INDIAN INSTITUTE OF

BANKING & FINANCE

RISK MANAGEMENT
 RISK MANAGEMENT
Module C-Treasury
Management

 Treasury Products
 Treasury Risk Management
 Derivative Products
 Integrated Treasury
 Integrated Treasury refers to integration of
money market, securities market and foreign
exchange operations.
-Meeting reserve requirements
-Efficient merchant services
-Global cash management
-Optimizing profit by exploiting market
opportunities in forex market, money market
and securities market
-Risk management
-Assisting bank management in ALM
 Treasury
Function Responsible for

Front Dealing
office
Mid- Risk management,
Office accounting and
management
information
Back Confirmations,
office settlement and
reconciliation
 FRONT OFFICE

Dealing

MID OFFICE BACK OFFICE

settlement
MIS
Treasury
 Money Market
 Certificate of Deposit (CD)
 Commercial Paper (C.P)
 Inter Bank Participation Certificates
 Inter Bank term Money
 Treasury Bills
 Call Money
 Certificate of Deposit
 CDs are short-term borrowings in the form of
Usance Promissory Notes having a maturity of
not less than 15 days up to a maximum of one
year.
 CD is subject to payment of Stamp Duty under
Indian Stamp Act, 1899 (Central Act)
 They are like bank term deposits accounts.
Unlike traditional time deposits these are freely
negotiable instruments and are often referred to
as Negotiable Certificate of Deposits
 Features of CD
 CDs can be issued by all scheduled commercial
banks except RRBs
 Minimum period 15 days
 Maximum period 1 year
 Minimum Amount Rs 1 lac and in multiples of
Rs. 1 lac
 CDs are transferable by endorsement
 CRR & SLR are to be maintained
 CDs are to be stamped
 Commercial Paper
 Commercial Paper (CP) is an unsecured
money market instrument issued in the
form of a promissory note.
 Who can issue Commercial Paper
(CP)
Highly rated corporate borrowers, primary
dealers (PDs) and satellite dealers (SDs)
and all-India financial institutions (FIs)
Eligibility for issue of CP

a) the tangible net worth of the company, as per the latest

audited balance sheet, is not less than Rs. 4 crore;
b) (b) the working capital (fund-based) limit of the
company from the banking system is not less than Rs.4
crore
c) and the borrowal account of the company is classified
as a Standard Asset by the financing bank/s.
 Rating Requirement
 All eligible participants should obtain the credit
rating for issuance of Commercial Paper
 Credit Rating Information Services of India Ltd.
(CRISIL)
 Investment Information and Credit Rating Agency
of India Ltd. (ICRA)
 Credit Analysis and Research Ltd. (CARE)
 Duff & Phelps Credit Rating India Pvt. Ltd. (DCR
India)
 The minimum credit rating shall be P-2 of CRISIL
or such equivalent rating by other agencies
 Maturity
CP can be issued for maturities between a
minimum of 15 days and a maximum upto
one year from the date of issue.
 If the maturity date is a holiday, the
company would be liable to make payment
on the immediate preceding working day.
 To whom issued
CP is issued to and held by individuals,
banking companies, other corporate
bodies registered or incorporated in India
and unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional
Investors (FIIs).
 Repo
 Uses of Repo
It helps banks to invest surplus cash
It helps investor achieve money market returns
with sovereign risk.
It helps borrower to raise funds at better rates
An SLR surplus and CRR deficit bank can use the
Repo deals as a convenient way of adjusting
SLR/CRR positions simultaneously.
RBI uses Repo and Reverse repo as instruments
for liquidity adjustment in the system
 Meaning of Repo
 It is a transaction in which two parties agree to sell
and repurchase the same security. Under such an
agreement the seller sells specified securities with
an agreement to repurchase the same at a
mutually decided future date and a price
 The Repo/Reverse Repo transaction can only be
done at Mumbai between parties approved by RBI
and in securities as approved by RBI (Treasury
Bills, Central/State Govt securities).
 Coupon rate and Yield
The difference between coupon rate and
yield arises because the market price of a
security might be different from the face
value of the security. Since coupon
payments are calculated on the face
value, the coupon rate is different from
the implied yield.
 Example
 10% Aug 2015 10 year Govt Bond
 Face Value RS.1000
 Market Value Rs.1200
 In this case Coupon rate is 10%
 Yield is 8.33%
 Call Money Market
The call money market is an integral part of
the Indian Money Market, where the day-
to-day surplus funds (mostly of banks) are
traded. The loans are of short-term
duration varying from 1 to 14 days.
The money that is lent for one day in this
market is known as "Call Money", and if it
exceeds one day (but less than 15 days) it
is referred to as "Notice Money".
 Call Money Market
Banks borrow in this market for the
following purpose
 To fill the gaps or temporary mismatches
in funds
 To meet the CRR & SLR mandatory
requirements as stipulated by the Central
bank
 To meet sudden demand for funds arising
out of large outflows.
 Factors influencing interest
rates
The factors which govern the interest rates are
mostly economy related and are commonly
referred to as macroeconomic factors. Some of
these factors are:
1) Demand for money
2) Government borrowings
3) Supply of money
4) Inflation rate
5) The Reserve Bank of India and the Government
policies which determine some of the variables
mentioned above.
 Gilt edged securities

