Ma0042

SMU
ASSIGNMENT
SEMESTER – 4
MA0042

SUBMITTED BY:

DEVESH NIDARIA (MBA)
ROLLNO:-581125616

Q 1. Explain treasury management, its need and benefits and
treasury exposure.

Ans: Treasury management is the process of planning, organising and managing the
organisation’s holdings, trading’s, corporate bonds, currencies, financial futures,
associated risks, options, derivatives, and payment systems. It handles all the
financial matters including external and internal funds for business, complex
strategies, and procedures of corporate finance to optimise interest and currency
flows. It helps in planning and executing communication programmes to enhance
investors’ confidence in the organisation.

According to Teigen Lee E (July 2001), “Treasury is the place of deposit reserved for
storing treasures and disbursement of collected funds”. The responsibility of treasury
management lies with the Chief Financial Officer (CFO) of the organisation. The
CFO’s responsibilities include capital and risk management, planning strategies,
investor relations and financial reporting. In large organisations, these
responsibilities are divided among the accounting and treasury sectors. Hence the
workflow between these two sectors must be ethical.

Need

Treasury management is mainly required to optimise the economy of the
organisation and provide an ability to manage financial risks.

Treasury management is important for the following reasons:

· The development in technology, breakdown of exchange controls, unpredictable
changes in interest and exchange rates, and globalisation of businesses requires
treasury management.

· To actively manage financial environment, organisations require treasury
management that provides the ability to undertake business opportunities and their
exposure to risks.

· The expanding range of hybrid capital instruments like convertible preference
issued with respect to subsidiary registration of the government need treasury
management to select the appropriate businesses in the various circumstances.

· It provides the caliber to develop appropriate skills in achieving economies of scale,
lower borrowing rates and netting-off balances.

· It enhances relationship between entity and its financial stakeholders which include
shareholders, fund lenders and taxation authorities.

· The treasury management acts as a centralised head office in the organisation and
provides financial service to various departments and enhances the financial growth
in the organisation.

Benefits

Few benefits of treasury management are:

· Implementation of treasury management in the organisation increases sales of the
products.

· It helps in providing confident employees who work effectively in the organisation.

· It enhances better guidelines and methods to manage risks especially in the areas
like foreign currency, and helps in maintaining banking relationships in the
organisation.

· The treasury management model helps in identifying risks based on changes in the
business conditions and operations, and implements relevant methods to reduce the
risk.

· The forecasted cash flow exposures can be derived from the historical data.

· In banking organisations, it helps to optimise asset and debt performance while
minimising the needs for external funding.

· The financial sector in the organisation will be able to analyse a variety of data
which include funds, transactions, foreign exchange rates, market data and third
party information.

· The treasury management system advises the organisation management on
aspects of liquidity of its short and long term planning.

· The organisation obtains a well maintained system of policies and procedures to
impose adequate level of control over treasury activities.

· An organisation investing in treasury management can expect increase in cash
visibility, better management of financial risk and enhancement of treasury efficiency
and accuracy.

In this section we discussed about treasury management and its need and benefits.
Next section deals with treasury exposure; need to manage risk, and the concepts of
corporate and hidden risks.

Treasury Exposure

Treasury exposure allows treasury management to various risks in the organisation.
Following are the few treasury exposures in an organisation:

· Financial exposure – The treasury management in the organisation are disclosed to
the powerful analytics that enable to measure the global treasury operations and
control financial market risks. It analyses the price and risk profile of financial
dealings on a pre-dealing basis. The exposure in foreign exchange market is
intense; hence hedging towards these risks by integrating business exposures and
treasury transactions helps an organisation to manage financial risk and stay
profitable.

· Foreign exchange exposure – This occurs due to the low profits and adverse
fluctuations in foreign exchange rates. Many organisations suffer from foreign
exchange risk by making purchases or sales in foreign currency or by owning assets
or liabilities in foreign countries. Hence a relevant course of action must be
implemented to reduce exposures in business operations.

