Treasury management

IBS BUSINESSIBS BUSINESS
SCHOOL,MUMBAISCHOOL,MUMBAI
RISK MANAGEMENTRISK MANAGEMENT
MODULEMODULE
11
Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS
BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI

SyllabusSyllabus
Module C: Treasury ManagementModule C: Treasury Management::
Treasury managementTreasury management; concepts and functions; instruments in the; concepts and functions; instruments in the
treasury market; development of new financial products; controltreasury market; development of new financial products; control
and supervision of Treasury management; linkage of domesticand supervision of Treasury management; linkage of domestic
operations with foreign operations.operations with foreign operations.
Asset-liability managementAsset-liability management; Interest rate risk; interest rate futures;; Interest rate risk; interest rate futures;
stock options; debt instruments; bond portfolio strategy; riskstock options; debt instruments; bond portfolio strategy; risk
control and hedging instruments.control and hedging instruments.
Investments –Investments – Treasury bills – Money markets instruments suchTreasury bills – Money markets instruments such
as CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance andas CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance and
rediscounting facilities.rediscounting facilities.
22

SyllabusSyllabus
Module D: Capital Management andModule D: Capital Management and
Profit PlanningProfit Planning
 Prudential Norms- Capital Adequacy-Basel II-Prudential Norms- Capital Adequacy-Basel II-
Asset Classification-provisioningAsset Classification-provisioning
 Profit and Profitability-Historical Perspective ofProfit and Profitability-Historical Perspective of
the Approach of Banks to profitability-Effects ofthe Approach of Banks to profitability-Effects of
NPA on profitability-A profitability Model-ShareNPA on profitability-A profitability Model-Share
holders value Maximization & EVA-Profitholders value Maximization & EVA-Profit
Planning-Measures to improve profitabilityPlanning-Measures to improve profitability
33

RISK MANAGEMENTRISK MANAGEMENT
Module C-TreasuryModule C-Treasury
ManagementManagement
 Treasury ProductsTreasury Products
 Treasury Risk ManagementTreasury Risk Management
 Derivative ProductsDerivative Products
44

Integrated TreasuryIntegrated Treasury
 Integrated Treasury refers to integration ofIntegrated Treasury refers to integration of
money market, securities market and foreignmoney market, securities market and foreign
exchange operations.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 market andopportunities in forex market, money market and
securities marketsecurities market
-Risk management-Risk management
-Assisting bank management in ALM-Assisting bank management in ALM
55

TreasuryTreasury
Function Responsible for
Front office Dealing
Mid-Office Risk management, accounting and
management information
Back office Confirmations, settlement and
reconciliation
66

FRONT OFFICE
BACK OFFICEMID OFFICE
Dealing
MIS
settlement
77

TreasuryTreasury
88

Money MarketMoney Market
 Certificate of Deposit (CD)Certificate of Deposit (CD)
 Commercial Paper (C.P)Commercial Paper (C.P)
 Inter Bank Participation CertificatesInter Bank Participation Certificates
 Inter Bank term MoneyInter Bank term Money
 Treasury BillsTreasury Bills
 Call MoneyCall Money
99

Certificate of DepositCertificate of Deposit
 CDs are short-term borrowings in the form ofCDs are short-term borrowings in the form of
Usance Promissory Notes having a maturity ofUsance Promissory Notes having a maturity of
not less than 15 days up to a maximum of onenot less than 15 days up to a maximum of one
year.year.
 CD is subject to payment of Stamp Duty underCD 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 freelyUnlike traditional time deposits these are freely
negotiable instruments and are often referred tonegotiable instruments and are often referred to
as Negotiable Certificate of Depositsas Negotiable Certificate of Deposits
1010

Features of CDFeatures of CD
 CDs can be issued by all scheduled commercialCDs can be issued by all scheduled commercial
banks except RRBsbanks except RRBs
 Minimum period 15 daysMinimum period 15 days
 Maximum period 1 yearMaximum period 1 year
 Minimum Amount Rs 1 lac and in multiples ofMinimum Amount Rs 1 lac and in multiples of
Rs. 1 lacRs. 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
1111

