Master of Business Administration - MBA Semester 4 MF 0016 Treasury Management 4 Credits (Book ID: B1311) Assignment- 60 marks Note:

Answer all questions. Kindly note that answers for 10 marks questions should be approximately of 400 words. Each question is followed by evaluation scheme. Q1. Consider yourself as a chief financial officer, describe the treasury functions that you handle and discuss how you will formulate the treasury policy. 10 marks (explanation of treasury functions-5 marks; explanation of treasury policy-5 marks) Ans: Evolution of treasury function: The treasury functions are reformed due to new technology and web based tools. The organizations adopted modern treasury functions to enhance cash flow by dividing it into three distinct areas which are operating cash flows, investing cash flows and financing cash flows. The treasury function enables the employees to manage cash, debt and investments over the internet. This includes cash management services like automatic consolidation of bank balances, transactions, details of cash flow etc. The evolving treasury function highlights debt management services by providing automatic calculations of interest rates and tracking fixed and floating rate debt instruments. The developing strategic role is a reformation of traditional function to modern function such as administrative, transaction and strategic activities. The administrative treasury deals with maintaining financial statement and the records based on new technology. Transaction activity has evolved from the introduction of risk management activities like foreign exchange, interest and commodity prices. Following are a few traditional treasury functions practiced in organizations: Cash management It deals with managing the collection and repayment of cash. Currency management It is the process of managing currencies which are used for overseas billing. Funding management It is the process of planning, and outsourcing the short, medium and long term cash needs in an organization.. Corporate finance It deals with strategic financial issues related to achieving goals such as way to raise and manage the capital, type of investing, percentage of profits to be shared among the shareholders (dividends), and decisions to merge with another organization. Formulation of Treasury Policy: The treasury policy acts as a key component of treasurys internal controls by providing framework for treasury operations. This policy provides working guidelines and parameters to the employees. The stages of treasury policy are: 1. The first step involves identifying the routine activities performed and their associated risks in the treasury. The treasurer, finance director and other departments like tax accounting, and internal audit are responsible to carry out this process. 2. The next step involves developing a set of procedures and strategies to manage the identified risks. Framing policy statements are best approach to set appropriate course of action in every activity. 3. The final step deals with approval of finalized treasury policy by the board members. This will legitimize the document by treasury department and rest of the organization.

Q2.The NCDEX trading system provides a fully automated screen based trading for futures commodities on basis of nationwide online monitoring and surveillance mechanism. Discuss explain the concept of commodity market, role of regulator and players. 10 marks (concept of commodity market - 3 marks; role of regulator - 3 marks; players - 4 marks) Ans: Commodity Market: Commodity market refers to the market in which commodities are traded. It consists of agreements for buying and selling commodities at an agreed price on a specific date. The commodities include oil, gold, agricultural products. The main commodity market terminals are in London, New York, and Chicago. In India, commodity market consists of retail and wholesale markets. It facilitates multi-commodity exchange within and outside the country based on requirements. The Indian commodity market has reformed due to the global expansion of trading opportunities. The demand for commodities in Indian domestic and global market is estimated to grow four times by next five years. Regulator of commodity market The regulators of commodity market usually form various governmental commissions in order to process the trading of commodities in the market. In India Forward Market Commission (FMC) acts as a regulator for commodity market. It is head quartered in Mumbai and holds a regulation authority which is overseen by the ministry of consumer affairs. The government is in a verge to introduce new forward contracts (regulation) amendments to empower FMC. This helps the regulators to introduce new products like options. Hence the stakeholders including farmers benefit from price discovery and price risk management. Players in commodity market: Commercials This group includes production, processing or merchandising of a commodity. Commercials make the most trading in commodity markets. Large speculators It includes a group of investors pooling their money to reduce risk and increase gain. Large speculators consist of money managers making investment decisions for overall investors group. Small speculators This group includes individual commodity traders trading on their own account or through brokers. The other players include hedgers, producers like farmers and consumers like refiners, jewelers, exporters and importers, textile mills.