· Currency exposure – It deals with future cash flows arising from domestic and
foreign currencies that involve assets and liabilities and generating revenues which
are susceptible to variations in foreign currency exchange rates. Hence the

identification of existing potential currency relationship that arises from business
activities includes hedging and other risk management activities.

· Event exposure – This happens due to a sudden change in the financial market
during an investment (an event) that has a detrimental effect on the value of that
investment. It is often associated with corporate bonds.

· Commodity exposure – This happens due to variations in the prices of commodities
which change the future and magnitude of market values. The commodities depend
on any production including foreign currencies, financial instruments or any physical
substances. Hence treasury management is liable to deal with various risks like
price, quantity, cost that are associated with commodities.

Q 2 Classify various money market instruments.

Ans: Money Market Instruments

In the previous section, we discussed about money market and call money market,
and their features. In this section we will discuss about money market instruments
and their features

Money market instruments take care of the borrowers' short-term needs and provide
the required liquidity to the lenders. The types of money market instruments are
treasury bills, commercial papers and certificate of deposits, bills of exchange, repo
and reverse repo.

2.3.1 Treasury Bills (T-Bills)

A treasury bill is a money market instrument. It is also known as T-Bills. It is a
promissory note issued by the Central Government of India at a discounted value to
meet its short-term requirements. Until 1950, T-Bills were also issued by the state
governments. After 1950, it is issued by Central Government. RBI issues T-bills on
behalf of the Central Government of India. They are issued by tender or tap. T-Bills
are highly liquid because they are guaranteed by the Central Government. These
bills can be used as claims against the government as they do not require any
acceptance or endorsement.

T-Bills are issued under four types - 14 days T-Bills, 91 days T-bills, 82 days T-Bills,
and 364 days T-Bills. T-bills are issued on auction by the RBI. The auction amount,
date of auction is announced by the RBI from time to time. Organisations like
provident funds, state run pension funds and the state governments are allowed to
participate in the auction, but they are not allowed to bid. RBI invites bids every
fortnight and decides the cut-off rate on the bids T-Bills are assets which are used for
the maintenance of a bank’s Statutory Liquidity Ratio (SLR) requirement. The
discount rate of the RBI auction based on bidders’ quotations gives expected returns
to the investors.

Features of T-Bills

Features of T-bills are as follows:

· T-bills are highly liquid as the RBI provides a ready market. Institutions like STCI,
DFHI and commercial banks provide a ready market for T-Bills.

· There is no risk in T-bills as the bills are issued by RBI on behalf of the Central
Government and guaranteed by the Government.

· T-bills are readily available throughout the week. Individuals can invest their surplus
funds on any day of the week.

· The fluctuation in the discount rate of T-bills is very low and it provides an assured
yield on the investment.

· The transaction cost is low. DFHI offers buying and selling rates daily. The
difference between the two rates is the transaction cost and it is found to be very
low.

2.3.2 Commercial Papers (CPs)

Commercial Papers (CPs) is a type of instrument in money market and it was
introduced in Jan 1990. Commercial paper is a short-term unsecured promissory
note issued by large corporations. They are issued in bearer forms on a discount to
face value. It issued by the corporations to raise funds for a short-term. The maturity
period ranges from 30 days to one year. CPs is negotiable by endorsement and
delivery. They are highly liquid as they have buy-back facility.

The CPs is issued in denominations of Rs. 5 lakh or multiples of Rs. 5 lakh.
Generally CPs is issued through banks, dealers or brokers. Sometimes they are
issued directly to the investors. It is purchased mostly by the commercial banks,
Non-Banking Finance Companies (NBFCs) and business organisations. CPs is
issued in domestic as well as international financial markets. In international financial
markets, they are known as Euro-commercial paper.

Features of commercial papers

The salient features of CPs are as follows:

· CPs is an unsecured promissory note.

· CPs can be issued for a maturity period of 15 days to less than one year.

· CPs is issued in the denomination of Rs.5 lakh. The minimum size of the issue is
Rs. 25 lakh.

· The ceiling amount of CPs should not exceed the working capital of the issuing
company.

The investors in CPs market are banks, individuals, business organisations and the
corporate units registered in India and incorporated units.

