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TREASURY MANAGEMENT FULL OVERVIEW

TREASURY MANAGEMENT FULL OVERVIEW

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  • 1. IBS BUSINESSIBS BUSINESS SCHOOL,MUMBAISCHOOL,MUMBAI RISK MANAGEMENTRISK MANAGEMENT MODULEMODULE 11 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 2. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 3. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 4. RISK MANAGEMENTRISK MANAGEMENT Module C-TreasuryModule C-Treasury ManagementManagement  Treasury ProductsTreasury Products  Treasury Risk ManagementTreasury Risk Management  Derivative ProductsDerivative Products 44 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 5. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 6. TreasuryTreasury Function Responsible for Front office Dealing Mid-Office Risk management, accounting and management information Back office Confirmations, settlement and reconciliation 66 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 7. FRONT OFFICE BACK OFFICEMID OFFICE Dealing MIS settlement 77 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 8. TreasuryTreasury 88 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 9. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 10. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 11. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 12. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 13. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 14. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 15. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 16. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 17. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 18. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 19. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 20. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 21. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 22. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 23. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 24. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 25. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 26. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 27. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 28. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 29. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 30. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 31. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 32. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 33. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 34. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 35. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 36. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 37. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 38. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 39. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 40. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 41. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 42. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 43. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 44. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 45. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 46. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 47. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 48. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 49. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 50. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 51. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 52. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI
  • 53. 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 Rahul Pagaria,12BSP2409 IBSRahul Pagaria,12BSP2409 IBS BUSINESS SCHOOL MUMBAIBUSINESS SCHOOL MUMBAI

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