Trsry & Risk MGMT Using Derivatives

TREASURY AND RISK MANAGEMENT
Mumbai Institute of mgmt and research

Index
1. Introduction
2. Evolution of Treasury Management in Banks
3. Objectives of the Treasury
4. Functions of a Treasurer
5. Responsibility of a Treasurer
6. Bank Of India - Pursuit of Growth
7. Treasury Management of Bank Of India
8. Responsibilities and Elements Of BOI Treasury
9. Call/Notice Money Market
10. Repo/Reverse-Repo Market:
11. Debt Market
12. Foreign Exchange Market
13. Capital Market
14. Certificates of Deposits
15. Commercial Paper (CP)
16. Commercial Bills
17. BONDS & DEBENTURES
18. Mutual Funds
19. Risk Management in Banks
20. Managing Risks

Introduction
Treasury management can be defined as “Treasury management is the management of an

organization’s liquidity to ensure that the right amount of cash resources are available in the
right place in the right currency and at the right time in such a way as to maximize the return
on surplus funds, minimize the financing costs of the business, and control interest rate risk
and currency exposure to an acceptable level”
The organization of finance department differs from organization to organization. There

is no statutory pattern. Legally and theoretically, the right of managing a company vests in its
shareholders, but their numbers being large and scattered, this task is entrusted to the Board of
Directors. The main representative of the Board of Directors is the Chief Executive Officer/
Managing Director. He is the competent authority to take decisions on matters relating to the
overall policy formulations and execution. To learn about the constitution of the treasury, a
study can be made about the constitution of the Finance department. The Vice-President
(Finance) is the chief (head) of the Finance department, to whom the Treasurer and the
Controller are responsible.
The dynamics of financial markets the world over are undergoing a transformation as
businesses are increasingly getting globalized and more and more economies are becoming
market driven. As a result of this changing scenario, one of the major consequences is the
increasing volatility in the level of market (interest) rates, exchange rates, money supply and
general level of prices.
Treasury management in banks is the management of an organization’s liquidity to

ensure that the right amount of cash resources are available in the right place in the right
currency and at the right time in such a way to satisfy the statutory requirement and to
maximize the return on surplus finds, minimize the financial costs of the business, and control
interest rate risk and currency exposure to an acceptable level.
. Depending on the size of the organization and nature of the business, the role of
treasury can vary from simple cash management to all financial affairs excluding financial
accounting, internal audit and other functions of a controller.
Treasury management in banks is primarily concerned with efficient allocation of banks’
resources. It aims to optimize the banks’ return with minimum risk and thereby improves the
profitability of the bank. It does myriad functions ranging from cash and liquidity management,
reserves management, funds management to transfer pricing, risk management and forex
management. An efficient treasury is always a profit centre to the bank.

The key factors required for an effective treasury management are its organizational
structure; its involvement in the ALCO of the bank; lending and funding policy; asset and
liability management skills; treasury management skills; policy guidelines; control and
supervision; proper infrastructure, etc.
A typical treasury comprises three sub-sections - front, middle and back office. Each
office has specified functions and goals to achieve. The front office usually performs the market
trading, tracking of exchange rates etc. It may consist of different desks, each deal with
different markets like forex, money market, fixed income etc. The front office also looks after
the market intelligence, relationships with investor and banks. The front office is the strategic
decision-making part of corporate treasury. The middle office usually cares about the risk
management aspects such as Asset Liability Management, disbursement of information on
various positions to the front office and compliance of reporting requirements. Back office does
all the background work like keeping the records and managing the past data and accounting
systems.
In treasury integration, it is a usual practice that a specialized solution provider
maintains both the back and middle office functions of treasury. However, the strategic front
office is managed by an internal team. The solution provider through the use of an integrated
computer system coupled with internet processes all the information and trade orders in real
time. Because, the solution provider manages these functions for a host of other companies
also the clients benefit on reduced costs through economies of scale.

