SMU         ASSIGNMENT         SEMESTER – 4             MA0042SUBMITTED BY:DEVESH NIDARIA (MBA)ROLLNO:-581125616
Q 1. Explain treasury management, its need and benefits andtreasury exposure.Ans: Treasury management is the process of pl...
· The expanding range of hybrid capital instruments like convertible preferenceissued with respect to subsidiary registrat...
· The treasury management system advises the organisation management onaspects of liquidity of its short and long term pla...
identification of existing potential currency relationship that arises from businessactivities includes hedging and other ...
Q 2 Classify various money market instruments.Ans: Money Market InstrumentsIn the previous section, we discussed about mon...
Features of T-bills are as follows:· T-bills are highly liquid as the RBI provides a ready market. Institutions like STCI,...
· 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 lak...
Advantages of CPsCPs is like T-Bills and is close a competitor of T-Bills, but T-Bills have an edge overCPs because they a...
Rs. 25 lakh and the minimum size of the issue is Rs.1 crore. The maturity periodranges from three months to one year.The i...
Classification of bills of exchangeThere are various types of bills of exchange in the market and they areas follow:· Dema...
seller. Repos enable collateralised short-term borrowing or lending of through sale orpurchase of debt instruments. The ma...
GDRs were developed on the basis of ADRs and are listed on stock exchangesoutside US. GDRs are traded globally instead of ...
· Entities route their investment through PNs to extract advantage of the tax lawssystem.· It provides a high degree of se...
Q 4. Describe ERM and Classify the difference between futuresand forwards contracts.Ans: Exchange Rate MechanismIn the pre...
4.3.1 Factors influencing exchange rateThe forex market consists of various tangible and intangible factors influencingexc...
speculators predict fall in the value of a currency in near future, they sell thatparticular currency and start buying oth...
But from the year 1993, all the exchanges are quoted in direct method. The twoways of exchange quotes are determined by bu...
Q5. Explain the process of risk management and various toolsinvolved in managing risksAns: Processes      of risk manageme...
· Monitor and review risk – The methods applied to manage risks are monitoredregularly due to the changing environment in ...
management authority processes on the high priority risk by calculating the riskexposure. This calculation is obtained by ...
In this section we discussed the management of risks and various processes andtools involved in managing risks. The next s...
Q 6. Explain the Framework for measuring and managing theliquidity risks.Ans: Measuring Liquidity RiskThe earlier section ...
The two simple ways to measure liquidity are:· Stock approach· Flow approachStock approachThe stock approach is the first ...
Upcoming SlideShare
Loading in …5
×

Ma0042

461 views

Published on

  • Be the first to comment

  • Be the first to like this

Ma0042

  1. 1. SMU ASSIGNMENT SEMESTER – 4 MA0042SUBMITTED BY:DEVESH NIDARIA (MBA)ROLLNO:-581125616
  2. 2. Q 1. Explain treasury management, its need and benefits andtreasury exposure.Ans: Treasury management is the process of planning, organising and managing theorganisation’s holdings, trading’s, corporate bonds, currencies, financial futures,associated risks, options, derivatives, and payment systems. It handles all thefinancial matters including external and internal funds for business, complexstrategies, and procedures of corporate finance to optimise interest and currencyflows. It helps in planning and executing communication programmes to enhanceinvestors’ confidence in the organisation.According to Teigen Lee E (July 2001), “Treasury is the place of deposit reserved forstoring treasures and disbursement of collected funds”. The responsibility of treasurymanagement lies with the Chief Financial Officer (CFO) of the organisation. TheCFO’s responsibilities include capital and risk management, planning strategies,investor relations and financial reporting. In large organisations, theseresponsibilities are divided among the accounting and treasury sectors. Hence theworkflow between these two sectors must be ethical.NeedTreasury management is mainly required to optimise the economy of theorganisation and provide an ability to manage financial risks.Treasury management is important for the following reasons:· The development in technology, breakdown of exchange controls, unpredictablechanges in interest and exchange rates, and globalisation of businesses requirestreasury management.· To actively manage financial environment, organisations require treasurymanagement that provides the ability to undertake business opportunities and theirexposure to risks.