Commercial PaperCommercial Paper
 Commercial Paper (CP) is an unsecuredCommercial Paper (CP) is an unsecured
money market instrument issued in themoney market instrument issued in the
form of a promissory note.form of a promissory note.
 Who can issue Commercial PaperWho can issue Commercial Paper
(CP)(CP)
Highly rated corporate borrowers, primaryHighly rated corporate borrowers, primary
dealers (PDs) and satellite dealers (SDs)dealers (PDs) and satellite dealers (SDs)
and all-India financial institutions (FIs)and all-India financial institutions (FIs)
1212

Eligibility for issue of CPEligibility for issue of CP
a)a) the tangible net worth of the company, as per thethe tangible net worth of the company, as per the
latest audited balance sheet, is not less than Rs. 4latest audited balance sheet, is not less than Rs. 4
crore;crore;
b)b) (b) the working capital (fund-based) limit of the(b) the working capital (fund-based) limit of the
company from the banking system is not less thancompany from the banking system is not less than
Rs.4 croreRs.4 crore
c)c) and the borrowal account of the company isand the borrowal account of the company is
classified as a Standard Asset by the financingclassified as a Standard Asset by the financing
bank/s.bank/s.
1313

Rating RequirementRating Requirement
 All eligible participants should obtain the creditAll eligible participants should obtain the credit
rating for issuance of Commercial Paperrating for issuance of Commercial Paper
 Credit Rating Information Services of India Ltd.Credit Rating Information Services of India Ltd.
(CRISIL)(CRISIL)
 Investment Information and Credit RatingInvestment Information and Credit Rating
Agency of India Ltd. (ICRA)Agency of India Ltd. (ICRA)
 Credit Analysis and Research Ltd. (CARE)Credit Analysis and Research Ltd. (CARE)
 Duff & Phelps Credit Rating India Pvt. Ltd.Duff & Phelps Credit Rating India Pvt. Ltd.
(DCR India)(DCR India)
 The minimum credit rating shall be P-2 ofThe minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by otherCRISIL or such equivalent rating by other
agenciesagencies
1414

MaturityMaturity
 CP can be issued for maturities between aCP can be issued for maturities between a
minimum of 15 days and a maximum uptominimum of 15 days and a maximum upto
one year from the date of issue.one year from the date of issue.
 If the maturity date is a holiday, theIf the maturity date is a holiday, the
company would be liable to make paymentcompany would be liable to make payment
on the immediate preceding working day.on the immediate preceding working day.
1515

To whom issuedTo whom issued
CP is issued to and held by individuals,CP is issued to and held by individuals,
banking companies, other corporatebanking companies, other corporate
bodies registered or incorporated in Indiabodies registered or incorporated in India
and unincorporated bodies, Non-Residentand unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign InstitutionalIndians (NRIs) and Foreign Institutional
Investors (FIIs).Investors (FIIs).
1616

RepoRepo
 Uses of RepoUses of Repo
It helps banks to invest surplus cashIt helps banks to invest surplus cash
It helps investor achieve money market returnsIt helps investor achieve money market returns
with sovereign risk.with sovereign risk.
It helps borrower to raise funds at better ratesIt helps borrower to raise funds at better rates
An SLR surplus and CRR deficit bank can useAn SLR surplus and CRR deficit bank can use
the Repo deals as a convenient way of adjustingthe Repo deals as a convenient way of adjusting
SLR/CRR positions simultaneously.SLR/CRR positions simultaneously.
RBI uses Repo and Reverse repo asRBI uses Repo and Reverse repo as
instruments for liquidity adjustment in the systeminstruments for liquidity adjustment in the system
1717