Evolution of Treasury Management in Banks
Traditionally, in Indian banking sector the role of treasury was limited only to ensure the
proper maintenance of the statutory ratios like CRR and SLR, activity in foreign exchange was
confined to meeting merchants and customers’ requirements for imports, exports, remittances
and deposits. Indian money market was ripe with imperfections arising out of administered
interest rates, therefore hardly reflected position of true liquidity in the system. Indian debt
market was also not developed cause of lack of liquidity and high SLR limit. Further, operations
Indian capital market was restricted.
Following the recommendations of different committees and working groups to study
the structure and role of bank and other organizations in the face of reforms, globalisation and
capital account convertibility. Accordingly RBI has initiated various measures to reform the
market and to develop institutional infrastructure and instruments needed to widen and
deepen the market. DFHI (Discount and Finance House of India) was set up to give market
participants a mechanism to meet their short term liquidity requirements by dealing in money
Market instruments like T-bills, bills rediscounting etc. further, introduction of instruments like
commercial papers and certificate of deposits greatly contributed to the development of the
money market. Again cap on call money market was lifted in phases and was completely
removed in 1989.(mention about SEBI, Primary Dealers, Custodians, Exchange Traded deals and
deal reporting for transparency and information dissemination, DVP mechanism, auction
system, removal of TDS on secondary market transactions, CCIL, NDs and NDFSD OM trading
platforms, etc).
Non-banking institutions like LIC, mutual fund houses etc. were allowed to enter into
the money market for lending. The introduction of DVP (delivery vs. payment) system for
security settlement at public debt offices substantially reduced the counter party risk. This also
won the confidence for introduction of Repo and expansion of repoable securities. With
deregulation of financial markets, RBI began using monetary intervention tools like repo and
open market operations (OMO) to manage liquidity in the financial system and make the
determination of interest rates more transparent for govt. securities.
Post liberalization, deregulation and financial market reforms, a vibrant capital market
as well as debt market has evolved in the country. This has enhanced the relative importance of
investments in the banking balance sheets. Investments are now viewed as alternative to
credit, the age old source of profit for banks. As financial investments are tradable assets, they
offer both interest spreads and capital appreciation. So these developments have initiated
excellent opportunities for Indian banks to cash in on the fluctuations of various yields,
currencies and prices. The risk regulated volatility, now, is at the heart of the transformation of
bank treasuries from mere CRR and SLR keepers to profit canters. An active treasury can
arbitrage (earning profit with minimum risk) by borrowing cheap and investing in high yield
giving portfolios. New accounting procedures requiring banks to revalue the investment

portfolio at market prices and making provision for depreciation (which affects the profitability)
has also made banks to monitor the risks and manage the investment portfolio.
Banks can raise rupee resources by sale of foreign currencies for meeting their rupee
requirements for lending to corporate provided such lending is profitable. Corporate have been
permitted borrow in INR and/or in foreign currencies, and, also to alternate between the INR
loan and the Foreign Currency Loan (FCL). Corporations will compare the cost of borrowings in
INR and in foreign currencies and decide to borrow in the currency on which the effective cost
is less. This aspect has also contributed towards the integration of Forex and money markets
Clearcorp Dealing Systems (India) Limited (Clearcorp), a wholly owned subsidiary of

CCIL, was incorporated in June, 2003 to facilitate, set up and carry on the business of providing
dealing systems/platform in Collateralised Borrowing and Lending Obligation(CBLO), Repos and
all money market instruments of any kind and also in foreign exchange, foreign currencies of all
kinds. Clearcorp has been set up to facilitate CCIL to segregate its other activities from the
Clearing & Settlement activity, a risk bearing activity. Accordingly, the Shareholders of CCIL at
their meeting held on June 4, 2003 resolved to transfer the activities of the Company relating to
Forex Dealing Platform and Collateralised Borrowing and Lending (CBLO) dealing platform to
Clearcorp and the same has been made operational from January 1, 2004.

Objectives of the Treasury
The treasury of a bank undertakes various operations for fulfilling the following objectives.
 To maintain the CRR and SLR as mandated by the RBI.
 To deploy profitably and without compromising the liquidity, the clearing surpluses of
the bank.
 To take advantage of the attractive trading and arbitrage opportunities in the money,
bond and forex markets.
 To identify and borrow on the best terms from the market to meet the clearing deficits
of the bank.
 To fund the bank’s balance sheet on a current and forward basis as cheaply as possible
taking into account the marginal impact of these actions.
 To effectively manage the forex assets and liabilities of the bank.
 To manage and contain the treasury risk within the approved and prudential norms of
bank and regulatory authority.
 To asses and advise and manage the financial risk of the non-treasury assets and
liabilities of the bank.
 To adopt the best practices in dealing clearing, settlement and risk management in
treasury operations.
 To offer value added treasury and related services to the bank’s customers and to act as
a profit centre as well.

