Master of Business Administration - Semester 4 MF 0016 TREASURY MANAGEMENT (4 credits) (Book ID: B1311) ASSIGNMENT- Set 1 Marks 60 Note:

Each Question carries 10 marks. Answer all the questions. Q1. Explain treasury management, its need and benefits and treasury exposure. Answer: Treasury Management Treasury management is the process of planning, organising and managing the organisations holdings, tradings, corporate bonds, currencies, financial futures, associated risks, options, derivatives, and payment systems. It handles all the financial matters including external and internal funds for business, complex strategies, and procedures of corporate finance to optimise interest and currency flows. It helps in planning and executing communication programmes to enhance investors confidence in the organisation. According to Teigen Lee E (July 2001), Treasury is the place of deposit reserved for storing treasures and disbursement of collected funds. The responsibility of treasury management lies with the Chief Financial Officer (CFO) of the organisation. The CFOs responsibilities include capital and risk management, planning strategies, investor relations and financial reporting. In large organisations, these responsibilities are divided among the accounting and treasury sectors. Hence the workflow between these two sectors must be ethical. Need Treasury management is mainly required to optimise the economy of the organisation and provide an ability to manage financial risks. Treasury management is important for the following reasons: The development in technology, breakdown of exchange controls, unpredictable changes in interest and exchange rates, and globalisation of businesses requires treasury management. To actively manage financial environment, organisations require treasury management that provides the ability to undertake business opportunities and their exposure to risks. It provides the caliber to develop appropriate skills in achieving economies of scale, lower borrowing rates and netting-off balances. It enhances relationship between entity and its financial stakeholders which include shareholders, fund lenders and taxation authorities. The treasury management acts as a centralised head office in the organisation and provides financial service to various departments and enhances the financial growth in the organisation. Benefits Few benefits of treasury management are: Implementation of treasury management in the organisation increases sales of the products.

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 It helps in providing confident employees who work effectively in the organisation. It enhances better guidelines and methods to manage risks especially in the areas like foreign currency, and helps in maintaining banking relationships in the organisation. The treasury management model helps in identifying risks based on changes in the business conditions and operations, and implements relevant methods to reduce the risk. In banking organisations, it helps to optimise asset and debt performance while minimising the needs for external funding. The financial sector in the organisation will be able to analyse a variety of data which include funds, transactions, foreign exchange rates, market data and third party information. An organisation investing in treasury management can expect increase in cash visibility, better management of financial risk and enhancement of treasury efficiency and accuracy. Treasury Exposure Treasury exposure allows treasury management to various risks in the organisation. Following are the few treasury exposures in an organisation: Financial exposure The treasury management in the organisation are disclosed to the powerful analytics that enable to measure the global treasury operations and control financial market risks.The exposure in foreign exchange market is intense; hence hedging towards these risks by integrating business exposures and treasury transactions helps an organisation to manage financial risk and stay profitable. Foreign exchange exposure This occurs due to the low profits and adverse fluctuations in foreign exchange rates. Many organisations suffer from foreign exchange risk by making purchases or sales in foreign currency or by owning assets or liabilities in foreign countries. Hence a relevant course of action must be implemented to reduce exposures in business operations. Currency exposure It deals with future cash flows arising from domestic and foreign currencies that involve assets and liabilities and generating revenues which are susceptible to variations in foreign currency exchange rates. Hence the identification of existing potential currency relationship that arises from business activities includes hedging and other risk management activities. Event exposure This happens due to a sudden change in the financial market during an investment (an event) that has a detrimental effect on the value of that investment. It is often associated with corporate bonds. Commodity exposure This happens due to variations in the prices of commodities which change the future and magnitude of market values. The commodities depend on any production including foreign currencies, financial instruments or any physical substances. Hence treasury management is liable to deal with various risks like price, quantity, cost that are associated with commodities.

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Q2. Classify various money market instruments. Answer: Money Market Instruments Money market instruments take care of the borrowers' short-term needs and provide the required liquidity to the lenders. The types of money market instruments are treasury bills, commercial papers and certificate of deposits, bills of exchange, repo and reverse repo. > Treasury Bills (T-Bills):A treasury bill is a money market instrument. It is also known as T-Bills. It is a promissory note issued by the Central Government of India at a discounted value to meet its short-term requirements. Until 1950, T-Bills were also issued by the state governments. T-Bills are highly liquid because they are guaranteed by the Central Government. T-Bills are issued under four types 14 days T-Bills, 91 days T-bills, 82 days T-Bills, and 364 days T-Bills. > Commercial Papers (CPs):Commercial Papers (CPs) is a type of instrument in money market and it was introduced in Jan 1990. Commercial paper is a short-term unsecured promissory note issued by large corporations. They are issued in bearer forms on a discount to face value. It issued by the corporations to raise funds for a short-term. The maturity period ranges from 30 days to one year. CPs is negotiable by endorsement and delivery. > Certificate of Deposits (CDs):Certificate of deposit (CDs) is a short-term instrument issued by commercial banks and financial institutions. It is a document issued for the amount deposited in a bank for a specified period at a specified rate of interest. The concerned bank issues a receipt which is both marketable and transferable in the market. CDs are known as negotiable instruments and they are also known as Negotiable Certificates of Deposit. > Bills of exchange:Bill of exchange is a financial instrument which is traded in bill market. According to the Indian Negotiable Instruments Act, 1881, It is a written instrument containing an unconditional order, signed by the maker directing a certain person to pay a certain amount of money only to, or to the order of the bearer of the instrument. The bills of exchange are drawn by the seller on the buyer for the value of goods delivered by the seller. > Repos and reverse repos:Repo is a money market instrument. It is a transaction in which individuals (sellers) sell their securities to another person (buyer) with an agreement to repurchase it at a specified date and interest rate. The transaction is repo from the viewpoint of the seller. Repos enable collateralised short-term borrowing or lending of through sale or purchase of debt instruments. > Reverse repo A reverse repo is a transaction of cash in which the lender purchases an asset from the borrower as a guarantee to get the loan repaid at the agreed interest on a specific date. It is the same transaction of repo but from the viewpoint of the lender. In other words, it is a repo transaction for the borrower, but the same transaction is a reverse repo for the lender.

