TREASURY TREASURY MANAGEMENTMANAGEMENT

RISK MANAGEMENTRISK MANAGEMENTTreasury ManagementTreasury Management

Treasury ProductsTreasury Products Treasury Risk ManagementTreasury Risk Management Derivative ProductsDerivative Products

Integrated TreasuryIntegrated Treasury Integrated Treasury refers to integration of Integrated Treasury refers to integration of

money market, securities market and money market, securities market and foreign exchange operations.foreign exchange operations.-Meeting reserve requirements-Meeting reserve requirements-Efficient merchant services-Efficient merchant services-Global cash management-Global cash management-Optimizing profit by exploiting market -Optimizing profit by exploiting market opportunities in forex market, money opportunities in forex market, money market and securities marketmarket and securities market-Risk management-Risk management-Assisting bank management-Assisting bank management

TreasuryTreasuryFunction

Responsible for

Front office

Dealing

Mid-Office

Risk management, accounting and management information

Back office

Confirmations, settlement and reconciliation

FRONT OFFICE

BACK OFFICEMID OFFICE

Dealing

MIS

settlement

TreasuryTreasury

Money MarketMoney Market

Certificate of Deposit (CD) Certificate of Deposit (CD) Commercial Paper (C.P)Commercial Paper (C.P) Inter Bank Participation Certificates Inter Bank Participation Certificates Inter Bank term Money Inter Bank term Money Treasury BillsTreasury Bills

Certificate of DepositCertificate of Deposit

CDs are short-term borrowings in the form of CDs are short-term borrowings in the form of Usance Promissory Notes having a maturity of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one not less than 15 days up to a maximum of one year.year.

CD is subject to payment of Stamp Duty under CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act) Indian Stamp Act, 1899 (Central Act)

They are like bank term deposits accounts. They are like bank term deposits accounts. Unlike traditional time deposits these are Unlike traditional time deposits these are freely negotiable instruments and are often freely negotiable instruments and are often referred to as Negotiable Certificate of referred to as Negotiable Certificate of Deposits Deposits

Features of CDFeatures of CD

CDs can be issued by all scheduled CDs can be issued by all scheduled commercial bankscommercial banks

Minimum period 15 daysMinimum period 15 days Maximum period 1 yearMaximum period 1 year Minimum Amount Rs 1 lac and in multiples Minimum Amount Rs 1 lac and in multiples

of Rs. 1 lacof Rs. 1 lac CDs are transferable by endorsementCDs are transferable by endorsement CRR & SLR are to be maintainedCRR & SLR are to be maintained CDs are to be stampedCDs are to be stamped

Commercial PaperCommercial Paper

Commercial Paper (CP) is an unsecured Commercial Paper (CP) is an unsecured money market instrument issued in the money market instrument issued in the form of a promissory note. form of a promissory note.

Who can issue Commercial Paper Who can issue Commercial Paper (CP) (CP) Highly rated corporate borrowers, Highly rated corporate borrowers, primary dealers (PDs) and satellite primary dealers (PDs) and satellite dealers (SDs) and financial institutions dealers (SDs) and financial institutions (FIs) (FIs)

Rating RequirementRating Requirement All eligible participants should obtain the All eligible participants should obtain the

credit rating for issuance of Commercial credit rating for issuance of Commercial PaperPaper

The Pakistan Credit Rating Agency Limited The Pakistan Credit Rating Agency Limited (PACRA)(PACRA)

JCR-VIS Credit Rating Co. Ltd.JCR-VIS Credit Rating Co. Ltd.

MaturityMaturity

CP can be issued for maturities between CP can be issued for maturities between a minimum of 15 days and a maximum a minimum of 15 days and a maximum upto one year from the date of issue.upto one year from the date of issue.

If the maturity date is a holiday, the If the maturity date is a holiday, the company would be liable to make company would be liable to make payment on the immediate preceding payment on the immediate preceding working day. working day.

To whom issuedTo whom issued

CP is issued to and held by CP is issued to and held by individuals, banking companies, individuals, banking companies, other corporate bodies registered or other corporate bodies registered or incorporated in Pakistan and incorporated in Pakistan and unincorporated bodies, Non-Resident unincorporated bodies, Non-Resident Pakistanis and Foreign Institutional Pakistanis and Foreign Institutional Investors (FIIs). Investors (FIIs).