Functions of a Treasurer
In this dynamic world of financial markets where a perfect risk return match is the key
to success. Treasury operations of a commercial bank consist mainly of two vital functions viz.
a) Ensuring strict compliance with the statutory requirements of maintaining the stipulated
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), and
b) Liquidity management by ensuring the optimum utilization of the residual resources
through investments (ii) raising additional resources required for meeting credit
demands at optimal cost and (iii) managing market and liquidity risks in the
transactions.
With financial market reforms, banks have been compelled to look for avenues for
alternatives to credit, the historical source of profits. It has been realized that credit function
alone is not efficient and banks should look to investments for earning market related returns
on funds. Investments have thus gained importance as an equally important part of the banks’
balance sheets. Therefore, over and above the statutory holding of government securities, as
SLR, a substantial portion of banks resources are deployed in government/corporate bonds and
other products as an alternative to credit.
The treasury operations also include providing of cover to the customers of the bank in
respect of their foreign exchange exposure for their trade transactions like exports, imports,
remittances, etc., and extending products and services to its customers for hedging the interest
rate risks. While doing so, the treasury also takes care of the associated functions like liquidity
management and asset-liability management of the domestic as well as foreign exchange
resources and deployment.
Basic Treasury Functions
Domestic Operations Forex Operations
a) Maintenance of statutory reserves a) Extending cover to foreign exchange

trade transactions
b) Managing liquidity
b) Funding and managing forex assets and
c) Profitability deployment of liabilities
reserves
c) Providing hedge to forex risks proprietary
d) Trading and a arbitrate and for its constituents

e) Hedge and cover operations d) Trading and Arbitrage

f) Mid / Back – Office function/s e) Mid / Back Office – functions

Responsibility of a Treasurer
In today’s highly competitive environment, the treasurer plays a vital role in the viability and
success of a bank and calls for effective internal and external interface. He performs a myriad of
functions such as, liquidity management, reserves management, funds management,
investments, managing capital adequacy, transfer pricing, technology and operations, risk
management, trading activities and offering hedge products. He has to arrive on an optimum
size of balance sheet, interface with various liability and asset groups internally, give correct
pricing signals keeping in mind the liquidity profile of the bank. On the external front he has to
provide active trading support to the market, add to the liquidity and continuously strive to
provide value added solutions to specific financial needs.
 Balance Sheet Management:
The ongoing reforms have provided the banks freedom to price most of their assets and
liabilities by themselves although there exists a broad band specified by the RBI. The pricing
of treasury assets and liabilities which form a critical mass of the balance sheet, is therefore,
very crucial to the balance sheet management. It is well known that the balance sheet
management is a dynamic and proactive process. It requires continuous monitoring,
analysis of market changes and controls. Demand and supply forces will impact the optimal
balance sheet size and its growth rate.
 Liquidity Management:
An important aspect of balance sheet management is Liquidity management. Liquidity

essentially means the ability to meet all contractual obligations as and when they arise, as
well as the ability to satisfy funds requirement to meet new business opportunities.
Liquidity planning involves an analysis of all major cash flows that arise in the bank as a
result of changes in the assets and liabilities and projecting these cash flows over the future.
Ideally, balance sheet projections should be prepared for a twelve month period on a
monthly basis. This would be in the nature of a monthly rolling forecast. This will enable the
treasury manager to identify any potential liquidity problems that may arise in the future,
such that corrective action can then be taken to maintain adequate liquidity. Liquidity
analysis involves a study of the maturity profile of existing assets and liabilities over which is
superimposed the impact of transactions that are planned for the future