The term government securities encompass all

Bonds & T-bills issued by the Central
Government, and state governments. These
securities are normally referred to, as "gilt-
edged" as repayments of principal as well as
interest are totally secured by sovereign
guarantee.
 Treasury Bills
Treasury bills, commonly referred to as T-Bills
are issued by Government of India against their
short term borrowing requirements with
maturities ranging between 14 to 364 days.
All these are issued at a discount-to-face value.
For example a Treasury bill of Rs. 100.00 face
value issued for Rs. 91.50 gets redeemed at the
end of it's tenure at Rs. 100.00.
 Who can invest in T-Bill

Banks, Primary Dealers, State

Governments, Provident Funds, Financial
Institutions, Insurance Companies, NBFCs,
FIIs (as per prescribed norms), NRIs &
OCBs can invest in T-Bills.
What is auction of Securities
Auction is a process of calling of bids with
an objective of arriving at the market
price. It is basically a price discovery
mechanism
 Debenture
 A Debenture is a debt security issued by a
company (called the Issuer), which offers
to pay interest in lieu of the money
borrowed for a certain period.
 These are long-term debt instruments
issued by private sector companies. These
are issued in denominations as low as Rs
1000 and have maturities ranging
between one and ten years.
Difference between debenture and
bond
Long-term debt securities issued by the
Government of India or any of the State
Government’s or undertakings owned by
them or by development financial
institutions are called as bonds.
Instruments issued by other entities are
called debentures.
 Current yield

This is the yield or return derived by the investor

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

 Primary Dealers can be referred to as Merchant

Bankers to Government of India, comprising the
first tier of the government securities market.
Satellite Dealers work in tandem with the Primary
Dealers forming the second tier of the market to
cater to the retail requirements of the market.
 These were formed during the year 1994-96 to
strengthen the market infrastructure
What role do Primary Dealers
play?
The role of Primary Dealers is to;
(i) commit participation as Principals in
Government of India issues through
bidding in auctions
(ii) provide underwriting services
(iii) offer firm buy - sell / bid ask quotes
for T-Bills & dated securities
(v) Development of Secondary Debt
Market
 OMO
 OMO or Open Market Operations is a
market regulating mechanism often
resorted to by Reserve Bank of India.
Under OMO Operations Reserve Bank of
India as a market regulator keeps buying
or/and selling securities through it's open
market window. It's decision to sell or/and
buy securities is influenced by factors such
as overall liquidity in the system,
 YIELD CURVE

 The relationship between time and yield

on a homogenous risk class of securities is
called the Yield Curve. The relationship
represents the time value of money -
showing that people would demand a
positive rate of return on the money they
are willing to part today for a payback into
the future
 SHAPE OF YIELD CURVE
A yield curve can be positive, neutral or flat. A positive
yield curve, which is most natural, is when the slope of
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
results, as people demand higher compensation for
parting their money for a longer time into the future. A
neutral yield curve is that which has a zero slope, i.e. is
flat across time. T his occurs when people are willing to
accept more or less the same returns across maturities.
The negative yield curve (also called an inverted yield
curve) is one of which the slope is negative, i.e. the long
term yield is lower than the short term yield
 LIBOR