· The interest rate of CPs depends on the prevailing interest rate on CPs market,
forex market and call money market. The attractive rate of interest in any of these
markets, affects the demand of CPs.

· The eligibility criteria for the companies to issue CPs are as follows:

- The tangible worth of the issuing company should not be less than Rs. 4.5 Crores.

- The company should have a minimum credit rating of P2 and A2 obtained from
Credit Rating Information Services of India (CRISIL) and Investment Information and
Credit Rating Agency of India Limited. (ICRA) respectively

- The current ratio of the issuing company should be 1.33:1.

- The issuing company has to be listed on stock exchange.

Advantages of CPs

CPs is like T-Bills and is close a competitor of T-Bills, but T-Bills have an edge over
CPs because they are less risky and more easily marketable. The advantages of
CPs are as follows:

· They are negotiable by endorsement and delivery.

· Highly safe and liquid instrument – They are believed to be one of the highest
quality investment instruments available in private sectors.

· CPs facilitates security for the loans. This results in creation of secondary market
for CPs and there is efficient movement of funds providing surplus cash to cash
deficit units.

· Flexible instrument – It can be issued with varying maturities as insisted by the
issuing company.

· High returns – The CPs provide high returns when compared to the banks.

2.3.3 Certificate of Deposits (CDs)

Certificate of deposit (CDs) is a short-term instrument issued by commercial banks
and financial institutions. It is a document issued for the amount deposited in a bank
for a specified period at a specified rate of interest. The concerned bank issues a
receipt which is both marketable and transferable in the market. The receipts are in
bearer or registered form. CDs are known as negotiable instruments and they are
also known as Negotiable Certificates of Deposit. Basically they are a part of bank’s
deposit; hence they are riskless in terms of payments and principal amount. CDs are
interest-bearing, maturity-dated obligations of banks. CDs benefit both the banker
and the investor. The bankers need not encash the deposit before the maturity and
the investor can sell the CDs in the secondary market before the maturity. This
contributes to the liquidity and ready marketability for the instrument. CDs can be
issued only by the schedule banks. It is issued at discount to face value. The
discount rate depends on the market conditions. CDs are issued in the multiples of

Rs. 25 lakh and the minimum size of the issue is Rs.1 crore. The maturity period
ranges from three months to one year.

The introduction of CDs in Indian market was assessed in 1980. RBI appointed the
Vaghul Working Group to study the Indian market for five years. Based on the
suggestions of Vaghul committee; RBI formulated a scheme for the issue of CDs. As
per the scheme, CDs can be issued only by the scheduled banks at a discount rate
to face value. There is no restriction on the discount rate by the RBI.

Features of CDs in Indian market

The characteristic features of CDs in Indian money market are as follows:

· Schedule banks are eligible to issue CDs

· Maturity period varies from three months to one year

· Banks are not permitted to buy back their CDs before the maturity

· CDs are subjected to CRR and Statutory Liquidity Ratio (SLR) requirements

· They are freely transferable by endorsement and delivery. They have no lock-in
period.

· CDs have to bear stamp duty at the prevailing rate in the markets

· The NRIs can subscribe to CDs on repatriation basis

2.3.4 Bills of exchange

Bill of exchange is a financial instrument which is traded in bill market. According to
the Indian Negotiable Instruments Act, 1881, “It is a written instrument containing an
unconditional order, signed by the maker directing a certain person to pay a certain
amount of money only to, or to the order of the bearer of the instrument”. The bills of
exchange are drawn by the seller on the buyer for the value of goods delivered by
the seller. They are also known as trade bills and are accepted by commercial
banks. It is a negotiable instrument whose ownership can be conveniently changed. .
It provides legal safeguards for change in ownership. It is considered as a self-
liquidating paper. The liquidity of bills of exchange is next to call loan and T-bills.

Classification of bills of exchange

There are various types of bills of exchange in the market and they are
as follow:

· Demand bill and Usance bill – Demand bill has to be paid immediately when
payment is asked for. Demand bill has no time period for payment. Usance bill is a
bill of exchange drawn for a period of time governed by the policies of a particular
trade or between the two countries involved. It is payable at the time specified which
is at a later date.