Effective liquidity management requires careful attention to balance sheet

structure and growth. A balance sheet that is wing rapidly needs careful scrutiny to
determine whether the liquidity of the bank is being adversely affected. Very often banks
put up excessive assets in the form of cash credit loans or 0ments in securities without
having matching source of funds of similar tenure. This mismatch in the maturities of assets
and liabilities may result in the bank being subjected to liquidity risk, because the bank
starts depending chronically and excessively on the most easily accessible source of funds
i.e. the inter-bank call money market. Thus, the bank may end up funding long - term assets
through overnight borrowings on an ongoing basis. It should be borne in mind that
dependence on the call market may not be advisable due to the sharp fluctuations in
market rates as well as volatility in the availability of funds in the market.
 Funds Management:
Funds management by the treasury involves providing a balanced and well diversified
liability base to fund the various assets in the balance sheet of the bank. Diversified
liabilities imply raising funds from a variety of sources, through a variety of instruments and
for a variety of tenures. Customer deposits are often the most suitable source of funds for a
bank, due to actuarial andbehaviour4 reasons. At the other end of the spectrum are the
funds obtained from the interbank money market which are very short term in tenure and
volatile as regards rate as well as availability. The treasury has to decide on an optimal mix
of funds from various sources to ensure that there is no excessive dependence on single
category. It is also advisable that the maturity profile of assets conform broadly to that of
the liabilities, so that there is no large structural mismatch in the balance sheet that can
lead to liquidity problems.
The treasury also has the responsibility for setting target balance sheet size and
key ratios, in consultation with all business groups. Asset and liability levels need to be
monitored and managed periodically to iron out any structural imbalances. The ALCO (Asset
and Liability Committee) should meet every month for the aspect of strategic business
planning. The size of the balance she is a matter of great importance for a bank, in light of
capital adequacy guidelines. A bank cannot afford to be driven just by volume goals which
aim at a certain percentage growth in credit and deposits year after year. This is because
balance sheet growth will call for additional capital in accordance with BIS guidelines and
capital is increasingly scarce. Therefore, the focus has now to shift on to the quality of
assets, with return on assets being a key criterion for measuring the efficiency of
deployment of funds.
 Transfer Pricing:
The treasury not only provides the interface between the bank and the external market, it
also provides an interface between the asset and liability groups of the bank. It helps to

provide a balance between the two, so that optimum returns can be obtained on the assets
without compromising liquidity. The treasurer has to ensure that the funds of the bank are
deployed in the most appropriate manner without sacrificing either yield or liquidity. This is
done very effectively through the means of a transfer pricing mechanism administered by
the treasury, which can provide correct signal to various business groups as to their future
asset and liability strategies. Benchmarking of rates provides a ready reference for business
groups about the correct business strategy to adopt given the balance sheet structure of
the bank as well as the conditions prevailing in the money markets and the treasury’s
forecast about the expected rate movements in the future.
Benchmarking is extremely important in today’s market environment which
allows free market pricing of assets and liabilities. The treasury is ideally placed for this
purpose since it has an overview of the balance sheet of the bank, a thorough
understanding of the bank’s overall funding needs as well as direct access to the external
market. Depending on the signals provided by the treasury in the form of benchmark rates
for assets and liabilities, focus of the individual business groups can be shifted from asset
growth to liability growth or vice versa as dictated by the needs of the bank, Thus a correct
transfer pricing provides a versatile tool in the hands of the treasury manager in optimizing
the asset-liability mix on the balance sheet and the returns generated thereon.
 Reserve Management & Investments:

In the Indian banking scenario, a large asset base of a bank consists of investments on
account of statutory reserves. Since such a large proportion of funds are deployed in such
reserves, management of these reserves is a very important factor in the overall
profitability of the bank. It should ideally take into account both liquidity as well as yield
considerations. Even though the long maturity securities offer the highest yields, they are
most susceptible to fall in price due to changes in the yield curve. On the other hand, short
dated securities have low price risk but they also give lower returns. Therefore the choice of
an appropriate mix of maturity patterns in the SLR portfolio is a very important function of
the treasury manager.
Along with this, the market risk of the portfolio in terms of its price sensitivity to
interest rate change needs to be quantified and periodically monitored by means of
analytical tools such as duration analysis. This will give a measure of the precise risk profile
of the security holdings, and enable the portfolio manager to initiate suitable corrective
action in line with the treasury’s overall investment strategy and risk return parameters.
Along with investment for statutory reserves, the treasury al makes investments in various
other kinds of instruments such as Certificate of Deposits, Commercial Papers, Public Sector
Bonds, Units, and Corporate Debts etc. These investment decisions depends on factors such
as bank’s liquidity position, money market condition tenure of funding available, market
liquidity in various instruments, yield and tax planning requirements. Treasury may hold

investment in these instruments till their maturity or it can trade on them to take advantage
of market opportunities.
 Trading and Distribution:

Trading and Distribution skills are keys to the success of any treasury. Tradability provides
liquidity in various instruments and generates non-fund based revenues. With increasing
competition among banks, spreads in traditional banking products are decreasing regularly.
On the other hand cost of various liabilities is rising. As a consequence, traditional funds
based incomes banks are gradually being eroded. With the onset of reforms it is also seen
that there is an increasing trend towards disintermediation in the financial markets.
Borrowers are directly accessing through the medium of debt instruments like CPs,
debentures, etc., or through forex external borrowings. Moreover, fund-based exposures
require balance sheet growth, and that in turn entails higher capital adequacy
requirements. In such a situation, non- fund based revenue gains greater importance. It is
here that the strength of the treasury lies. It can help to transform a borrower of funds into
an issuer of debt. It can then distribute these debt instruments to investors who were till
now only depositors. This will enable the bank to earn a fee income without any balance
sheet growth and without locking up funds of its own. Trading in instruments creates more
liquidity and increases investor appetite. This has been the trend in financial markets the
world over. Securitization of debt is likely to be an important growth area in the Indian
market too in the near future.