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Q3. What are the features of ADRs and GDRs? Answer: ADRs and GDRs A Depository Receipt (DR) is a versatile financial security that is traded on a local stock exchange but it represents a security that is issued by a foreign publicly listed company. Two of the most common types of DRs are the American Depository Receipt (ADR) and Global Depository Receipt (GDR). ADR is a security issued by a non-U.S. company and is traded on U.S. stock exchanges. ADRs are issued to offer investment methods that avoid the unwieldy laws applied to the non-citizens who buy shares on local exchanges. ADRs are listed on NYSE, AMEX or NASDAQ. Few advantages of ADRs are: ADRs are easy and cost efficient methods to buy shares in foreign companies. ADRs save money by reducing administration costs and avoiding foreign taxes on the transaction. GDRs were developed on the basis of ADRs and are listed on stock exchanges outside US. GDRs are traded globally instead of the original shares on exchanges. The objective of GDR is to enable investors to gain economic exposure to a planned company in developed markets. Features of GDRs are as follows: GDR holders do not have a voting right. It has less exchange risk as compared to foreign currency loan. GDR investors may cancel his receipt by advising the depository. ADRs and GDRs are excellent means of investment for NRIs and foreign nationals who want to invest in India. By buying these, they can invest directly in Indian companies without going through the harassment of understanding the rules in Indian financial market.

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Q4. Describe ERM and classify the differences between futures and forwards contracts. Answer: Exchange Rate Mechanism (ERM) Exchange Rate Mechanism (ERM) deals with the rate at which value of one currency is converted into the value of another currency. For example, USD 1.00 is equal to Indian Rs. 45.18. This is called as conversion rate. The exchange rate in the forex market is determined by demand and supply of foreign currency. There are two types of ERM. Floating (flexible) exchange rate It deals with currency exchange rates which are determined by free markets. There is no government interference and the market forces determine the equilibrium exchange rates. The values of the currency can be allowed to float (decrease or increase). Fixed (pegged) exchange rate In this mechanism, the value of a nations currency is matched with another currency or to another measure of value like gold or basket of currencies and if the reference value increases or decreases even the currency pegged also changes. It helps in reducing uncertainty associated with exchange rate fluctuations and reduces the inflationary pressures. Differences between Futures and Forwards Contracts Some of the significant differences between futures and forwards contracts are given in table: Table : Differences between Futures and Forwards Contracts Futures Contracts In this contract, two parties make an agreement for future transaction. Forwards Contracts It is an agreement with later dates of the company or individuals buying at a specific price.

It mainly deals with settling of amount Forwards are settled at the start of the only at the end of trading period with the contract trading period with a forward price. settlement price. The profit and loss on futures are The profit and loss are realised during the exchanged in terms of cash every day. settlement period in order to increase credit exposure. The receiver of delivery is not known. Most of futures contracts are highly standardised. It clearly specifies the receiver of delivery. The forwards contracts are personalised and unique.

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It is traded on an exchange.

It is traded Over the Counter (OTC).

Q5. Explain the process of risk management and various tools involved in managing risks Answer: The process of risk management Risk management acts as an internal part of business planning. The process of risk management consists of generic steps in order to guide the organisation to achieve success with managing exposures. The basic steps of risk management process are: Establishing the context It is the process of analysing the strategic and organisational context under which the risks occur. This helps in planning the implementation of relevant measures to mitigate the occurring risks. Identifying risks The organisations are associated with variety of risks that hinders in achieving the targets. It is important to define the type of risks associated with business operations. This will provide the organisation to have a fundamental understanding of the activities from which the risk originated and hence enables to assess the magnitude of the risk. It also involves identifying the affecting stakeholders. Quantifying risks It consists of measuring the probability and frequencies of the risks. It also involves assessing the consequences of the occurring risks. The consequences may involve economic, political and social factors causing risks. Formulating policy The formulation of policy provides a framework to handle risks. It provides standard levels of exposures to protect cash flows in the organisation. Policy framing depends on organisations objectives and its risk tolerance levels. Evaluating risk It involves the process of ranking the risks based on tolerance level. By this, the organisation will be able to prioritise the risk category and related consequences and the overall cost for mitigating the risk. Treating risk This process involves development and implementation of a plan with specific methods to handle the identified risk by considering strategic and operational risk priorities, stakeholders involved and the consequences. Monitor and review risk The methods applied to manage risks are monitored regularly due to the changing environment in the investment levels. Hence it requires restoring the target levels based on the assumptions and decisions concerning the changes with respect to business environment, government policies. These policies and decisions are reviewed regularly. Various tools involved in managing risks The risk management tools forecasts the analysis and implementation of various methods in order to mitigate risks. It includes several systems and