Q3.Consider yourself as a CEO of an automobile company in India, Which tool will you adopt to minimize risk occurring in the production process. 10 marks (explanation of risk management - 3 marks, explanation of process of risk management - 4 marks; explain tools used to minimize risks - 3 marks) Ans: Management of Risks: Management of risks enables the organizations to reduce risk levels in order to meet the profit targets. It deals with analyzing the possibility that some future event may harm the growth of the organization. The organization experiences variety of risks during the business operations. Hence these risks are defined so that it provides basis for measuring the level of risk and implement the relevant methods to mitigate it. The overall responsibility of the risk management lies with the top level management which includes the CEO, the CFO and the board of directors in the organization. Processes The basic steps of risk management process are: Establishing the context It is the process of analyzing the strategic and organizational context under which the risks occur. Identifying risks This will provide the organization 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. Formulating policy The formulation of policy provides a framework to handle risks. It provides standard levels of exposures to protect cash flows in the organization. Evaluating risk- It involves the process of ranking the risks based on tolerance level. 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 which are reviewed regularly. Tools available for managing risks The risk management tools forecasts the analysis and implementation of various methods in order to mitigate risks. 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. Process Decision Program Chart (PDPC) The tool identifies the different levels of risk and the countermeasure tasks. Risky calculations This method of managing risk includes the process of continuous scanning of the risk at various phases in the business operations. Insurance The tool can be applied to any physical property like equipment in the organization in order to recover from the loss occurred due to damages. Fault Tree Analysis (FTA) The tool is used as a deductive technique to analyze the reliability and safety in the organization.

Q4.Suppose you are the CEO of MS Bank Corporation. Your bank is facing interest rate risk, which has affected its operation significantly. Discuss the factors that influence the level of market interest rate. 10 marks (Explanation of interest rate risk - 4 marks; explanation of various types of products/ credit facilities offered - 6 marks) Ans: Interest Rate Risk (IRR): The interest rate risk occurs due to the change in unconditional level of interest rates which changes the investments values. These changes affect securities inversely but can be reduced by diversifying and hedging techniques. The rise in interest rates decreases the value of bond prices. The top management and the board of directors hold the responsibilities of managing interest rate risk. It is important for the senior management to understand the nature and degree of interest rate risk and the overall business strategies. Most of the banks experience interest rate risk with many banking products. Any lender or borrower is affected with interest rate risk. For example a lender earning movable rate of interest can experience reduction in future revenues due to the decline in interest rates. Similarly the borrower experiences higher payments of interest rates when the interest rate increases.The various types of interest rate risks are: Volatility risk It refers to the risk occurring in the future price of asset. The holder of an option experiences volatility of underlying assets based on current market situation. Rate level risk It refers to the interest rates that fluctuate variably over a period of time. The probability of the change in the magnitude of interest rates varies according to the period of investments. During the period of investments due to market conditions and regulatory involvements, it is possible to restructure the interest rate levels. This restructuring helps the organizations to maintain asset and liabilities according to their maturing periods. Reinvestment risk It occurs when the interest earned from an investment does not provide same rate of return during reinvestments. Hence there is a possibility to reinvest the cash flows at a lower rate of return. Price risk It refers to the risk occurring in future due to the decline in price of a security like bonds or physical commodities. The variations in market price causes loss to an asset. Call/Put risk During the appraisal of bonds the funds include call/put option. The two options experiences risk during the fluctuations of interest rates. The call option usually work when there is decline in the interest rate. This affects the banks investing in bonds such that the cash flows are reinvested at decreased level of pricing. Similarly the put option works during the increase of interest rate. This creates greater additional costs with issues of bonds. Real interest rate risk It occurs due to the dissimilarity between the nominal changes of interest rates and changes in inflation. The inflation factors play an important role during the assessment of costs. It affects the revenue or expenditures of the banks asset and liabilities.