 Customer Focus:
In a competitive environment, treasury should never lose its customer focus. In addition to
trading avenues, which are essentially volatile in nature, treasury should also have non-
volatile sources of revenue which are reflected in the diversified customer base of the bank.
With the growing liberalization and the opening up of the economy to international
financial markets and investors, the treasury departments of various banks would have to
function in a multi-product, multi-currency environment and cater to the multiple needs of
its customers. There will be pressure on the treasury to offer various rupee-based and cross
currency hedge products to their clients who have foreign currency exposures on their
balance sheets.
In fact, the recent changes in the 1regulations would, over a period of time,
ensure the convergence of local currency and foreign currency yield curves and enable the
clients to manage their foreign currency assets and liabilities in a more profitable manner
through the use of foreign exchange derivatives both in the area of currency and interest
rates. Customers today, with the help of the Foreign Exchange Unit of the treasury, are able
to raise foreign currency funds either through direct commercial borrowing or through use
of export credit agency schemes and are also able to reduce the interest costs through
embedded options or arrear swaps. While these products provide the client with the much
desired interest saving, these are not without inherent risks. It is imperative for treasury to
clearly define and explain these risks to their corporate clients and to help them effectively
manage these risks keeping in mind the dynamic nature of the foreign exchange markets.
 Risk Management:
Treasury risk management is a separate topic in its own right. One of the major responsibilities
of a successful treasury is to manage the risks arising out of the financial transactions entered
into by the treasury. The most important risks which it has to manage are liquidity risk and price
risk in addition to counterparty risk and issuer risk. In order to manage various risks, there
should be a well-defined contingency liquidity plan, term structure for interest rate limits,
maximum cumulative overflow limits, Factor sensitivities, etc. These limits should be monitored
by an independent risk manager, and the reports highlighting these limits, their usage and
excesses, if any, should be generated by an independent system, monitored and managed by
technology and operations.
In conclusion, it is worth reiterating that in today’s fast changing market environment,

treasury management has acquired a greater degree of complexity and sophistication. The
success of any treasury thus depends a great deal on strong risk management, independent
back-office operations and first rate technology, These issues have become all the more

important as profitability and commercial viability have become key criteria for assessing
performance. And, it is these very fundamentals that form the edifice of a successful treasury
that can sustain efficient allocation of internal resources on the one hand and accelerate the
globalisation of our financial markets on the other.

Bank Of India - Pursuit of Growth

Bank Of India, one of the leading Public Sector Bank in India, in its outlook and
approach, has the objective of progress and prosperity of all. Bank of India was founded in 1906
by a by a group of businessmen from Mumbai with a paid–up capital of Rs.50 lacs and work
force of 50 employees. The Bank was under private ownership and control till July 1969 when it
was nationalized along with 13 other banks. It is one of India's leading banks, with about 2,645
branches in India spread over all states/ union territories including 93 specialised branches.
These branches are controlled through 48 Zonal Offices. There are 24 branches/ offices
(including three representative offices) abroad.
VISION:
“TO BECOME THE BANK OF CHOICE FOR CORPORATES, MEDIUM BUSINESSES AND UPMARKET
RETAIL CUSTOMERS AND TO PROVIDE COST EFFECTIVE DEVELOPMENTAL BANKING FOR SMALL
BUSINESS, MASS MARKET AND RURAL MARKETS.”
MISSION:
“TO PROVIDE SUPERIOR, PROACTIVE BANKING SERVICE TO NICHE MARKETS GLOBALLY, WHILE
PROVIDING COST-EFFECTIVE, RESPONSITVE SERVICE TO OTHERS IN OUR ROLE AS A
DEVELOPMENT BANK AND IN SO DOING, MEET THE REQUIREMENTS OF OUR STAKEHOLDERS.”
In 2008, Bank Of India recorded an operating profit of Rs. 3701.21 crore, growth of
54.54% as against previous year’s growth of 40.78%. Net Profit increased to Rs. 2009.40 crore
recording growth of 78.90% as against previous year’s growth of 60.12%.The Bank earned a
profit before tax of Rs. 2684.71 crore during the year 2007-08. The contribution from different
segments of operations was - Treasury Rs. 334.80 crore, Wholesale Banking Rs. 1006.44 crore
and Retail Banking Rs. 1750.92 crore. The Bank’s Capital Adequacy Ratio, at 12.95 % during the
year as against 11.75% during the previous year. The CAR is higher than the regulatory
requirement of 9%. As per Basel II framework, the Capital Adequacy Ratio of the bank stood at
12.04% as on 31.03.2008. Net worth of the Bank in FY 2007-08 has increased to Rs. 8627.77
crore from Rs. 5503.73 crore. Gross NPA’s has came down from Rs.2479 crores in 2006 and
2101 crores in 2007 to 1931 crores in 2008 while he net NPA has came down from Rs. 1120
crores in 2006 and Rs 812crores in 2007 to Rs. 592 crores in 2008.