· Inland bill – It is drawn in India and must be payable in India. It is drawn upon a
person residing in India.

· Foreign bill – It is drawn outside India. They are payable in and outside India. It is
drawn in the favour of person residing inside or outside India.

· Documentary bills – These bills are accompanied by documents related to goods
such as loading bills, railway receipts.

· Accommodation bill – An accommodation bill is a bill of exchange which is accepted
and sometimes endorsed without any receipt of monetary aid offered to the person
accommodated.

Supply bill – It is a bill made by the supplier to the government or semi government
to get advance payment for the goods supplied to them.

· Hundi – It is used by indigenous bankers to raise money, or finance to trade in India
or to remit the funds. The two types of hundi are darshani and muddati. Darshani is
used for payment of goods from the place of origination to the destination place.
Muddati is payable after the end of period and it is limited.to local places.

2.3.5 Repos and reverse repos

Repo and its structure

Repo is a money market instrument. It is a transaction in which individuals (sellers)
sell their securities to another person (buyer) with an agreement to repurchase it at a
specified date and interest rate. The transaction is repo from the viewpoint of the

seller. Repos enable collateralised short-term borrowing or lending of through sale or
purchase of debt instruments. The maturity of repos is from one to fourteen days.

The important features of Repos are:

· Repos have a low credit risk due to existence of a collateral and Subsidiary General
Ledger (SGL) mechanism.

· Interest rate risk is low as the period of lending is very short.

· Low liquidity risk as lending person has surplus funds.

· Settlement risk is small because all the transactions are settled through SGL
system and public debt office at the RBI.

Repo rate is the annual interest rate for the funds which is transferred by lender to
borrower. The repo rate is lower than the interbank loans. The factors affecting repo
rate are high credit worthiness of the borrower and low collateral loan rates when
compared to other money market instruments.

Q 3. What are the features of ADRs and GDRs?
Ans: A Depository Receipt (DR) is a versatile financial security that is traded on a
local stock exchange but it represents a security that is issued by a foreign publicly
listed company. Two of the most common types of DRs are the American Depository
Receipt (ADR) and Global Depository Receipt (GDR).

ADR is a security issued by a non-U.S. company and is traded on U.S. stock
exchanges. ADRs are issued to offer investment methods that avoid the unwieldy
laws applied to the non-citizens who buy shares on local exchanges. ADRs are listed
on NYSE, AMEX or NASDAQ.

Few advantages of ADRs are:

· ADRs are easy and cost efficient methods to buy shares in foreign companies.

· ADRs save money by reducing administration costs and avoiding foreign taxes on
the transaction.

GDRs were developed on the basis of ADRs and are listed on stock exchanges
outside US. GDRs are traded globally instead of the original shares on exchanges.
The objective of GDR is to enable investors to gain economic exposure to a planned
company in developed markets.

Features of GDRs are as follows:

· GDR holders do not have a voting right.

· It has less exchange risk as compared to foreign currency loan.

· GDR investors may cancel his receipt by advising the depository.

ADRs and GDRs are excellent means of investment for NRIs and foreign nationals
who want to invest in India. By buying these, they can invest directly in Indian
companies without going through the harassment of understanding the rules in
Indian financial market.

3.6.1 Benefits of depository receipts

The increasing demand for DRs is determined by the need of investors to diversify
their portfolios, reduce risk and invest internationally. It allows the investors to
achieve the benefits of global divergence without the added expense and
complexities of investing directly in the local trading markets.

3.6.2 Participatory notes

International entrance to Indian capital market is limited to Foreign Institutional
Investors (FIIs). The market has found a way to avoid the limitation by creating an
instrument called Participatory Notes (PNs). PNs are basically contract notes.

Indian traders buy securities and then issue PNs to foreign investors. Any dividends
or capital gains collected from the primary securities are returned back to the
investors. Any entity investing in PNs may not register with SEBI, whereas all FIIs
have to register compulsorily.

The benefits of PNs are as follows:

· Entities route their investment through PNs to extract advantage of the tax laws
system.