  3. 3. · The expanding range of hybrid capital instruments like convertible preferenceissued with respect to subsidiary registration of the government need treasurymanagement 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 includeshareholders, fund lenders and taxation authorities.· The treasury management acts as a centralised head office in the organisation andprovides financial service to various departments and enhances the financial growthin the organisation.BenefitsFew benefits of treasury management are:· Implementation of treasury management in the organisation increases sales of theproducts.· It helps in providing confident employees who work effectively in the organisation.· It enhances better guidelines and methods to manage risks especially in the areaslike foreign currency, and helps in maintaining banking relationships in theorganisation.· The treasury management model helps in identifying risks based on changes in thebusiness conditions and operations, and implements relevant methods to reduce therisk.· The forecasted cash flow exposures can be derived from the historical data.· In banking organisations, it helps to optimise asset and debt performance whileminimising the needs for external funding.· The financial sector in the organisation will be able to analyse a variety of datawhich include funds, transactions, foreign exchange rates, market data and thirdparty information.
  4. 4. · The treasury management system advises the organisation management onaspects of liquidity of its short and long term planning.· The organisation obtains a well maintained system of policies and procedures toimpose adequate level of control over treasury activities.· An organisation investing in treasury management can expect increase in cashvisibility, better management of financial risk and enhancement of treasury efficiencyand 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 ofcorporate and hidden risks.Treasury ExposureTreasury 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 tothe powerful analytics that enable to measure the global treasury operations andcontrol financial market risks. It analyses the price and risk profile of financialdealings on a pre-dealing basis. The exposure in foreign exchange market isintense; hence hedging towards these risks by integrating business exposures andtreasury transactions helps an organisation to manage financial risk and stayprofitable.· Foreign exchange exposure – This occurs due to the low profits and adversefluctuations in foreign exchange rates. Many organisations suffer from foreignexchange risk by making purchases or sales in foreign currency or by owning assetsor liabilities in foreign countries. Hence a relevant course of action must beimplemented to reduce exposures in business operations.· Currency exposure – It deals with future cash flows arising from domestic andforeign currencies that involve assets and liabilities and generating revenues whichare susceptible to variations in foreign currency exchange rates. Hence the
  5. 5. identification of existing potential currency relationship that arises from businessactivities includes hedging and other risk management activities.· Event exposure – This happens due to a sudden change in the financial marketduring an investment (an event) that has a detrimental effect on the value of thatinvestment. It is often associated with corporate bonds.· Commodity exposure – This happens due to variations in the prices of commoditieswhich change the future and magnitude of market values. The commodities dependon any production including foreign currencies, financial instruments or any physicalsubstances. Hence treasury management is liable to deal with various risks likeprice, quantity, cost that are associated with commodities.
  6. 6. Q 2 Classify various money market instruments.Ans: Money Market InstrumentsIn the previous section, we discussed about money market and call money market,and their features. In this section we will discuss about money market instrumentsand their featuresMoney market instruments take care of the borrowers short-term needs and providethe required liquidity to the lenders. The types of money market instruments aretreasury bills, commercial papers and certificate of deposits, bills of exchange, repoand 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 apromissory note issued by the Central Government of India at a discounted value tomeet its short-term requirements. Until 1950, T-Bills were also issued by the stategovernments. After 1950, it is issued by Central Government. RBI issues T-bills onbehalf of the Central Government of India. They are issued by tender or tap. T-Billsare highly liquid because they are guaranteed by the Central Government. Thesebills can be used as claims against the government as they do not require anyacceptance 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 likeprovident funds, state run pension funds and the state governments are allowed toparticipate in the auction, but they are not allowed to bid. RBI invites bids everyfortnight and decides the cut-off rate on the bids T-Bills are assets which are used forthe maintenance of a bank’s Statutory Liquidity Ratio (SLR) requirement. Thediscount rate of the RBI auction based on bidders’ quotations gives expected returnsto the investors.Features of T-Bills
  7. 7. 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 CentralGovernment and guaranteed by the Government.· T-bills are readily available throughout the week. Individuals can invest their surplusfunds on any day of the week.· The fluctuation in the discount rate of T-bills is very low and it provides an assuredyield on the investment.· The transaction cost is low. DFHI offers buying and selling rates daily. Thedifference between the two rates is the transaction cost and it is found to be verylow.2.3.2 Commercial Papers (CPs)Commercial Papers (CPs) is a type of instrument in money market and it wasintroduced in Jan 1990. Commercial paper is a short-term unsecured promissorynote issued by large corporations. They are issued in bearer forms on a discount toface value. It issued by the corporations to raise funds for a short-term. The maturityperiod ranges from 30 days to one year. CPs is negotiable by endorsement anddelivery. 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 areissued directly to the investors. It is purchased mostly by the commercial banks,Non-Banking Finance Companies (NBFCs) and business organisations. CPs isissued in domestic as well as international financial markets. In international financialmarkets, they are known as Euro-commercial paper.Features of commercial papersThe salient features of CPs are as follows:· CPs is an unsecured promissory note.