Meaning of RepoMeaning of Repo
 It is a transaction in which two parties agree toIt is a transaction in which two parties agree to
sell and repurchase the same security. Undersell and repurchase the same security. Under
such an agreement the seller sells specifiedsuch an agreement the seller sells specified
securities with an agreement to repurchase thesecurities with an agreement to repurchase the
same at a mutually decided future date and asame at a mutually decided future date and a
priceprice
 The Repo/Reverse Repo transaction can only beThe Repo/Reverse Repo transaction can only be
done at Mumbai between parties approved bydone at Mumbai between parties approved by
RBI and in securities as approved by RBIRBI and in securities as approved by RBI
(Treasury Bills, Central/State Govt securities).(Treasury Bills, Central/State Govt securities).
1818

Coupon rate and YieldCoupon rate and Yield
The difference between coupon rate andThe difference between coupon rate and
yield arises because the market price of ayield arises because the market price of a
security might be different from the facesecurity might be different from the face
value of the security. Since couponvalue of the security. Since coupon
payments are calculated on the facepayments are calculated on the face
value, the coupon rate is different from thevalue, the coupon rate is different from the
implied yield.implied yield.
1919

ExampleExample
 10% Aug 2015 10 year Govt Bond10% 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%
2020

Call Money MarketCall Money Market
The call money market is an integral part ofThe call money market is an integral part of
the Indian Money Market, where the day-the Indian Money Market, where the day-
to-day surplus funds (mostly of banks) areto-day surplus funds (mostly of banks) are
traded. The loans are of short-termtraded. The loans are of short-term
duration varying from 1 to 14 days.duration varying from 1 to 14 days.
The money that is lent for one day in thisThe money that is lent for one day in this
market is known as "market is known as "Call MoneyCall Money", and if it", and if it
exceeds one day (but less than 15 days) itexceeds one day (but less than 15 days) it
is referred to as "is referred to as "Notice MoneyNotice Money".".
2121

Call Money MarketCall Money Market
Banks borrow in this market for theBanks borrow in this market for the
following purposefollowing purpose
 To fill the gaps or temporary mismatchesTo fill the gaps or temporary mismatches
in fundsin funds
 To meet the CRR & SLR mandatoryTo meet the CRR & SLR mandatory
requirements as stipulated by the Centralrequirements as stipulated by the Central
bankbank
 To meet sudden demand for funds arisingTo meet sudden demand for funds arising
out of large outflows.out of large outflows.
2222

Factors influencing interestFactors influencing interest
ratesrates
The factors which govern the interest rates areThe factors which govern the interest rates are
mostly economy related and are commonlymostly economy related and are commonly
referred to asreferred to as macroeconomic factorsmacroeconomic factors. Some of. Some of
these factors are:these factors are:
1)1) Demand for moneyDemand for money
2)2) Government borrowingsGovernment borrowings
3)3) Supply of moneySupply of money
4)4) Inflation rateInflation rate
5)5) The Reserve Bank of India and theThe Reserve Bank of India and the
Government policies which determine some ofGovernment policies which determine some of
the variables mentioned above.the variables mentioned above.
2323

Gilt edged securitiesGilt edged securities
The term government securities encompass allThe term government securities encompass all
Bonds & T-bills issued by the CentralBonds & T-bills issued by the Central
Government, and state governments. TheseGovernment, and state governments. These
securities are normally referred to, as "gilt-securities are normally referred to, as "gilt-
edged" as repayments of principal as well asedged" as repayments of principal as well as
interest are totally secured by sovereigninterest are totally secured by sovereign
guarantee.guarantee.
2424

Treasury BillsTreasury Bills
Treasury bills, commonly referred to as T-BillsTreasury bills, commonly referred to as T-Bills
are issued by Government of India against theirare issued by Government of India against their
short term borrowing requirements withshort term borrowing requirements with
maturities ranging between 14 to 364 days.maturities ranging between 14 to 364 days.
All these are issued at a discount-to-face value.All these are issued at a discount-to-face value.
For example a Treasury bill of Rs. 100.00 faceFor example a Treasury bill of Rs. 100.00 face
value issued for Rs. 91.50 gets redeemed at thevalue issued for Rs. 91.50 gets redeemed at the
end of it's tenure at Rs. 100.00.end of it's tenure at Rs. 100.00.
2525