Treasury Operations: Bank continued to play an active role in all segments of the market –
Funds, Equity, Forex and Bonds during the year 2007-08. During the year the equity market
reached historic levels but fell sharply in January 2008. Bank earned substantial income from
the various IPOs and follow on offers. The equity desk made significant contribution towards
Treasury income.
Forex Business: The forex business handled by the bank showed a robust growth. While the
export turnover during the year 2007-08 was Rs. 28326 crore, the Import turnover was Rs.
24471 crore for the year 2007-08. The Bank continues to be a leading player in forex market.
The aggregate turnover of Bank’s Treasury Branch during the year 2007-08 was Rs. 1365252
crore.
Investments: During the year the market interest rates moved within a short band in tandem
with market liquidity conditions. The yield on benchmark 10- year G-sec on 31-03-07 was at
7.98 % and it ended the year on 31-03-08 at 7.94%. Bank maintained an optimum level of
investments keeping a balance between yield income and market risk. As against the SLR
requirement of 25% of Net Demand and Time Liabilities (NDTL), Bank maintained SLR
investments marginally higher at 1.27 of NDTL. At year end SLR investments on gross basis
amounted to Rs. 33806.03 crore (89.71% of total investments) and Non SLR investments stood
at Rs. 3875.57 crore (10.29% of total investments). Investments are made in accordance with
the comprehensive policy in this regard approved by the Board. The policy is reviewed
periodically to respond to market developments / regulatory requirements.

Treasury Management of Bank Of India
Treasury of Bank Of India is a profit centre constantly endeavouring to cater to the ever
dynamic investment requirements of the bank. Bank of India’s treasury (H.O) is concerned with
trading in money, debt, capital and forex market. Bank Of India have an integrated treasury
which provides a holistic approach to funding the balance sheet and deployment of funds
across the domestic as well as global money and forex markets. This approach also enables the
bank to optimize its asset-liability management and also capitalize on arbitrage opportunities.
Organizational structure of a Bank Of India treasury facilitate the handling of all market
operations, from dealing to settlement, custody and accounting, in both the domestic and
foreign exchange markets.
The organizational set up of the treasury of Bank Of India ensures greater efficiency and
transparency with Chairman, Board of Directors and Executive Director at the top most position
in the hierarchy. Assets Liability Management Committee (ALCO) prepares the “Investment
Policy” in consultation with the GM and AGMs of the treasury department on the grounds of
the report prepared by the treasury’s mid-office.
The treasury department (H.O) is headed by General Manager who directs controls and
co-ordinates the activities of the department along with the AGMs. AGM Front-Office (Forex,
Bonds, MM, Derivatives ) and AGM Mid & Back-Office heads the representative departments.
Highly knowledgeable and professional executives work under the guidance of the respective
AGMs to optimize its asset-liability management and also capitalize on investment, trading and
arbitrage opportunities to earn profits.
In money market the bank transacts in almost all instruments including the CCIL
(Clearing Corporation of India Ltd.) created CBLO (Collateralized Borrowing and Lending
Obligations) market. The treasury of Bank of India is an active member of Negotiated Dealing
System (NDS) and Real Time Gross Settlement (RTGS). Bank is also a member of FIMMDA.
Coming to the operations, the bank operates through front office, back office and mid
office, though the mid office is not fully functional. The front office consists of the dealers who
take on the dealing transactions in different instruments with the counter party through the
NDS platform.
Appropriate Information technology (process, package and infrastructure) is necessary
for treasury management as the operations/transactions are distinct from branch banking and
are also very critical. As best software packages available in the market which suit it the bank’s
needs are adopted.
In view of the voluminous and complex nature of transactions handled by the BOI
treasury, various functions are segregated as under:

Front – Office: The front office of a treasury has a responsibility to manage investment and
market risks in accordance with instructions received from the bank’s ALCO. This is undertaken
through the Dealing Room which acts as the bank’s interface to international and domestic
financial markets.
 Study the market trends and risk.
 Buying securities for investment purposes.
 Buying/selling in securities for taking advantage of the fluctuations in the market
 Executing deals for the portfolio management/strategic operations of the bank
 Borrow/lend in the inter-bank money market
 To borrow/lend in CBLO, repo markets
 Maintenance of front office records
 Keeping liaisons with counter-parties, brokers and back office to ensure that all deals
have been completed
Mid – Office: Mid-office is responsible for onsite risk measurement, monitoring and
management reporting. The other functions of Mid Office are:
 Limit setting and monitoring exposures in relation to limits;
 Assessing likely market movements based on internal assessments and external /
internal research;
 Evolving hedging strategies for assets and liabilities;
 Interacting with the bank’s Risk Management Department on liquidity and market risk;
 Monitoring open currency positions;
 Calculating and reporting VAR;
 Stress testing and back testing of investment and trading portfolios;
 Risk-return analysis; and
 Marking open positions to market to assess unrealized gain and losses.
Back – Office: The key functions of back-office are:

 Deal slip verification;

 Generation and dispatch of interbank confirmations;
 Monitoring receipt of confirmations from counterparty banks;
 Monitoring receipt of confirmations of forward contracts;
 Effecting/receiving payments;
 Settlement through CCIL or direct through Nostro as applicable;
 Monitoring receipt of forex funds in interbank contracts; (It) Statutory reports to the
RBI;
 Management of Nostro Funds-to advise latest Funds position to enable the F/O to take
the decision for the surplus/short fall of funds;
 Reconciliation of Nostro/other accounts;
 Monitoring approved exposure and position limits; and
 Accounting.
Responsibilities and Elements Of BOI Treasury
 Maintenance of CRR and SLR
Bank Of India along with other banks in India is required to maintain stipulated level of cash
reserve ratio (CRR) and statutory liquidity ratio (SLR). In regard to cash reserve, the provisions
of section 42(1) of the Reserve Bank of India Act, 1934, governs the scheduled PCBs whereas,
non scheduled PCBs are governed by the provisions of section 18 read with section 56 of the
Banking Regulation Act, 1949 (As applicable to co operative Societies ) , hereinafter referred as
Act. The provisions of section 24 of the Act ibid govern maintenance of SLR for all the banks
(scheduled as well as non-scheduled).
Statutory Minimum CRR

In terms of section 42(1) of the Reserve Bank of India (RBI) Act, 1934, the scheduled
PCBs were required to maintain with the RBI during the fortnight, a minimum average daily
balance of 5 % as on 31st January, 2009 of their total net demand and time liabilities (NDTL) in
India obtaining on the last Friday of the second preceding fortnight. In term of the proviso to
sub-section (1) of section 42 of the RBI Act 1934, RBI is empowered to increase, through
Gazette notification, the said rate up to 15% of the NDTL.
Consequent upon the amendment to sub-section (1) of Section 42 of the RBI Act 1934, effective
from June 22, 2006 the Reserve Bank having regard to the needs of securing monetary stability
in the country, can prescribe the Cash Reserve Ratio (CRR) for Scheduled Commercial Banks
without any floor rate or ceiling rate. The statutory minimum CRR requirement of 3 per cent of
total demand and time liabilities no longer exists with effect from June 22, 2006, RBI has
decided to continue with the status quo on the rate of CRR required to be maintained by
Scheduled Commercial Banks at the rate of 6.5 per cent of the demand and time liabilities.
Statutory Liquidity Ratio (SLR)