  8. 8. · 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 isRs. 25 lakh.· The ceiling amount of CPs should not exceed the working capital of the issuingcompany.The investors in CPs market are banks, individuals, business organisations and thecorporate 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 thesemarkets, 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 fromCredit Rating Information Services of India (CRISIL) and Investment Information andCredit 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.
  9. 9. Advantages of CPsCPs is like T-Bills and is close a competitor of T-Bills, but T-Bills have an edge overCPs because they are less risky and more easily marketable. The advantages ofCPs are as follows:· They are negotiable by endorsement and delivery.· Highly safe and liquid instrument – They are believed to be one of the highestquality investment instruments available in private sectors.· CPs facilitates security for the loans. This results in creation of secondary marketfor CPs and there is efficient movement of funds providing surplus cash to cashdeficit units.· Flexible instrument – It can be issued with varying maturities as insisted by theissuing 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 banksand financial institutions. It is a document issued for the amount deposited in a bankfor a specified period at a specified rate of interest. The concerned bank issues areceipt which is both marketable and transferable in the market. The receipts are inbearer or registered form. CDs are known as negotiable instruments and they arealso known as Negotiable Certificates of Deposit. Basically they are a part of bank’sdeposit; hence they are riskless in terms of payments and principal amount. CDs areinterest-bearing, maturity-dated obligations of banks. CDs benefit both the bankerand the investor. The bankers need not encash the deposit before the maturity andthe investor can sell the CDs in the secondary market before the maturity. Thiscontributes to the liquidity and ready marketability for the instrument. CDs can beissued only by the schedule banks. It is issued at discount to face value. Thediscount rate depends on the market conditions. CDs are issued in the multiples of
  10. 10. Rs. 25 lakh and the minimum size of the issue is Rs.1 crore. The maturity periodranges from three months to one year.The introduction of CDs in Indian market was assessed in 1980. RBI appointed theVaghul Working Group to study the Indian market for five years. Based on thesuggestions of Vaghul committee; RBI formulated a scheme for the issue of CDs. Asper the scheme, CDs can be issued only by the scheduled banks at a discount rateto face value. There is no restriction on the discount rate by the RBI.Features of CDs in Indian marketThe 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-inperiod.· CDs have to bear stamp duty at the prevailing rate in the markets· The NRIs can subscribe to CDs on repatriation basis2.3.4 Bills of exchangeBill of exchange is a financial instrument which is traded in bill market. According tothe Indian Negotiable Instruments Act, 1881, “It is a written instrument containing anunconditional order, signed by the maker directing a certain person to pay a certainamount of money only to, or to the order of the bearer of the instrument”. The bills ofexchange are drawn by the seller on the buyer for the value of goods delivered bythe seller. They are also known as trade bills and are accepted by commercialbanks. 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.