Q5.The treasury maintains the bank funds, it automatically surrounds liquidity and interest rate risks. Discuss the relationship between treasury and ALM. 10 marks (Explain treasury-3 marks; explain ALM-3 marks; explain the relationship between treasury and ALM 4marks) Ans: Introduction: Treasury management is to manage the firms holdings in order to enable the company to use the techniques and tools required to minimize the expenses and maximize returns on cash surpluses. It also provides them the required treasure funding in the desired currency at the appropriate time. Asset Liability Management (ALM) is a strategic plan implemented by an organization to control the variation in the interest rate of its earnings and liabilities on assets. ALM deals with strategic balance sheet management which involves the various risks caused due to the changes in exchange rates and the position of liquidity, interest rates in the organization. As the treasury maintains the bank funds, it automatically surrounds liquidity and interest rate risks. Relationship between treasury and ALM is as follows: The balance sheet of a bank contains huge market risk and credit risk. In general, banking operations is limited to accepting deposits and providing credit to borrowers. But treasury department of a bank operates in financial markets; and connecting core banking functions and the operations of market. Hence, it is the responsibility of treasury to identify and examine the market risk. Treasury is also exposed to market risk while trading in forex and securities markets. It is sometimes easier for treasury to manage risk aggregates, especially for derivatives like options that can be economic only in marketable size. Many credits products are replaced by treasury products while the market is developing. For example, facility of working capital is replaced by commercial papers. It is possible to trade treasury products and hence, banks can generate liquidity in times of need. It is much easier for treasury products to monitor and administer the risks involved in the movements of exchange rate and interest rate. The mismatches of asset liability cannot be ignored as physical movements of asset and liabilities are not possible. It should also be realized that banks earn profits out of mismatches. So, it is not recommended to completely remove mismatches from the balance sheet. Treasury makes use of derivatives to bridge the gap between liquidity and rate sensitivity. Risk management has become an essential part of treasury because of the above mentioned reasons. Either ALM is a part of dealing room or ALCO support is a part of treasury team in many banks. The head of treasury team is always a very important member of ALCO that contributes to risk management, product pricing and other issues of policies.

Q6.ALM deals with strategic balance sheet management, which involves various risks, caused due to the changes in exchange rates and the position of liquidity, interest rates in the organization. Discuss how the ALM contributes to the risks in balance sheet management. 10 Marks (explanation of ALM- 3 marks; explanation how the ALM contributes to the risks in balance sheet management-7marks) Ans: ALM has become a key driving force for profit in banks. The primary focus of ALM is to enforce risk management functions. ALM has three vital bases which are ALM information system, ALM organization and ALM process. ALM information system is the communication base that assists in conducting business practices. The ALM organization includes ALCO which comprises of banks senior management team that decides the business strategy of a bank. ALM analyses, monitors and reports the risk profiles to the ALCO. It is the ALCO which is responsible for balance sheet planning and strategically manages the interest rate risk, liquidity risk and other risk factors. The staffs forecast the effects of market variations related to the balance sheet and recommend the actions required to be taken. The business and risk management practice of a bank confirms the banks operation within the predefined limits set by the committee. Banks implementing ALM are also required to formulate policies to achieve the objectives of ALM. These policies should cover the aspects like spread management, loan quality, non-interest income, control of expenses, tax management and capital adequacy. The ALM functions conducted in a bank are as follows: Managing liquidity and other market risk. Funding and capital planning. Planning profit and projecting growth. Trading risk management.

We will discuss the liquidity and interest rate risk management conducted in banks by ALM which is as follows: Liquidity risk management - Bank measures and manages liquidity in the economy. A proper liquidity management reduces the chance of an adverse situation in the bank. Liquidity is traced through maturity or cash flow mismatches. For measuring and managing net funding requirements, banks calculate the cumulative surplus or deficit of funds at specific maturity dates. Banks monitor the cumulative mismatches by establishing internal prudential limits as approved by the committee. A copy of the note approved by the committee is dispatched to the department of banking supervision which is RBI in India. Interest rate risk management Interest rate risk arises in banks due to the variation and deregulation of interest rates and operational variability in assets and liabilities. The changes in interest rates affect the current earnings and the net worth of the bank. The gap analysis is considered as the suitable tool to measure the interest rate risk. Each bank establishes certain prudential limits on individual gaps with the approval of the management committee. The prudential limits influence the total assets, earning assets of the bank.