· It provides a high degree of secrecy, which enables large funds to carry out their
operations without revealing their identity.

· Investors use PNs to enter Indian market and shift to fully fledged FII structure
when they are established.

Q 4. Describe ERM and Classify the difference between futures
and forwards contracts.

Ans: Exchange Rate Mechanism

In the previous section we discussed about foreign exchange market, its types and
participants involved. This section deals with exchange rate mechanism.

Exchange Rate Mechanism (ERM) deals with the rate at which value of one currency
is converted into the value of another currency. For example, USD 1.00 is equal to
Indian Rs. 45.18. This is called as conversion rate. The exchange rate in the forex
market is determined by demand and supply of foreign currency. There are two
types of ERM. They are:

· Floating (flexible) exchange rate – It deals with currency exchange rates which are
determined by free markets. There is no government interference and the market
forces determine the equilibrium exchange rates. The values of the currency can be
allowed to float (decrease or increase).

· Fixed (pegged) exchange rate – In this mechanism, the value of a nation’s currency
is matched with another currency or to another measure of value like gold or basket
of currencies and if the reference value increases or decreases even the currency
pegged also changes. It helps in reducing uncertainty associated with exchange rate
fluctuations and reduces the inflationary pressures.

The various government policies towards ERM are:

· Managed float – It refers to the floating exchange rate with the participation of the
government in the market. It is also called as dirty float.

· Clean float – It deals with the exchange rate with no participation of government in
the market.

· Fixed exchange rate – It refers to the exchange rates that are fixed to some par
value though a small degree of flexibility exists.

4.3.1 Factors influencing exchange rate

The forex market consists of various tangible and intangible factors influencing
exchange rates. The factors are as follows:

· Rate of inflation between different countries – It depends upon the purchasing
power parity which states that the average value of exchange rate between the two
currencies depends upon the purchasing power. If a currency has less purchasing
power in its domestic country, then it is

considered as overvalued. Hence it will exert downward pressure in the domestic
currency. But if the currency has higher purchasing power in its domestic country, it
is considered as undervalued and an upward pressure will be exerted in local
currency.

· New exchange rate = Old exchange rate x (Initial rate of currency ÷ Final rate of
currency)

· Interest rates between different countries – The increase in interest rates
simultaneously increases foreign investments which results in higher demand for
local currency causing the exchange rates to increase.

· Balance of payments (BOP) – The relation between the balance of payments and
exchange rates can be determined by the elasticity of demand for exports and
imports. If there is deficit in the BOP, the international confidence on the currency will
be diminished and exchange rate tends to decline.

· Capital movements – The most important factors affecting the exchange rates in
today’s world economy are international investments in the form of Foreign Direct
Investments (FDI) and Foreign Institutional Investors (FII). A country like India
entices large capital inflows through foreign investments which might result in an
appreciation in the domestic currency. Cash outflow might result in depreciation in
the domestic currency.

Speculations – The speculators mainly study the country’s economic ups and downs
and its flexibility with international trade. They forecast the possible future exchange
rates based on that particular country’s economic strengths and weaknesses. If

speculators predict fall in the value of a currency in near future, they sell that
particular currency and start buying other currencies which have a greater value.

· Strength of economy – The economic fundamentals of a country must be strong so
that the domestic currency remains stable. The various factors indicating country’s
economic strength are fiscal balance, international liabilities, current account
balance, forex reserves, and inflation rate.

· Stock exchange operations – The various stock exchange operations like foreign
securities, debentures, stocks and shares influence exchange rate.

Differences between Futures and Forwards Contracts

The financial futures contract is defined as “simultaneous right and obligation to buy
or sell standard quantity of a specific financial instrument (or commodity) at a specific
future date and at a price agreed between the parties at the time the contract was
signed”. Forward Contracts are made by the bank with a customer agreeing to buy
or sell a currency at an agreed price in future.

Forward and future contracts are used in trade securities, currencies and
commodities where these contracts are set to be settled at a future date. In trading
world, these contracts work in common and are often considered as derivative
trading methods. The quoting methods are:

· Direct – In this method, the foreign exchange rate is quoted as domestic currency
per unit of foreign currency. For example, the direct quotation of exchange rate
determines euro GBP 1 is equal to INR 85.99.