  11. 11. Classification of bills of exchangeThere are various types of bills of exchange in the market and they areas follow:· Demand bill and Usance bill – Demand bill has to be paid immediately whenpayment is asked for. Demand bill has no time period for payment. Usance bill is abill of exchange drawn for a period of time governed by the policies of a particulartrade or between the two countries involved. It is payable at the time specified whichis at a later date.· Inland bill – It is drawn in India and must be payable in India. It is drawn upon aperson residing in India.· Foreign bill – It is drawn outside India. They are payable in and outside India. It isdrawn in the favour of person residing inside or outside India.· Documentary bills – These bills are accompanied by documents related to goodssuch as loading bills, railway receipts.· Accommodation bill – An accommodation bill is a bill of exchange which is acceptedand sometimes endorsed without any receipt of monetary aid offered to the personaccommodated.Supply bill – It is a bill made by the supplier to the government or semi governmentto get advance payment for the goods supplied to them.· Hundi – It is used by indigenous bankers to raise money, or finance to trade in Indiaor to remit the funds. The two types of hundi are darshani and muddati. Darshani isused 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 reposRepo and its structureRepo 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 aspecified date and interest rate. The transaction is repo from the viewpoint of the
  12. 12. seller. Repos enable collateralised short-term borrowing or lending of through sale orpurchase 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 GeneralLedger (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 SGLsystem and public debt office at the RBI.Repo rate is the annual interest rate for the funds which is transferred by lender toborrower. The repo rate is lower than the interbank loans. The factors affecting reporate are high credit worthiness of the borrower and low collateral loan rates whencompared 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 alocal stock exchange but it represents a security that is issued by a foreign publiclylisted company. Two of the most common types of DRs are the American DepositoryReceipt (ADR) and Global Depository Receipt (GDR).ADR is a security issued by a non-U.S. company and is traded on U.S. stockexchanges. ADRs are issued to offer investment methods that avoid the unwieldylaws applied to the non-citizens who buy shares on local exchanges. ADRs are listedon 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 onthe transaction.
  13. 13. GDRs were developed on the basis of ADRs and are listed on stock exchangesoutside 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 plannedcompany 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 nationalswho want to invest in India. By buying these, they can invest directly in Indiancompanies without going through the harassment of understanding the rules inIndian financial market.3.6.1 Benefits of depository receiptsThe increasing demand for DRs is determined by the need of investors to diversifytheir portfolios, reduce risk and invest internationally. It allows the investors toachieve the benefits of global divergence without the added expense andcomplexities of investing directly in the local trading markets.3.6.2 Participatory notesInternational entrance to Indian capital market is limited to Foreign InstitutionalInvestors (FIIs). The market has found a way to avoid the limitation by creating aninstrument called Participatory Notes (PNs). PNs are basically contract notes.Indian traders buy securities and then issue PNs to foreign investors. Any dividendsor capital gains collected from the primary securities are returned back to theinvestors. Any entity investing in PNs may not register with SEBI, whereas all FIIshave to register compulsorily.The benefits of PNs are as follows:
  14. 14. · Entities route their investment through PNs to extract advantage of the tax lawssystem.· It provides a high degree of secrecy, which enables large funds to carry out theiroperations without revealing their identity.· Investors use PNs to enter Indian market and shift to fully fledged FII structurewhen they are established.
  15. 15. Q 4. Describe ERM and Classify the difference between futuresand forwards contracts.Ans: Exchange Rate MechanismIn the previous section we discussed about foreign exchange market, its types andparticipants involved. This section deals with exchange rate mechanism.Exchange Rate Mechanism (ERM) deals with the rate at which value of one currencyis converted into the value of another currency. For example, USD 1.00 is equal toIndian Rs. 45.18. This is called as conversion rate. The exchange rate in the forexmarket is determined by demand and supply of foreign currency. There are twotypes of ERM. They are:· Floating (flexible) exchange rate – It deals with currency exchange rates which aredetermined by free markets. There is no government interference and the marketforces determine the equilibrium exchange rates. The values of the currency can beallowed to float (decrease or increase).· Fixed (pegged) exchange rate – In this mechanism, the value of a nation’s currencyis matched with another currency or to another measure of value like gold or basketof currencies and if the reference value increases or decreases even the currencypegged also changes. It helps in reducing uncertainty associated with exchange ratefluctuations 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 thegovernment in the market. It is also called as dirty float.· Clean float – It deals with the exchange rate with no participation of government inthe market.· Fixed exchange rate – It refers to the exchange rates that are fixed to some parvalue though a small degree of flexibility exists.