Who can invest in T-BillWho can invest in T-Bill
Banks, Primary Dealers, StateBanks, Primary Dealers, State
Governments, Provident Funds, FinancialGovernments, Provident Funds, Financial
Institutions, Insurance Companies,Institutions, Insurance Companies,
NBFCs, FIIs (as per prescribed norms),NBFCs, FIIs (as per prescribed norms),
NRIs & OCBs can invest in T-Bills.NRIs & OCBs can invest in T-Bills.
2626

What is auction ofWhat is auction of
SecuritiesSecurities
Auction is a process of calling of bids withAuction is a process of calling of bids with
an objective of arriving at the market price.an objective of arriving at the market price.
It is basically a price discovery mechanismIt is basically a price discovery mechanism
2727

DebentureDebenture
 A Debenture is a debt security issued by aA Debenture is a debt security issued by a
company (called the Issuer), which offerscompany (called the Issuer), which offers
to pay interest in lieu of the moneyto pay interest in lieu of the money
borrowed for a certain period.borrowed for a certain period.
 These are long-term debt instrumentsThese are long-term debt instruments
issued by private sector companies.issued by private sector companies.
These are issued in denominations as lowThese are issued in denominations as low
as Rs 1000 and have maturities rangingas Rs 1000 and have maturities ranging
between one and ten years.between one and ten years.
2828

Difference between debenture andDifference between debenture and
bondbond
Long-term debt securities issued by theLong-term debt securities issued by the
Government of India or any of the StateGovernment of India or any of the State
GovernmentGovernment’’s or undertakings owned bys or undertakings owned by
them or by development financialthem or by development financial
institutions are called as bonds.institutions are called as bonds.
Instruments issued by other entities areInstruments issued by other entities are
called debentures.called debentures.
2929

Current yieldCurrent yield
This is the yield or return derived by the investorThis is the yield or return derived by the investor
on purchase of the instrument (yield related toon purchase of the instrument (yield related to
purchase price)purchase price)
It is calculated by dividing the coupon rate by theIt is calculated by dividing the coupon rate by the
purchase price of the debenture. For e. g: If anpurchase price of the debenture. For e. g: If an
investor buys a 10% Rs 100 debenture of ABCinvestor buys a 10% Rs 100 debenture of ABC
company at Rs 90, his current Yield on thecompany at Rs 90, his current Yield on the
instrument would be computed as:instrument would be computed as:
Current Yield = (10%*100)/90 X 100 , That isCurrent Yield = (10%*100)/90 X 100 , That is
11.11% p.a.11.11% p.a.
3030

Primary Dealers & SatellitePrimary Dealers & Satellite
DealersDealers
 Primary Dealers can be referred to as MerchantPrimary Dealers can be referred to as Merchant
Bankers to Government of India, comprising theBankers to Government of India, comprising the
first tier of the government securities market.first tier of the government securities market.
Satellite Dealers work in tandem with theSatellite Dealers work in tandem with the
Primary Dealers forming the second tier of thePrimary Dealers forming the second tier of the
market to cater to the retail requirements of themarket to cater to the retail requirements of the
market.market.
 These were formed during the year 1994-96 toThese were formed during the year 1994-96 to
strengthen the market infrastructurestrengthen the market infrastructure
3131

What role do Primary DealersWhat role do Primary Dealers
play?play?
The role of Primary Dealers is to;The role of Primary Dealers is to;
(i) commit participation as Principals in(i) commit participation as Principals in
Government of India issues throughGovernment of India issues through
bidding in auctionsbidding in auctions
(ii) provide underwriting services(ii) provide underwriting services
(iii) offer firm buy - sell / bid ask quotes for(iii) offer firm buy - sell / bid ask quotes for
T-Bills & dated securitiesT-Bills & dated securities
(v) Development of Secondary Debt(v) Development of Secondary Debt
MarketMarket
3232