Coupon rate and YieldCoupon rate and Yield

The difference between coupon rate The difference between coupon rate and yield arises because the market and yield arises because the market price of a security might be different price of a security might be different from the face value of the security. from the face value of the security. Since coupon payments are Since coupon payments are calculated on the face value, the calculated on the face value, the coupon rate is different from the coupon rate is different from the implied yield.implied yield.

Example Example

10% Aug 2015 10 year Govt Bond 10% Aug 2015 10 year Govt Bond Face Value RS.1000Face Value RS.1000 Market Value Rs.1200Market Value Rs.1200 In this case Coupon rate is 10%In this case Coupon rate is 10% Yield is 8.33%Yield is 8.33%

Call Money MarketCall Money Market

The call money market is an integral part The call money market is an integral part of the Pakistani Money Market, where of the Pakistani Money Market, where the day-to-day surplus funds (mostly of the day-to-day surplus funds (mostly of banks) are traded. The loans are of banks) are traded. The loans are of short-term duration varying from 1 to 14 short-term duration varying from 1 to 14 days.days.

The money that is lent for one day in this The money that is lent for one day in this market is known as "market is known as "Call MoneyCall Money", and if ", and if it exceeds one day (but less than 15 it exceeds one day (but less than 15 days) it is referred to as "days) it is referred to as "Notice MoneyNotice Money". ".

Call Money MarketCall Money Market

Banks borrow in this market for the Banks borrow in this market for the following purposefollowing purpose

To fill the gaps or temporary To fill the gaps or temporary mismatches in funds mismatches in funds

To meet the CRR & SLR mandatory To meet the CRR & SLR mandatory requirements as stipulated by the requirements as stipulated by the Central bank Central bank

To meet sudden demand for funds To meet sudden demand for funds arising out of large outflows.arising out of large outflows.

Factors influencing interest Factors influencing interest ratesrates

The factors which govern the interest rates The factors which govern the interest rates are mostly economy related and are are mostly economy related and are commonly referred to as commonly referred to as macroeconomic macroeconomic factorsfactors. Some of these factors are:. Some of these factors are:

1) 1) Demand for money Demand for money 2) 2) Government borrowingsGovernment borrowings3) 3) Supply of money Supply of money 4) 4) Inflation rateInflation rate5) 5) The SBP and the Government policies The SBP and the Government policies

which determine some of the variables which determine some of the variables mentioned above.mentioned above.

Treasury BillsTreasury Bills

Treasury bills, commonly referred to as T-Treasury bills, commonly referred to as T-Bills are issued by Government of Pakistan Bills are issued by Government of Pakistan against their short term borrowing against their short term borrowing requirements with maturities ranging requirements with maturities ranging between 14 to 364 days. between 14 to 364 days.

All these are issued at a discount-to-face All these are issued at a discount-to-face value. For example a Treasury bill of Rs. value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at gets redeemed at the end of it's tenure at Rs. 100.00. Rs. 100.00.

Who can invest in T-BillWho can invest in T-Bill

Banks, Primary Dealers, State Banks, Primary Dealers, State Governments, Provident Funds, Governments, Provident Funds, Financial Institutions, Insurance Financial Institutions, Insurance Companies, NBFCs, DFIs invest in T-Companies, NBFCs, DFIs invest in T-Bills.Bills.

What is auction of What is auction of SecuritiesSecurities

Auction is a process of calling of bids Auction is a process of calling of bids with an objective of arriving at the with an objective of arriving at the market price. It is basically a price market price. It is basically a price discovery mechanism discovery mechanism

DebentureDebenture

A Debenture is a debt security issued A Debenture is a debt security issued by a company (called the Issuer), which by a company (called the Issuer), which offers to pay interest in lieu of the offers to pay interest in lieu of the money borrowed for a certain period. money borrowed for a certain period.

These are long-term debt instruments These are long-term debt instruments issued by private sector companies. issued by private sector companies. These are issued in denominations as These are issued in denominations as low as Rs 1000 and have maturities low as Rs 1000 and have maturities ranging between one and ten years. ranging between one and ten years.

Current yieldCurrent yield

This is the yield or return derived by the This is the yield or return derived by the investor on purchase of the instrument investor on purchase of the instrument (yield related to purchase price) (yield related to purchase price) It is calculated by dividing the coupon rate It is calculated by dividing the coupon rate by the purchase price of the debenture. For by the purchase price of the debenture. For e. g: If an investor buys a 10% Rs 100 e. g: If an investor buys a 10% Rs 100 debenture of ABC company at Rs 90, his debenture of ABC company at Rs 90, his current Yield on the instrument would be current Yield on the instrument would be computed as: computed as: Current Yield = (10%*100)/90 X 100 , That Current Yield = (10%*100)/90 X 100 , That is 11.11% p.a.is 11.11% p.a.