  16. 16. 4.3.1 Factors influencing exchange rateThe forex market consists of various tangible and intangible factors influencingexchange rates. The factors are as follows:· Rate of inflation between different countries – It depends upon the purchasingpower parity which states that the average value of exchange rate between the twocurrencies depends upon the purchasing power. If a currency has less purchasingpower in its domestic country, then it isconsidered as overvalued. Hence it will exert downward pressure in the domesticcurrency. But if the currency has higher purchasing power in its domestic country, itis considered as undervalued and an upward pressure will be exerted in localcurrency.· New exchange rate = Old exchange rate x (Initial rate of currency ÷ Final rate ofcurrency)· Interest rates between different countries – The increase in interest ratessimultaneously increases foreign investments which results in higher demand forlocal currency causing the exchange rates to increase.· Balance of payments (BOP) – The relation between the balance of payments andexchange rates can be determined by the elasticity of demand for exports andimports. If there is deficit in the BOP, the international confidence on the currency willbe diminished and exchange rate tends to decline.· Capital movements – The most important factors affecting the exchange rates intoday’s world economy are international investments in the form of Foreign DirectInvestments (FDI) and Foreign Institutional Investors (FII). A country like Indiaentices large capital inflows through foreign investments which might result in anappreciation in the domestic currency. Cash outflow might result in depreciation inthe domestic currency.Speculations – The speculators mainly study the country’s economic ups and downsand its flexibility with international trade. They forecast the possible future exchangerates based on that particular country’s economic strengths and weaknesses. If
  17. 17. speculators predict fall in the value of a currency in near future, they sell thatparticular currency and start buying other currencies which have a greater value.· Strength of economy – The economic fundamentals of a country must be strong sothat the domestic currency remains stable. The various factors indicating country’seconomic strength are fiscal balance, international liabilities, current accountbalance, forex reserves, and inflation rate.· Stock exchange operations – The various stock exchange operations like foreignsecurities, debentures, stocks and shares influence exchange rate.Differences between Futures and Forwards ContractsThe financial futures contract is defined as “simultaneous right and obligation to buyor sell standard quantity of a specific financial instrument (or commodity) at a specificfuture date and at a price agreed between the parties at the time the contract wassigned”. Forward Contracts are made by the bank with a customer agreeing to buyor sell a currency at an agreed price in future.Forward and future contracts are used in trade securities, currencies andcommodities where these contracts are set to be settled at a future date. In tradingworld, these contracts work in common and are often considered as derivativetrading methods. The quoting methods are:· Direct – In this method, the foreign exchange rate is quoted as domestic currencyper unit of foreign currency. For example, the direct quotation of exchange ratedetermines euro GBP 1 is equal to INR 85.99.· Indirect – It refers to the number of units of foreign currency required to buy onedollar. For example, the indirect quotation of exchange rate determines INR 100 isequal to USD 2.213.Cross rates – The currency exchange rate between two currencies both of which arenot official currencies of the country in which the exchange rates are quoted.
  18. 18. But from the year 1993, all the exchanges are quoted in direct method. The twoways of exchange quotes are determined by buying and selling price. For example, 1USD = INR 45.16/18, the buying rate is equal to INR 45.16 and selling rate is equalto INR 45.18. The lowest rate is called buying rate and highest rate is called sellingrate.Differences between Futures and Forwards ContractsFutures Contracts Forwards ContractsIn this contract, two parties make an It is an agreement with later dates of theagreement 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 theat the end of trading period with the contract trading period with a forwardsettlement price. price.The profit and loss on futures are The profit and loss are realised during theexchanged 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 personalisedstandardised. and unique.It is traded on an exchange. It is traded Over the Counter (OTC).
  19. 19. Q5. Explain the process of risk management and various toolsinvolved in managing risksAns: Processes of risk management.Risk management acts as an internal part of business planning. The process of riskmanagement consists of generic steps in order to guide the organisation to achievesuccess with managing exposures. The basic steps of risk management processare:· Establishing the context – It is the process of analysing the strategic andorganisational context under which the risks occur. This helps in planning theimplementation of relevant measures to mitigate the occurring risks.· Identifying risks – The organisations are associated with variety of risks that hindersin achieving the targets. It is important to define the type of risks associated withbusiness operations. This will provide the organisation to have a fundamentalunderstanding of the activities from which the risk originated and hence enables toassess the magnitude of the risk. It also involves identifying the affectingstakeholders.· Quantifying risks – It consists of measuring the probability and frequencies of therisks. It also involves assessing the consequences of the occurring risks. Theconsequences 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 tolerancelevel. By this, the organisation will be able to prioritise the risk category and relatedconsequences and the overall cost for mitigating the risk.· Treating risk – This process involves development and implementation of a planwith specific methods to handle the identified risk by considering strategic andoperational risk priorities, stakeholders involved and the consequences.