OMOOMO
 OMO or Open Market Operations is aOMO or Open Market Operations is a
market regulating mechanism oftenmarket regulating mechanism often
resorted to by Reserve Bank of India.resorted to by Reserve Bank of India.
Under OMO Operations Reserve Bank ofUnder OMO Operations Reserve Bank of
India as a market regulator keeps buyingIndia as a market regulator keeps buying
or/and selling securities through it's openor/and selling securities through it's open
market window. It's decision to sell or/andmarket window. It's decision to sell or/and
buy securities is influenced by factorsbuy securities is influenced by factors
such as overall liquidity in the system,such as overall liquidity in the system,
3333

YIELD CURVEYIELD CURVE
 The relationship between time and yieldThe relationship between time and yield
on a homogenous risk class of securitieson a homogenous risk class of securities
is called the Yield Curve. The relationshipis called the Yield Curve. The relationship
represents the time value of money -represents the time value of money -
showing that people would demand ashowing that people would demand a
positive rate of return on the money theypositive rate of return on the money they
are willing to part today for a payback intoare willing to part today for a payback into
the futurethe future
3434

SHAPE OF YIELD CURVESHAPE OF YIELD CURVE
AA yieldyield curve can be positive, neutral or flat. Acurve can be positive, neutral or flat. A
positive yield curve, which is most natural, is whenpositive yield curve, which is most natural, is when
the slope of the curve is positive, i.e. the yield at thethe slope of the curve is positive, i.e. the yield at the
longer end is higher than that at the shorter end of thelonger end is higher than that at the shorter end of the
time axis. This results, as people demand highertime axis. This results, as people demand higher
compensation for parting their money for a longercompensation for parting their money for a longer
time into the future. A neutral yield curve is thattime into the future. A neutral yield curve is that
which has a zero slope, i.e. is flat across time. T hiswhich has a zero slope, i.e. is flat across time. T his
occurs when people are willing to accept more or lessoccurs when people are willing to accept more or less
the same returns across maturities. The negative yieldthe same returns across maturities. The negative yield
curve (also called an inverted yield curve) is one ofcurve (also called an inverted yield curve) is one of
which the slope is negative, i.e. the long term yield iswhich the slope is negative, i.e. the long term yield is
lower than the short term yieldlower than the short term yield
3535

LIBORLIBOR
 LIBOR stands for the London Interbank OfferedLIBOR stands for the London Interbank Offered
Rate and is the rate of interest at which banksRate and is the rate of interest at which banks
borrow funds from other banks, in marketableborrow funds from other banks, in marketable
size, in the London interbank market.size, in the London interbank market.
 LIBOR is the most widely used "benchmark" orLIBOR is the most widely used "benchmark" or
reference rate for short term interest rates. It isreference rate for short term interest rates. It is
compiled by the British Bankers Association ascompiled by the British Bankers Association as
a free service and released to the market ata free service and released to the market at
about 11.00[London time] each day.about 11.00[London time] each day.
3636

CRR & SLRCRR & SLR
The minimum and maximum levels of CRR areThe minimum and maximum levels of CRR are
prescribed at 3% and 20% of demand and termprescribed at 3% and 20% of demand and term
liabilities (DTL) of the bank, respectively, underliabilities (DTL) of the bank, respectively, under
Reserve Bank of India Act of 1934. TheReserve Bank of India Act of 1934. The
minimum and maximum SLR are prescribed atminimum and maximum SLR are prescribed at
25% and 40% of DTL respectively, under25% and 40% of DTL respectively, under
Banking Regulation Act of 1949. The CRR andBanking Regulation Act of 1949. The CRR and
SLR are to be maintained on fortnightly basis.SLR are to be maintained on fortnightly basis.
The RBI is authorized to increase or decreaseThe RBI is authorized to increase or decrease
the CRR and SLR at its discretion.the CRR and SLR at its discretion.
3737