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models that enhance correlation of risks and returns across investments and support portfolio management process. The major tools available for risk management are: Failure Mode Effects Analysis (FMEA) This tool is used for identifying the cost of potential failures in the business operations. This method can be applied during analysis and design phases of the business operations which help in identifying the significant failures caused by risk. The FMEA method is divided into three steps: The first step includes the process of identifying the elements causing failure. Once the elements are identified, it concentrates on the mode of failure. The last step includes assessing the probability of the effects of failure. Process Decision Program Chart (PDPC) The tool identifies the different levels of risk and the countermeasure tasks. The process of planning is essential before the tool is used for measuring risks. It includes identifying the element causing risk. The next process consists of identifying the context of problem and measures to reduce risks. Risky calculations This method of managing risk includes the process of continuous scanning of the risk at various phases in the business operations. It is the process of calculating the most occurring risks. These are identified by the priorities given to the risks during their occurrence with respect to its severity. Hence the risk management authority processes on the high priority risk by calculating the risk exposure. This calculation is obtained by the following methods: - Risk exposure The probability of the risk occurrence and total loss to the organisation provides the overall exposure of specific risk. Risk Exposure, RE = Probability of occurring risk x Total loss due to risk - Risk reduction leverage (RRL) The value of the return on investment for countermeasures is obtained. The reduction in the risk exposure and cost of countermeasure helps in prioritising the possible countermeasures. RRL = Reduction in Risk Exposure Cost of countermeasure - Managing risk Once the risks are identified and calculated the following processes are performed to mitigate risk. This process is less in terms of cost and choosing the best plan can avoid risk exposures and provides a better action to perform. It includes the stages of identifying the risk and choosing plans to avoid, or reduce risk. If the method avoiding is considered, the risk management chooses the alternative actions to counterpart the risk else if it is reduction method, then it changes the current action by adding new action to reduce the risk. The contingency planning depends upon the risk exposure and reduction leverage. Insurance It is the most common risk management tool used in organisations. The insurance can be applied to any physical property like equipment in the organisation in order to recover from the loss occurred due to damages. The risk management can prior analyse the risks causing damages to the organisation and formulates insurance policy during any losses to the organisation.

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 Fault Tree Analysis (FTA) The tool is used as a deductive technique to analyse the reliability and safety in the organisation. It is usually implemented for dynamic systems. It provides the foundation for analysis process and justification for implemented changes and additions of various actions to reduce risks. Q6. Explain the framework for measuring and managing the liquidity risks. Answer: The framework for measuring and managing theliquidity risk can be divided into three dimensions. They are: 1. Measuring and managing net funding requirements. 2. Managing market access. 3. Contingency planning. 1. Measuring Liquidity Risk: A banks future cash inflows are compared with the future cash outflows over a series of definite time periods via a maturity ladder. These cash flows arise due to assets that have already crossed their maturity dates, other nonmaturing saleable assets and tapped credit lines that are well established. The cash outflow consists of contingent liabilities and liabilities falling due, especially devoted lines of credit that can be drawn down. The maturity ladder is represented by comparing sources and sum of currency in flows and sources and sum of currency outflows. The two simple ways to measure liquidity are: Stock approach Flow approach 2. Managing market access: - Some liquidity management techniques are important not because of influence on the assumptions used during construction of the maturity ladders, but due to their direct involvement to increase the bank's liquidity. To check the sufficient changes in liabilities banks need to inspect the level of confidence on individual funding sources. In addition a bank should understand and evaluate the use of inter-company financing for its individual business offices. The addition of loan-sale clauses in loan documentation and the rate of using the asset-sales markets are two possible indicators of the bank's ability to perform asset sales under unfavorable scenarios. 3. Contingency planning:An effective contingency plan should address the following major issues: Have a strategy to handle crisis. Have back up facilities to access cash in emergency. The degree to which these issues have been solved determines the approach of the bank and how well it can perform during the time of crisis. Strategy: - Several strategies should be used in contingency planning to deal with crisis. The most important are those that involve the coordination and control at the managerial level. A contingency plan must have procedures to ensure that the flow of information is stable and uninterrupted, and they prove handy to the senior management in taking important decisions.

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Back-up liquidity: - Contingency plans should also include a facility to make a shortage of cash flow at the time of emergencies. A bank can make use of these funds whenever there is huge crisis. So the plan must have clear description of when and how much of the funds from these sources are available for the banks to use.

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