· Indirect – It refers to the number of units of foreign currency required to buy one
dollar. For example, the indirect quotation of exchange rate determines INR 100 is
equal to USD 2.213.

Cross rates – The currency exchange rate between two currencies both of which are
not official currencies of the country in which the exchange rates are quoted.

But from the year 1993, all the exchanges are quoted in direct method. The two
ways of exchange quotes are determined by buying and selling price. For example, 1
USD = INR 45.16/18, the buying rate is equal to INR 45.16 and selling rate is equal
to INR 45.18. The lowest rate is called buying rate and highest rate is called selling
rate.

Differences between Futures and Forwards Contracts

Futures Contracts Forwards Contracts

In this contract, two parties make an It is an agreement with later dates of the
agreement for future transaction. company or individuals buying at a specific
price.

It mainly deals with settling of amount only Forwards are settled at the start of the
at the end of trading period with the contract trading period with a forward
settlement price. price.

The profit and loss on futures are The profit and loss are realised during the
exchanged in terms of cash every day. settlement period in order to increase
credit exposure.

The receiver of delivery is not known. It clearly specifies the receiver of delivery.

Most of futures contracts are highly The forwards contracts are personalised
standardised. and unique.

It is traded on an exchange. It is traded Over the Counter (OTC).

Q5. Explain the process of risk management and various tools
involved in managing risks

Ans: Processes of risk management.

Risk management acts as an internal part of business planning. The process of risk
management consists of generic steps in order to guide the organisation to achieve
success with managing exposures. The basic steps of risk management process
are:

· Establishing the context – It is the process of analysing the strategic and
organisational context under which the risks occur. This helps in planning the
implementation of relevant measures to mitigate the occurring risks.

· Identifying risks – The organisations are associated with variety of risks that hinders
in achieving the targets. It is important to define the type of risks associated with
business operations. This will provide the organisation to have a fundamental
understanding of the activities from which the risk originated and hence enables to
assess the magnitude of the risk. It also involves identifying the affecting
stakeholders.

· Quantifying risks – It consists of measuring the probability and frequencies of the
risks. It also involves assessing the consequences of the occurring risks. The
consequences may involve economic, political and social factors causing risks.

· Formulating policy – The formulation of policy provides a framework to handle risks.
It provides standard levels of exposures to protect cash flows in the organisation.
Policy framing depends on organisation’s objectives and its risk tolerance levels.

· Evaluating risk – It involves the process of ranking the risks based on tolerance
level. By this, the organisation will be able to prioritise the risk category and related
consequences and the overall cost for mitigating the risk.

· Treating risk – This process involves development and implementation of a plan
with specific methods to handle the identified risk by considering strategic and
operational risk priorities, stakeholders involved and the consequences.

· Monitor and review risk – The methods applied to manage risks are monitored
regularly due to the changing environment in the investment levels. Hence it requires
restoring the target levels based on the assumptions and decisions concerning the
changes with respect to business environment, government policies. These policies
and decisions are reviewed regularly.

Tools available for managing risks

The risk management tools forecasts the analysis and implementation of various
methods in order to mitigate risks. It includes several systems and models that
enhance correlation of risks and returns across investments and support portfolio
management process. The major tools available for risk management are:

· Failure Mode Effects Analysis (FMEA) – This tool is used for identifying the cost of
potential failures in the business operations. This method can be applied during
analysis and design phases of the business operations which help in identifying the
significant failures caused by risk. The FMEA method is divided into three steps:

-The first step includes the process of identifying the elements causing failure.

-Once the elements are identified, it concentrates on the mode of failure.

-The last step includes assessing the probability of the effects of failure.

Process Decision Program Chart (PDPC) – The tool identifies the different levels of
risk and the countermeasure tasks. The process of planning is essential before the
tool is used for measuring risks. It includes identifying the element causing risk. The
next process consists of identifying the context of problem and measures to reduce
risks.