Demand and Time LiabilitiesDemand and Time Liabilities
Main components of DTL are:Main components of DTL are:
 Demand deposits (held in current and savingsDemand deposits (held in current and savings
accounts, margin money for LCs, overdue fixedaccounts, 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 liabilitiesForeign 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. )
3838

SLRSLR
SLR is to be maintained in the form of theSLR is to be maintained in the form of the
following assets:following assets:
 Cash balances (excluding balancesCash balances (excluding balances
maintained for CRR)maintained for CRR)
 Gold (valued at price not exceedingGold (valued at price not exceeding
current market price)current market price)
 Approved securities valued as per normsApproved securities valued as per norms
prescribed by RBI.prescribed by RBI.
3939

VaRVaR
Value at Risk (VaR)Value at Risk (VaR) is the most probableis the most probable
loss that we may incur in normal marketloss that we may incur in normal market
conditions over a given period due to theconditions over a given period due to the
volatility of a factor, exchange rates, interestvolatility of a factor, exchange rates, interest
rates or commodity prices. The probability ofrates or commodity prices. The probability of
loss is expressed as a percentage – VaR at 95%loss is expressed as a percentage – VaR at 95%
confidence level, implies a 5% probability ofconfidence level, implies a 5% probability of
incurring the loss; at 99% confidence level theincurring 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 amountsThe loss is generally stated in absolute amounts
for a given transaction value (or value of afor a given transaction value (or value of a
investment portfolio).investment portfolio).
4040

VaRVaR
The VaR is an estimate of potential loss, always for a givenThe 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 /
INR rate for a 30- day period at 95% confidence levelINR rate for a 30- day period at 95% confidence level
means that Rupee is likely to lose 5p in exchange valuemeans that Rupee is likely to lose 5p in exchange value
with 5% probability, or in other words, Rupee is likely towith 5% probability, or in other words, Rupee is likely to
depreciate by maximum 5p on 1.5 days of the perioddepreciate 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. 10,000,000for one week for a investment portfolio of Rs. 10,000,000
similarly means that the market value of the portfolio issimilarly 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 theprobability 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.
4141

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 ofExchange rate is expressed as the price per unit of
foreign currency in terms of the home currency is knownforeign currency in terms of the home currency is known
as theas the “Home currency quotation” or “Direct Quotation“Home currency quotation” or “Direct Quotation””
 Exchange rate is expressed as the price per unit ofExchange rate is expressed as the price per unit of
home currency in terms of the foreign currency is knownhome currency in terms of the foreign currency is known
as theas the “Foreign Currency Quotation” or “Indirect“Foreign Currency Quotation” or “Indirect
QuotationQuotation””
 Direct Quotation is used in New York and other foreignDirect Quotation is used in New York and other foreign
exchange markets and Indirect Quotation is used inexchange markets and Indirect Quotation is used in
London foreign exchange market.London foreign exchange market.
4242

PrinciplesPrinciples
 Direct Quotation: Buy Low, Sell High:Direct Quotation: Buy Low, Sell High:
 The prime motive of any trader is to make profit. ByThe prime motive of any trader is to make profit. By
purchasing the commodity at lower price and selling it atpurchasing the commodity at lower price and selling it at
a higher price a trader earns the profit. In foreigna higher price a trader earns the profit. In foreign
exchange, the banker buys the foreign currency at aexchange, the banker buys the foreign currency at a
lesser price and sells it at a higher price.lesser price and sells it at a higher price.
 Indirect Quotation: Buy High, Sell Low:Indirect Quotation: Buy High, Sell Low:
 A trader for a fixed amount of investment would acquireA trader for a fixed amount of investment would acquire
more units of the commodity when he purchases and formore units of the commodity when he purchases and for
the same amount he would part with lesser units of thethe same amount he would part with lesser units of the
commodity when he sells.commodity when he sells.
4343

