Month 1 2 3 4 5 6

Volatility 5.77 8.16 10.00 11.55 12.90 14.14

Position 3,198,976

Possible Loss

184,581 261,036 319,898 369,482 412,668 452,335

Maximum Loss 2,000,000


Electronic Banking

• Why is Security important and in what areas should communications systems (telephone, email, proprietary, internet) seek to give confidence?

• Authorisation

• Non repudiation

• Authentication

• Confidentiality

• Integrity

What do these mean?

Electronic Banking

• Authorisation. Determines that the users or entities involved are authorised to perform the actions they have taken.

• Non repudiation. Evidence that the sender of the transaction intended to send the transaction (and that the receiver received it).

• Authentication. Guarantees that each party requesting access to the transaction are who they claim to be.


Electronic Banking

• Confidentiality. Ensures that access to the transaction is restricted to certain individuals.

• Integrity. Prevents data from being either maliciously or accidentally changed or corrupted.

Internally, protection is also needed against Fraud and Error



The Dealing Process

Authorised deal by FD, treas etc Dealer Bank

Deal done

Dealer limits

Confirmation

Authorised/Mandates

Bank dealer logs details

authorised Limits on BankLimits on company

Co dealer logs details on TMS + competitive quotes.Also logs in ERP system

Both parties send confirmations and reconcile

Segregation of duties

Settlement to standard settlement instructions

Segregation of duties

Company back office

Security/ controls on settlement

Internal audit, Physical access, Dual input, Pre formatted payment details, Passwords, Encryption, Authorisations, Answer back, Reconciliation

Conversation recorded


Electronic BankingSecurity

So how do we attain security and have a system that works?

• Authorisation for payments/deals

• Segregation of duties (back office/dealer)

• Physical security– Dedicated computers for payments– Separate room– Password protected



• Different levels of authorisation/activity– Input– Second input– Verification– Authorisation and release

• Free format

• Pre-format/Templates in TMS



• Encryption or cyphertext– Private key or symmetric– Public key or asymmetric (public key

infrastructure, PKI)

not only ensures confidentiality but also provides authentication of the sender thus preventing repudiation

– SSL, Secure Sockets Layer– HTTPS, Hypertext Transfer Protocol, Secure



• Digital Signature• Uses the asymetric method to perform two

functions– Authentication– Integrity


Performance Measurement

• Why have performance measurement?

1. To justify existence

2. To show value added

3. To motivate and reward

4. To control

• What areas need benchmarks/objectives

• What benchmarks may be used



• Measures used will depend on objectives/policy i.e.

• Cover everything then focus on expertise of dealing

• Selective cover then focus on performance against a benchmark versus risk taken



• Some areas Cash management

• Liquidity management

• Risk management, FX and Interest Rate

• Efficiency of Treasury



• Benchmarks should be1. Agreed2. Attainable3. Measurable• Some might be1. Cost per £1,000 of revenue2. Time to process3. Forward rate4. Three month Libor5. Overnight

Copyright anbirts1 Treasury Management Policy Process and Performance.

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