Treasury Management An Introduction

Treasury Management

An Introduction to

Forex & Derivatives

First Edition

Raj Kumar Sharma

Copyright Page: Treasury Management - An Introduction

Copyright © [2023] [Raj Kumar Sharma]

All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law.

Title: Treasury Management - An Introduction

Author: Raj Kumar Sharma

ISBN:

First Edition:2023

Cover Design: Raj Kumar Sharma

Disclaimer: The information contained in this book is for general informational purposes only. While the author has made every effort to ensure the accuracy and completeness of the content, they make no representations or warranties, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the book or the information, products, services, or related graphics contained in the book for any purpose. Any reliance you place on such information is therefore strictly at your own risk.

The book is not intended to provide specific financial, legal, or professional advice. Readers are encouraged to seek the counsel of qualified professionals for advice regarding their specific financial or business situations.

Any unauthorized use, reproduction, or distribution of this book may violate copyright laws and result in legal action. For permissions or inquiries, please contact:

Raj Kumar Sharma

Raj462001@gmail.com

Preface

Welcome to the fascinating world of Treasury Management! In this dynamic financial landscape, the effective management of treasury functions has never been more crucial for organizations seeking to thrive in a constantly evolving global economy. As financial markets become increasingly interconnected and complex, the art of treasury management, including derivatives, options, bonds, and risk mitigation, offers a vital compass to navigate the seas of uncertainty and opportunity, avoiding the pitfalls of past financial debacles.

This book serves as a comprehensive and accessible introduction to the fundamentals of Treasury Management, encompassing a diverse range of financial instruments and strategies. Whether you are a seasoned finance professional looking to deepen your expertise or a newcomer eager to grasp the essentials, the contents within these pages are tailored to cater to your needs.

The primary objective of this book is to demystify Treasury Management concepts and empower readers with the knowledge and tools to make informed decisions. We will explore the core functions and responsibilities of treasury departments within organizations, emphasizing the importance of prudent cash and liquidity management, efficient working capital practices, and strategic risk mitigation through derivatives and options.

As we embark on this journey, we will delve into the world of bonds, understanding their role in financing operations and managing debt. Bonds, being a cornerstone of fixed income markets, are critical instruments that treasury professionals must master to optimize an organization's funding strategies and debt portfolio.

Risk mitigation lies at the heart of treasury management, and we will explore various methodologies to identify, measure, and manage financial risks. Whether it's market risk, credit risk, or liquidity risk, we will investigate the tools at a treasury's disposal to safeguard financial stability and ensure business continuity.

Throughout the book, we will also explore the exciting realm of money markets, where short-term borrowing and lending of funds occur. Understanding money market instruments and the intricacies of short-term cash management is crucial for treasury professionals to ensure an organization's liquidity needs are met efficiently.

The lessons of past financial debacles have taught us the importance of sound treasury management practices. As we progress through this book, we will draw from historical events, analyzing the consequences of inadequate treasury risk management and the role of financial derivatives in amplifying systemic risks.

Although this book is titled an Introduction, it aspires to be more than just a starting point. As treasury management continues to evolve, the pursuit of knowledge and refinement of skills become lifelong endeavors. We encourage readers to use this book as a stepping stone towards a deeper understanding of treasury management, including derivatives, options, bonds, and risk mitigation, and as a gateway to a continuous learning journey.

Finally, I extend my heartfelt appreciation to all those who have contributed to the development of this book. The collective wisdom and experience of treasury professionals worldwide have shaped the ideas and insights presented here. I am immensely grateful for their dedication to the field of finance and their commitment to sharing knowledge.

As you embark on this exploration of Treasury Management, I hope you find inspiration and a newfound appreciation for the art and science of managing financial resources, while learning from the lessons of the past to navigate a prosperous and resilient financial future.

Wishing you an enlightening and enriching journey into Treasury Management!

Raj Kumar Sharma

Preface

Introduction to treasury management

Treasury management for banks

Overview of treasury functions

Cash Management

Cash Forecasting

Data Collection

Collaboration

Scenario Planning

Review and Adjustment

Liquidity Management

Working Capital Management

Debt Management

Cash Concentration and Pooling

Investment Management

Financial Markets

Primary Market

Investment Bank / Underwriter

Registrar of the Issue

Banker to the Issue

IPO Process

Secondary Market

Over-The Counter Market

Types of Financial Instruments

Equity

Common Equity

Rights Issue / Rights Shares

Bonus Share

Preference Share

Cumulative Preference Shares

Cumulative convertible preference shares

Participating Preference Share

American Depository Receipt

Global Depository Receipt

Security Receipt

Government securities (G-Secs)

Debentures

T-Bill

Commercial Paper

Repurchase Agreement (Repo)

Bond

Zero Coupon Bond

Convertible Bond

High-Yield Bond

Floating Rate Bond

Perpetual Bond

Asset-Backed Securities (ABS)

Organizational Structure

Front Office

Mid Office

Back Office

Foreign Exchange Market

Spot rate

Cash rate

Tom rate

Forward rate

Forward Contract

For the Indian exporter (Purchase Contract):

For the Indian importer (Sell Contract):