Spot and ForwardSpot and Forward
TransactionsTransactions
 ‘‘A’ Bank agrees to buy from ‘B’ Bank USDA’ Bank agrees to buy from ‘B’ Bank USD
100000. The actual exchange of100000. The actual exchange of
currencies i.e. payment of rupees andcurrencies i.e. payment of rupees and
receipt of US Dollars, under the contractreceipt 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.
4444

Interpretation of QuotationInterpretation of Quotation
 The market quotation for a currency consists ofThe market quotation for a currency consists of
the spot rate and the forward margin. Thethe spot rate and the forward margin. The
outright forward rate has to be calculated byoutright forward rate has to be calculated by
loading the forward margin into the spot rate.loading the forward margin into the spot rate.
For example US Dollar is quoted as under in theFor example US Dollar is quoted as under in the
inter-bank market on a given day as under :inter-bank market 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
4545

TT Buying RateTT Buying Rate
 TT Buying Rate (TT stands for TelegraphicTT Buying Rate (TT stands for Telegraphic
Transfer)Transfer)
 This is the rate applied when the transactionThis is the rate applied when the transaction
does not involve any delay in realization of thedoes not involve any delay in realization of the
foreign exchange by the bank. In other words,foreign exchange by the bank. In other words,
the nostro account of the bank would alreadythe nostro account of the bank would already
have been credited. The rate is calculated byhave been credited. The rate is calculated by
deducting from the inter-bank buying rate thededucting from the inter-bank buying rate the
exchange margin as determined by the Bank.exchange margin as determined by the Bank.
4646

Bills Buying RateBills Buying Rate
 This is the rate to be applied when aThis is the rate to be applied when a
foreign bill is purchased. When a bill isforeign bill is purchased. When a bill is
purchased, the proceeds will be realizedpurchased, the proceeds will be realized
by the Bank after the bill is presented toby the Bank after the bill is presented to
the drawee at the overseas center. In thethe drawee at the overseas center. In the
case of a usance bill the proceeds will becase of a usance bill the proceeds will be
realized on the due date of the bill whichrealized on the due date of the bill which
includes the transit period and the usanceincludes the transit period and the usance
period of the bill.period of the bill.
4747

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.45.8500/8600
Forward Premium
September 0.2950/3000
October 0.5400/5450
November 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 ? 4848

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. 45.8600
Add Forward Margin .5450Add Forward Margin .5450
----------------------------
46.405046.4050
Add Exchange Margin .0580Add Exchange Margin .0580
------------------------------
Forward Rate 46.4630Forward Rate 46.4630
Rounded Off to multiple of 25 paise Rs.46.4625Rounded Off to multiple of 25 paise Rs.46.4625
Amount Payable to the bank Rs.46,46,250Amount Payable to the bank Rs.46,46,250
4949

SwapSwap
 A swap agreement between two partiesA swap agreement between two parties
commits each counterparty to exchangecommits each counterparty to exchange
an amount of funds, determined by aan amount of funds, determined by a
formula, at regular intervals, until the swapformula, at regular intervals, until the swap
expires.expires.
 In the case of a currency swap, there is anIn the case of a currency swap, there is an
initial exchange of currency and a reverseinitial exchange of currency and a reverse
exchange at maturity.exchange at maturity.
5050

MechanicsMechanics
 Firm A needs fixed rate loan –AAA ratedFirm A needs fixed rate loan –AAA rated
 Firm B needs floating rate -A ratedFirm B needs floating rate -A rated
 Firm A enjoys anFirm A enjoys an absolute advantageabsolute advantage inin
both credit markets.both credit markets.
11%9%
LIBOR
+0.0%
LIBOR
+1%
Firm A Firm B
Fixed-
rate
finance
Floating-
rate
finance
5151

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%
5252

MechanicsMechanics
GainGain
A B
Borrows at
9.0%
fixed
for 7 years
Borrows at
LIBOR + 1%
floating
for 7 years
9.5%
LIBOR
Interest payments to each
other in years t1 to t7.
5353

Treasury management

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