YIELD CURVEYIELD CURVE

The relationship between time and The relationship between time and yield on a homogenous risk class of yield on a homogenous risk class of securities is called the Yield Curve. securities is called the Yield Curve. The relationship represents the time The relationship represents the time value of money - showing that people value of money - showing that people would demand a positive rate of would demand a positive rate of return on the money they are willing return on the money they are willing to part today for a payback into the to part today for a payback into the future future

SHAPE OF YIELD CURVESHAPE OF YIELD CURVE

A A yieldyield curve can be positive, neutral or flat. A positive curve can be positive, neutral or flat. A positive yield curve, which is most natural, is when the slope of yield curve, which is most natural, is when the slope of the curve is positive, i.e. the yield at the longer end is the curve is positive, i.e. the yield at the longer end is higher than that at the shorter end of the time axis. This higher than that at the shorter end of the time axis. This results, as people demand higher compensation for results, as people demand higher compensation for parting their money for a longer time into the future. A parting their money for a longer time into the future. A neutral yield curve is that which has a zero slope, i.e. is neutral yield curve is that which has a zero slope, i.e. is flat across time. T his occurs when people are willing to flat across time. T his occurs when people are willing to accept more or less the same returns across maturities. accept more or less the same returns across maturities. The negative yield curve (also called an inverted yield The negative yield curve (also called an inverted yield curve) is one of which the slope is negative, i.e. the long curve) is one of which the slope is negative, i.e. the long term yield is lower than the short term yield term yield is lower than the short term yield

LIBORLIBOR

LIBOR stands for the London Interbank LIBOR stands for the London Interbank Offered Rate and is the rate of interest at Offered Rate and is the rate of interest at which banks borrow funds from other banks, which banks borrow funds from other banks, in marketable size, in the London interbank in marketable size, in the London interbank market. market.

LIBOR is the most widely used "benchmark" LIBOR is the most widely used "benchmark" or reference rate for short term interest rates. or reference rate for short term interest rates. It is compiled by the British Bankers It is compiled by the British Bankers Association as a free service and released to Association as a free service and released to the market at about 11.00[London time] each the market at about 11.00[London time] each day.day.

CRR & SLRCRR & SLR

The minimum and maximum levels of CRR The minimum and maximum levels of CRR are prescribed at 7% and 18% of demand are prescribed at 7% and 18% of demand and term liabilities (DTL) of the bank, and term liabilities (DTL) of the bank, respectively, under SBP BPRD Circular 9 of respectively, under SBP BPRD Circular 9 of 2006. The CRR and SLR are to be 2006. The CRR and SLR are to be maintained on fortnightly basis. The SBP is maintained on fortnightly basis. The SBP is authorized to increase or decrease the authorized to increase or decrease the CRR and SLR at its discretion.CRR and SLR at its discretion.

Demand and Time LiabilitiesDemand and Time Liabilities

Main components of DTL are:Main components of DTL are: Demand deposits (held in current and savings Demand deposits (held in current and savings

accounts, margin money for LCs, overdue fixed accounts, margin money for LCs, overdue fixed deposits etc.)deposits etc.)

Time deposits (in fixed deposits, recurring deposits, Time deposits (in fixed deposits, recurring deposits, reinvestment deposits etc.)reinvestment deposits etc.)

Overseas borrowingsOverseas borrowings Foreign outward remittances in transit (FC liabilities Foreign outward remittances in transit (FC liabilities

net of FC assets)net of FC assets) Other demand and time liabilities (accrued interest, Other demand and time liabilities (accrued interest,

credit balances in suspense account etc. )credit balances in suspense account etc. )

SLRSLR

SLR is to be maintained in the form SLR is to be maintained in the form of the following assets:of the following assets:

Cash balances (excluding balances Cash balances (excluding balances maintained for CRR)maintained for CRR)

Gold (valued at price not exceeding Gold (valued at price not exceeding current market price)current market price)

Approved securities valued as per Approved securities valued as per norms prescribed by SBP.norms prescribed by SBP.