Factor affecting foreign exchange rates

Interest rate differential

Inflation

Economic Performance

GDP growth rate

Industrial production

Non-farm payrolls

Balance of trade

Export and import growth

Unemployment rate

Social & Political Influences

Government Intervention

Free-Float vs Pegged Exchange Rate

Free-Float

Pegged Exchange Rate

Managed Float

Crawling Peg

Risk is foreign exchange

Exchange Rate Risk

Country Risk

Political Risk

Settlement Risk

Pre-Settlement Risk

Economic Risk

Translation Risk

Credit Risk

Leverage Risk

Liquidity Risk

Interest Rate Risk

Operational Risk

Open Position

Gap Risk

Correspondent Relationship

Nostro Account

Vostro Account

Loro Account

Derivative

Future Contracts

Forward Contract

Options

American Options

European Options

Call options

Put options

Option Selling

At the Money Option

In the Money Option

Out of Money Option

Option Pricing

Option Structures

Range Forward

Ratio Range Forward

Zero Cost Range Forward

Call Spread

Bull Call Spread

Bear Call Spread

Put Spread

Seagull

Butterfly Spread

Straddle

Interest Rate Swaps

Forward Rate Agreements

Interest Rate Futures

Interest Rate Options

Principal Only Swap or Currency Swap

Money Market

Treasury Bills

Commercial Paper

Call Money

Notice Money & Term Money

Certificate of Deposit

Inter Bank Participation Certificate

CBLO

Repo & Reverse Repo

Eurodollar Deposits

Floating rate note

Foreign Currency Loans

International Trade Credits

Pre-Shipment Credit

Post-Shipment Credit

Buyers Credit

Suppliers Credit

External Commercial Borrowings (ECBs)

Foreign Currency Convertible Bonds (FCCBs)

Foreign Currency Exchangeable Bonds (FCEB)

Loans Syndication

Foreign Currency Loan by Domestic Bank

Equity Market

Importance of Treasury Risk Management

Nick Leeson

Jerome Kerviel

John Rusnak

Toshihide Iguchi

The Great Depression (1929-1933)

The Subprime Mortgage Crisis

European Debt Crises

About the author

Other books by the author

Balance Sheet Analysis

Ratio Analysis

Export Business- A Beginner's Guide

My Choice My Life

Bull’s Eye- An Investment Guide for Beginners

Destination-Beyond Frontiers

Declaration

Introduction to treasury management

Treasury management refers to the process of managing a company's financial resources to achieve its objectives, which can include maximizing liquidity, managing financial risk, and optimizing returns.

The treasury function is responsible for overseeing a company's cash and financial instruments, such as investments, debt, and foreign currency exposure.

At its core, treasury management is about managing a company's cash flows to ensure it has sufficient funds to meet its obligations and invest in growth opportunities. This involves monitoring and forecasting cash flows, investing excess cash in short-term instruments, and ensuring access to credit facilities when needed.

In addition to managing cash flows, treasury management also involves managing financial risks such as interest rate risk, foreign exchange risk, and credit risk. This involves developing strategies to mitigate these risks through hedging or other risk management techniques.

Treasury management is crucial for businesses of all sizes and across all industries. Without effective treasury management, a company may be exposed to liquidity shortages, financial risks, and missed investment opportunities.

By managing its financial resources effectively, a company can improve its financial stability and profitability.

In order to effectively manage treasury operations, companies often employ specialized professionals with expertise in areas such as cash management, risk management, and financial analysis. These professionals work closely with senior management to develop and implement treasury policies and strategies that support the company's overall goals and objectives.

Treasury management for banks

Treasury management for banks involves the effective management of the bank's cash flows, investments, and financial risks to optimize returns and maintain financial stability. It includes activities such as cash management, liquidity management, investment management, financial risk management, and funding and capital management.

The goal of treasury management for banks is to ensure that the bank has sufficient liquidity to meet its obligations, invest its excess cash to generate returns, manage financial risks such as interest rate risk and foreign exchange risk, and optimize its funding and capital structure to support business growth.

Effective treasury management for banks requires specialized knowledge and expertise, as well as close collaboration with other departments within the bank, such as finance, accounting, and risk management.

The Reserve Bank of India (RBI) also provides guidelines and regulations for treasury operations for banks to ensure compliance with regulatory requirements and promote financial stability.

Overview of treasury functions

The importance of treasury management can be summarized as follows:

Liquidity management: It’s very important for any organization be it a manufacturing concern or a financial institution like bank to maintain its liquidity position in control. Liquidity refers to the ability of a company to meet its short-term obligations. Thus, it has to keep adequate amount of cash or cash equivalent securities / investments which can be easily converted to cash to meet the day-to-day requirement of operational payments or repayments.

To maintain adequate level of liquidity, role of treasury is very crucial. It is the responsibility of treasury to invest funds in such a manner that it can fetch higher returns but at the same time is available for meeting short term requirements.

Thus, a treasury has to keep a balance between its investment choices and the company’s cash requirement. It cannot keep excess amount in cash or cash equivalent as the return generation from cash is zero and cash equivalent will be much less in comparison to other investment avenues. Thus, Treasury uses various risk mitigation tools to generate higher returns at the same time keep the liquidity position in check.

Cash flow analysis is an important tool to ascertain the short-term cash requirement.

Cash management: Managing cash flows is a critical aspect of treasury management. It involves optimizing cash flows to ensure that the business has sufficient liquidity to meet its obligations, such as paying suppliers and employees, while minimizing idle cash balances. Cash forecasting and liquidity management are the roles directly connected with treasury.

Investment management: Effective treasury management involves investing excess cash in financial instruments to generate returns while maintaining liquidity. The investment portfolio may include short-term securities, money market funds, and other financial instruments.

Financial risk management: Treasury management helps businesses and financial institutions to manage various financial risks such as interest rate risk, foreign exchange risk, and credit risk. These risks can have a significant impact on the financial performance of the business, and effective risk management can help mitigate these risks.

Funding and capital management: Treasury management helps businesses and financial institutions to optimize their funding and capital structure to support business growth. This includes managing the cost