 LIBOR stands for the London Interbank Offered

Rate and is the rate of interest at which banks
borrow funds from other banks, in marketable
size, in the London interbank market.
 LIBOR is the most widely used "benchmark" or
reference rate for short term interest rates. It is
compiled by the British Bankers Association as a
free service and released to the market at about
11.00[London time] each day.
 CRR & SLR
The minimum and maximum levels of CRR are
prescribed at 3% and 20% of demand and term
liabilities (DTL) of the bank, respectively, under
Reserve Bank of India Act of 1934. The
minimum and maximum SLR are prescribed at
25% and 40% of DTL respectively, under
Banking Regulation Act of 1949. The CRR and
SLR are to be maintained on fortnightly basis.
The RBI is authorized to increase or decrease
the CRR and SLR at its discretion.
 Demand and Time Liabilities
Main components of DTL are:
 Demand deposits (held in current and savings accounts,
margin money for LCs, overdue fixed deposits etc.)
 Time deposits (in fixed deposits, recurring deposits,
reinvestment deposits etc.)
 Overseas borrowings
 Foreign outward remittances in transit (FC liabilities
net of FC assets)
 Other demand and time liabilities (accrued interest,
credit balances in suspense account etc. )
 SLR
SLR is to be maintained in the form of the
following assets:
 Cash balances (excluding balances
maintained for CRR)
 Gold (valued at price not exceeding
current market price)
 Approved securities valued as per norms
prescribed by RBI.
 VaR
Value at Risk (VaR) is the most probable loss
that we may incur in normal market conditions
over a given period due to the volatility of a factor,
exchange rates, interest rates or commodity prices.
The probability of loss is expressed as a
percentage – VaR at 95% confidence level, implies
a 5% probability of incurring the loss; at 99%
confidence level the VaR implies 1% probability of
the stated loss. The loss is generally stated in
absolute amounts for a given transaction value (or
value of a investment portfolio).
 VaR
The VaR is an estimate of potential loss, always for a given
period, at a given confidence level.. A VaR of 5p in USD /
INR rate for a 30- day period at 95% confidence level
means that Rupee is likely to lose 5p in exchange value
with 5% probability, or in other words, Rupee is likely to
depreciate by maximum 5p on 1.5 days of the period
(30*5% ) . A VaR of Rs. 100,000 at 99% confidence level
for one week for a investment portfolio of Rs. 10,000,000
similarly means that the market value of the portfolio is
most likely to drop by maximum Rs. 100,000 with 1%
probability over one week, or , 99% of the time the
portfolio will stand at or above its current value.
 Exchange Rate Quotation
 Exchange Quotations :
There are two methods
 Exchange rate is expressed as the price per unit of
foreign currency in terms of the home currency is known
as the “Home currency quotation” or “Direct Quotation”
 Exchange rate is expressed as the price per unit of home
currency in terms of the foreign currency is known as
the “Foreign Currency Quotation” or “Indirect Quotation”
 Direct Quotation is used in New York and other foreign
exchange markets and Indirect Quotation is used in
London foreign exchange market.
 Principles
 Direct Quotation: Buy Low, Sell High:
 The prime motive of any trader is to make profit. By
purchasing the commodity at lower price and selling it at
a higher price a trader earns the profit. In foreign
exchange, the banker buys the foreign currency at a
lesser price and sells it at a higher price.
 Indirect Quotation: Buy High, Sell Low:
 A trader for a fixed amount of investment would acquire
more units of the commodity when he purchases and for
the same amount he would part with lesser units of the
commodity when he sells.
Spot and Forward Transactions

 ‘A’ Bank agrees to buy from ‘B’ Bank USD

100000. The actual exchange of currencies
i.e. payment of rupees and receipt of US
Dollars, under the contract may take place :
 on the same day or
 two days later or
 some day later, say after a month.
 Interpretation of Quotation
 The market quotation for a currency consists of
the spot rate and the forward margin. The
outright forward rate has to be calculated by
loading the forward margin into the spot rate.
For example US Dollar is quoted as under in the
inter-bank market on a given day as under :
 Spot 1 USD = Rs.44.1000/1300
 Spot/November 0200/0500
 Spot/December 1500/1800
 TT Buying Rate
 TT Buying Rate (TT stands for Telegraphic
Transfer)
 This is the rate applied when the transaction
does not involve any delay in realization of the
foreign exchange by the bank. In other
words, the nostro account of the bank would
already have been credited. The rate is
calculated by deducting from the inter-bank
buying rate the exchange margin as
determined by the Bank.
 Bills Buying Rate

 This is the rate to be applied when a

foreign bill is purchased. When a bill is
purchased, the proceeds will be realized
by the Bank after the bill is presented to
the drawee at the overseas center. In the
case of a usance bill the proceeds will be
realized on the due date of the bill which
includes the transit period and the usance
period of the bill.
 Problem
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 ?
 Solution
This is an example Forward Sale Contract .
Inter Bank Spot Selling Rate Rs. 45.8600
Add Forward Margin .5450
--------------
46.4050
Add Exchange Margin .0580
---------------
Forward Rate 46.4630
Rounded Off to multiple of 25 paise Rs.46.4625
Amount Payable to the bank Rs.46,46,250
 Swap
 A swap agreement between two parties
commits each counterparty to exchange
an amount of funds, determined by a
formula, at regular intervals, until the
swap expires.
 In the case of a currency swap, there is an
initial exchange of currency and a reverse
exchange at maturity.
 Mechanics
 Firm A needs fixed rate loan –AAA rated
 Firm B needs floating rate -A rated
 Firm A enjoys an absolute advantage in
both credit markets.
Firm A Firm B
Fixed-
rate 9% 11%
finance
Floating- LIBOR LIBOR
rate
finance +0.0% +1%
 Mechanics
STEP !
Firm A will borrow at Fixed rate 9%
Firm B will borrow at floating rate (LIBOR +1)%
STEP 2
Firm A will pay Floating rate [LIBOR] to Firm B
Firm B will Pay Fixed rate [9.5%] only

Gain
Net interest cost LIBOR- .5%
Net Interest cost 9+[ 1%+0.5%]=10.5%
 Mechanics
Interest payments to each
Gain other in years t 1 to t 7.

A B
9.5%
Borrows at Borrows at
9.0% LIBOR + 1%
fixed LIBOR floating
for 7 years for 7 years