VaRVaR

Value at Risk (VaR)Value at Risk (VaR) is the most probable loss is the most probable loss that we may incur in normal market conditions that we may incur in normal market conditions over a given period due to the volatility of a over a given period due to the volatility of a factor, exchange rates, interest rates or factor, exchange rates, interest rates or commodity prices. The probability of loss is commodity prices. The probability of loss is expressed as a percentage – VaR at 95% expressed as a percentage – VaR at 95% confidence level, implies a 5% probability of confidence level, implies a 5% probability of incurring the loss; at 99% confidence level the incurring the loss; at 99% confidence level the VaR implies 1% probability of the stated loss. VaR implies 1% probability of the stated loss. The loss is generally stated in absolute The loss is generally stated in absolute amounts for a given transaction value (or amounts for a given transaction value (or value of a investment portfolio).value of a investment portfolio).

VaRVaR

The VaR is an estimate of potential loss, always for a given The VaR is an estimate of potential loss, always for a given period, at a given confidence level.. A VaR of 5p in USD / period, at a given confidence level.. A VaR of 5p in USD / PKR rate for a 30- day period at 95% confidence level PKR rate for a 30- day period at 95% confidence level means that Rupee is likely to lose 5p in exchange value means that Rupee is likely to lose 5p in exchange value with 5% probability, or in other words, Rupee is likely to with 5% probability, or in other words, Rupee is likely to depreciate by maximum 5p on 1.5 days of the period depreciate by maximum 5p on 1.5 days of the period (30*5% ) . A VaR of Rs. 100,000 at 99% confidence level (30*5% ) . A VaR of Rs. 100,000 at 99% confidence level for one week for a investment portfolio of Rs. 10,000,000 for one week for a investment portfolio of Rs. 10,000,000 similarly means that the market value of the portfolio is similarly means that the market value of the portfolio is most likely to drop by maximum Rs. 100,000 with 1% most likely to drop by maximum Rs. 100,000 with 1% probability over one week, or , 99% of the time the probability over one week, or , 99% of the time the portfolio will stand at or above its current value.portfolio will stand at or above its current value.

Exchange Rate QuotationExchange Rate Quotation Exchange Quotations :Exchange Quotations :There are two methodsThere are two methods Exchange rate is expressed as the price per unit Exchange rate is expressed as the price per unit

of foreign currency in terms of the home currency of foreign currency in terms of the home currency is known as the is known as the “Home currency quotation” or “Home currency quotation” or “Direct Quotation“Direct Quotation””

Exchange rate is expressed as the price per unit Exchange rate is expressed as the price per unit of home currency in terms of the foreign currency of home currency in terms of the foreign currency is known as the is known as the “Foreign Currency Quotation” or “Foreign Currency Quotation” or “Indirect Quotation“Indirect Quotation” ”

Direct Quotation is used in New York and other Direct Quotation is used in New York and other foreign exchange markets and Indirect Quotation foreign exchange markets and Indirect Quotation is used in London foreign exchange market.is used in London foreign exchange market.

PrinciplesPrinciples Direct Quotation: Buy Low, Sell High:Direct Quotation: Buy Low, Sell High: The prime motive of any trader is to make profit. The prime motive of any trader is to make profit.

By purchasing the commodity at lower price and By purchasing the commodity at lower price and selling it at a higher price a trader earns the selling it at a higher price a trader earns the profit. In foreign exchange, the banker buys the profit. In foreign exchange, the banker buys the foreign currency at a lesser price and sells it at a foreign currency at a lesser price and sells it at a higher price.higher price.

Indirect Quotation: Buy High, Sell Low:Indirect Quotation: Buy High, Sell Low: A trader for a fixed amount of investment would A trader for a fixed amount of investment would

acquire more units of the commodity when he acquire more units of the commodity when he purchases and for the same amount he would purchases and for the same amount he would part with lesser units of the commodity when he part with lesser units of the commodity when he sells.sells.

Spot and Forward Spot and Forward TransactionsTransactions

‘‘A’ Bank agrees to buy from ‘B’ Bank A’ Bank agrees to buy from ‘B’ Bank USD 100000. The actual exchange of USD 100000. The actual exchange of currencies i.e. payment of rupees and currencies i.e. payment of rupees and receipt of US Dollars, under the contract receipt of US Dollars, under the contract may take place :may take place :

on the same day oron the same day or two days later ortwo days later or some day later, say after a month.some day later, say after a month.