  20. 20. · Monitor and review risk – The methods applied to manage risks are monitoredregularly due to the changing environment in the investment levels. Hence it requiresrestoring the target levels based on the assumptions and decisions concerning thechanges with respect to business environment, government policies. These policiesand decisions are reviewed regularly.Tools available for managing risksThe risk management tools forecasts the analysis and implementation of variousmethods in order to mitigate risks. It includes several systems and models thatenhance correlation of risks and returns across investments and support portfoliomanagement process. The major tools available for risk management are:· Failure Mode Effects Analysis (FMEA) – This tool is used for identifying the cost ofpotential failures in the business operations. This method can be applied duringanalysis and design phases of the business operations which help in identifying thesignificant 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 ofrisk and the countermeasure tasks. The process of planning is essential before thetool is used for measuring risks. It includes identifying the element causing risk. Thenext process consists of identifying the context of problem and measures to reducerisks.Risky calculations – This method of managing risk includes the process ofcontinuous scanning of the risk at various phases in the business operations. It is theprocess of calculating the most occurring risks. These are identified by the prioritiesgiven to the risks during their occurrence with respect to its severity. Hence the risk
  21. 21. management authority processes on the high priority risk by calculating the riskexposure. This calculation is obtained by the following methods:- Risk exposure – The probability of the risk occurrence and total loss to theorganisation 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 forcountermeasures is obtained. The reduction in the risk exposure and cost ofcountermeasure helps in prioritising the possible countermeasures.RRL = Reduction in Risk Exposure ÷ Cost of countermeasureManaging risk – Once the risks are identified and calculated the following processesare performed to mitigate risk. This process is less in terms of cost and choosing thebest plan can avoid risk exposures and provides a better action to perform. Itincludes 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 alternativeactions to counterpart the risk else if it is reduction method, then it changes thecurrent action by adding new action to reduce the risk. The contingency planningdepends upon the risk exposure and reduction leverage.Insurance – It is the most common risk management tool used in organisations. Theinsurance can be applied to any physical property like equipment in the organisationin order to recover from the loss occurred due to damages. The risk managementcan prior analyse the risks causing damages to the organisation and formulatesinsurance policy during any losses to the organisation.· Fault Tree Analysis (FTA) – The tool is used as a deductive technique to analysethe reliability and safety in the organisation. It is usually implemented for dynamicsystems. It provides the foundation for analysis process and justification forimplemented changes and additions of various actions to reduce risks.
  22. 22. In this section we discussed the management of risks and various processes andtools involved in managing risks. The next section deals with the quantitative riskmeasurement.
  23. 23. Q 6. Explain the Framework for measuring and managing theliquidity risks.Ans: Measuring Liquidity RiskThe earlier section dealt with the risks associated with liquidity, now let us focus onthe measurement of liquidity. The framework for measuring and managing theliquidity 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 situationof IISF that relates to their clients, also calculating the cumulative net excess overthe time interval for the liquidity taxation.This analysis is nothing but constructing a maturity ladder and then calculating acumulative net excess or shortage of funds at particular maturity dates.Maturity ladderA bank‘s future cash inflows are compared with the future cash outflows over aseries of definite time periods via a maturity ladder. These cash flows arise due toassets that have already crossed their maturity dates, other non-maturing saleableassets and tapped credit lines that are well established. The cash outflow consists ofcontingent liabilities and liabilities falling due, especially devoted lines of credit thatcan be drawn down. The maturity ladder is represented by comparing sources andsum of currency inflows and sources and sum of currency outflows.
  24. 24. The two simple ways to measure liquidity are:· Stock approach· Flow approachStock approachThe 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 methodaims at determining the bank’s ability to use its short term debts as a measure ofliquid assets that can be used for other purposes.Under this method certain ratios, like liquid assets, short term liabilities, purchasedfunds to total assets and others are calculated and compared to the targets that abank has set for itself. Though the stock approach is useful in determining theliquidity from one aspect, it does not reveal the essential liquidity profile of a bank.Flow approachThe flow approach predicts liquidity at different points of time. It looks at the liquidityrequirements for a minimum of 15 days. Next it consults the maturity ladder andtracks 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 riskbased on figures obtained from measured liquidity risk.

×