Risky calculations – This method of managing risk includes the process of
continuous scanning of the risk at various phases in the business operations. It is the
process of calculating the most occurring risks. These are identified by the priorities
given to the risks during their occurrence with respect to its severity. Hence the risk

management authority processes on the high priority risk by calculating the risk
exposure. This calculation is obtained by the following methods:

- Risk exposure – The probability of the risk occurrence and total loss to the
organisation provides the overall exposure of specific risk.

Risk Exposure, RE = Probability of occurring risk x Total loss due to risk

- Risk reduction leverage (RRL) – The value of the return on investment for
countermeasures is obtained. The reduction in the risk exposure and cost of
countermeasure helps in prioritising the possible countermeasures.

RRL = Reduction in Risk Exposure ÷ Cost of countermeasure

Managing risk – Once the risks are identified and calculated the following processes
are performed to mitigate risk. This process is less in terms of cost and choosing the
best plan can avoid risk exposures and provides a better action to perform. It
includes the stages of identifying the risk and choosing plans to avoid, or reduce risk.
If the method avoiding is considered, the risk management chooses the alternative
actions to counterpart the risk else if it is reduction method, then it changes the
current action by adding new action to reduce the risk. The contingency planning
depends upon the risk exposure and reduction leverage.

Insurance – It is the most common risk management tool used in organisations. The
insurance can be applied to any physical property like equipment in the organisation
in order to recover from the loss occurred due to damages. The risk management
can prior analyse the risks causing damages to the organisation and formulates
insurance policy during any losses to the organisation.

· Fault Tree Analysis (FTA) – The tool is used as a deductive technique to analyse
the reliability and safety in the organisation. It is usually implemented for dynamic
systems. It provides the foundation for analysis process and justification for
implemented changes and additions of various actions to reduce risks.

In this section we discussed the management of risks and various processes and
tools involved in managing risks. The next section deals with the quantitative risk
measurement.

Q 6. Explain the Framework for measuring and managing the
liquidity risks.

Ans: Measuring Liquidity Risk

The earlier section dealt with the risks associated with liquidity, now let us focus on
the measurement of liquidity. The framework for measuring and managing the
liquidity risk can be divided into three dimensions. They are:

· Measuring and managing net funding requirements.

· Managing market access.

· Contingency planning.

Measuring and managing Net Funding Requirement (NFR)

Net Funding Requirement (NFR) of an organisation depends on the liquidity situation
of IISF that relates to their clients, also calculating the cumulative net excess over
the time interval for the liquidity taxation.

This analysis is nothing but constructing a maturity ladder and then calculating a
cumulative net excess or shortage of funds at particular maturity dates.

Maturity ladder

A bank‘s future cash inflows are compared with the future cash outflows over a
series of definite time periods via a maturity ladder. These cash flows arise due to
assets that have already crossed their maturity dates, other non-maturing saleable
assets and tapped credit lines that are well established. The cash outflow consists of
contingent liabilities and liabilities falling due, especially devoted lines of credit that
can be drawn down. The maturity ladder is represented by comparing sources and
sum of currency inflows and sources and sum of currency outflows.

The two simple ways to measure liquidity are:

· Stock approach

· Flow approach

Stock approach

The stock approach is the first step in the evaluation of liquidity. Under this method,
liquidity is treated as stock. By comparing items on the balance-sheet this method
aims at determining the bank’s ability to use its short term debts as a measure of
liquid assets that can be used for other purposes.

Under this method certain ratios, like liquid assets, short term liabilities, purchased
funds to total assets and others are calculated and compared to the targets that a
bank has set for itself. Though the stock approach is useful in determining the
liquidity from one aspect, it does not reveal the essential liquidity profile of a bank.

Flow approach

The flow approach predicts liquidity at different points of time. It looks at the liquidity
requirements for a minimum of 15 days. Next it consults the maturity ladder and
tracks the cash flow mismatches over a series of specified time periods.

It aims at safe-guarding the ability of the firm in meeting its repayment commitments
(like funding risk), calculating and limiting the liquidity maturity transformation risk
based on figures obtained from measured liquidity risk.

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