Interpretation of QuotationInterpretation of Quotation

The market quotation for a currency The market quotation for a currency consists of the spot rate and the forward consists of the spot rate and the forward margin. The outright forward rate has to be margin. The outright forward rate has to be calculated by loading the forward margin calculated by loading the forward margin into the spot rate. For example US Dollar is into the spot rate. For example US Dollar is quoted as under in the inter-bank market quoted as under in the inter-bank market on a given day as under :on a given day as under :

Spot 1 USD = Rs.44.1000/1300Spot 1 USD = Rs.44.1000/1300 Spot/November 0200/0500Spot/November 0200/0500 Spot/December 1500/1800Spot/December 1500/1800

TT Buying Rate TT Buying Rate

TT Buying Rate (TT stands for Telegraphic TT Buying Rate (TT stands for Telegraphic Transfer)Transfer)

This is the rate applied when the This is the rate applied when the transaction does not involve any delay in transaction does not involve any delay in realization of the foreign exchange by the realization of the foreign exchange by the bank. In other words, the nostro account bank. In other words, the nostro account of the bank would already have been of the bank would already have been credited. The rate is calculated by credited. The rate is calculated by deducting from the inter-bank buying rate deducting from the inter-bank buying rate the exchange margin as determined by the exchange margin as determined by the Bank.the Bank.

Bills Buying Rate Bills Buying Rate

This is the rate to be applied when a This is the rate to be applied when a foreign bill is purchased. When a bill is foreign bill is purchased. When a bill is purchased, the proceeds will be realized purchased, the proceeds will be realized by the Bank after the bill is presented to by the Bank after the bill is presented to the drawee at the overseas center. In the drawee at the overseas center. In the case of a usance bill the proceeds the case of a usance bill the proceeds will be realized on the due date of the will be realized on the due date of the bill which includes the transit period bill which includes the transit period and the usance period of the bill.and the usance period of the bill.

ProblemProblem

You would like to import machinery from USA worth USD 100000

to be payable to the overseas supplier on 31st Oct[a] Spot Rate USD = Rs.45.8500/8600Forward Premium September 0.2950/3000October 0.5400/5450November 0.7600/7650[b] exchange margin 0.125%[c] Last two digits in multiples of nearest 25

paise Calculate the rate to be quoted by the bank ?

SolutionSolution

This is an example Forward Sale Contract .This is an example Forward Sale Contract .Inter Bank Spot Selling Rate Rs. 45.8600Inter Bank Spot Selling Rate Rs. 45.8600Add Forward Margin .5450Add Forward Margin .5450 ---------------------------- 46.405046.4050Add Exchange Margin .0580Add Exchange Margin .0580 ------------------------------Forward Rate 46.4630Forward Rate 46.4630Rounded Off to multiple of 25 paise Rs.46.4625Rounded Off to multiple of 25 paise Rs.46.4625Amount Payable to the bank Rs.46,46,250 Amount Payable to the bank Rs.46,46,250

SwapSwap

A swap agreement between two A swap agreement between two parties commits each counterparty parties commits each counterparty to exchange an amount of funds, to exchange an amount of funds, determined by a formula, at regular determined by a formula, at regular intervals, until the swap expires.intervals, until the swap expires.

In the case of a currency swap, there In the case of a currency swap, there is an initial exchange of currency and is an initial exchange of currency and a reverse exchange at maturity.a reverse exchange at maturity.

MechanicsMechanics

Firm A needs fixed rate loan –AAA Firm A needs fixed rate loan –AAA ratedrated

Firm B needs floating rate -A Firm B needs floating rate -A ratedrated

Firm A enjoys an Firm A enjoys an absolute advantageabsolute advantage in both credit markets.in both credit markets.11%9%

LIBOR+0.0%

LIBOR+1%

Firm A Firm B

Fixed-rate

finance

Floating-rate

finance

MechanicsMechanics

STEP !STEP !

Firm A will borrow at Fixed rate 9% Firm A will borrow at Fixed rate 9%

Firm B will borrow at floating rate (LIBOR +1)%Firm B will borrow at floating rate (LIBOR +1)%

STEP 2STEP 2

Firm A will pay Floating rate [LIBOR] to Firm BFirm A will pay Floating rate [LIBOR] to Firm B

Firm B will Pay Fixed rate [9.5%] onlyFirm B will Pay Fixed rate [9.5%] only

GainGain

Net interest cost LIBOR- .5%Net interest cost LIBOR- .5%

Net Interest cost 9+[ 1%+0.5%]=10.5%Net Interest cost 9+[ 1%+0.5%]=10.5%

MechanicsMechanics

Gain Gain

A B

Borrows at9.0%fixed

for 7 years

Borrows atLIBOR + 1%

floatingfor 7 years

9.5%

LIBOR

Interest payments to each other in years t 1 to t 7.