In terms of Section 24 (2-A) of the B.R. Act, 1949 all Scheduled Commercial Banks, in
addition to the average daily balance which they are required to maintain under Section 42 of
the RBI, Act, 1934, are required to maintain in India, an amount which shall not, at the close of
the business on any day, be less than 24 % (this is now amended and there is no floor in terms
of the Act . It could now be specified by the RBI)or such other percentage not exceeding 40 per
cent as the RBI may from time to time, by notification in gazette of India, specify, of the total of
its demand and time liabilities in India as on the last Friday of the second preceding fortnight,
a) In cash, or
b) In gold valued at a price not exceeding the current market price, or
c) In unencumbered approved securities valued at a price as specified by the RBI from time to
time.(this is at the market price or the market value as announced by the FIMMDA)
SLR Securities:
1. Govt Of India Securities
2. State Development Loans
3. Other approved securities.
The obligation to maintain the required liquid assets arises on each day of a fortnight
commencing from Saturday, and ending with the second following Friday. The compliance with
this obligation is monitored ordinarily with reference to the position of the SLR as on the
relevant alternate Friday.
Banks are also required to maintain SLR on borrowing through CBLO. However,
securities lodged in the Gilt Account of the bank maintained with CCIL under CSGL facilities
remaining unencumbered at the end of any day can be reckoned for SLR purposes by the

concerned bank. For this purpose, CCIL provides a daily statement to banks/RBI listing the
securities lodged/utilized/remaining unencumbered.
If a bank fails to maintain the required amount of SLR, it shall be liable to pay to RBI in
respect of that default, the penal interest for that day at the rate of 3 per cent per annum
above the bank rate on the shortfall and if the default continues on the next succeeding
working day, the penal interest may be increased to a rate of 5 percent per annum above the
Bank Rate for the concerned days of default on the shortfall.
All the PCBs are required to maintain investments in government securities, for SLR
purposes, only in SGL Accounts with Reserve Bank or in Constituent SGL Accounts of scheduled
commercial banks, Primary Dealers (PDs), State Co-op. Banks, and Stock Holding Corporation of
India Ltd. or in the dematerialized accounts with depositories such as National Securities
Depositories Ltd (NSDL), Central Depository Services Ltd., (CDSL) and National Securities
Clearing Corporation Ltd. (NSCCL).
Current a/c with RBI

As every bank is required to have a current a/c with RBI, Bank Of India is also required to
have a current a/c with RBI and the daily closing balance of this current a/c is considered for
CRR calculation and the excess balance over CRR requirement for SLR calculation. Certain
amount of cushion is needed in the balance on the last day of the reporting fortnight.
Subsidiary General Ledger (SGL)

Bank investing in government securities has to hold the securities book-entry form
(commonly known as Subsidiary General Ledger form). The RBI has permitted banks, primary
dealers and certain other entities like NSCCL, SHCIL and NSDL to provide CSGL facilities to
subscribers. Transfers through SGL accounts by the banks having SGL facility can be made only
if they maintain a regular current account with the Reserve Bank. Before issue of SGL transfer
forms covering the sale transactions, banks should ensure that they have sufficient balance in
the respective SGL accounts. Under no circumstances, should an SGL transfer form issued by a
bank in favour of another bank, bounce for want of sufficient balance in the SGL account. The
purchasing bank should issue the cheques only after receipt of the SGL transfer forms from the
selling bank.
If the SGL transfer form bounces for want of sufficient balance in the SGL Account, the
bank which has issued the form will be liable for the following penal action:
1. The amount of SGL form (cost of purchase paid by the purchaser of the bank) will be debited
immediately to the current account of the selling bank with the Reserve Bank.

2. In the event of an overdraft arising in the current account following such a debit, penal
interest will be charged by the Reserve Bank on the amount of the overdraft at a rate of 3%
points above the SBI DFHI’s call money lending rate on the day in question.
3. If the bouncing of the SGL form occurs thrice, the bank will be debarred from trading with the
use of the SGL facility for a period of 6 months from the date of occurrence of the third
bouncing. If after restoration of the facility, any SGL form of the bank bounces again, the bank
will be permanently debarred from the use of the SGL facility in all the PDOs of the Reserve
Bank.
Investment Fluctuation Reserve (IFR)

With a view to build up adequate reserves to guard against market risks:
 Banks should build up Investment Fluctuation Reserve (IFR) out of realised gains on sale of
investments, and subject to available net profit, of a minimum of 5 per cent of the
investment portfolio by March 2008. This minimum requirement should be computed with
reference to investments in two categories, viz., and ‘Held for Trading (HFT) ’and‘ Available
for Sale (AFS). It will not be necessary to include investment under ‘Held to Maturity’
category for the purpose. However, banks are free to build up a higher percentage of IFR up
to 10 per cent of the portfolio depending on the size and composition of their portfolio,
with the approval of their Board of Directors.
 Banks should transfer maximum amount of the gains realised on sale of investment in
securities to the IFR. Transfer to IFR shall be as an appropriation of net profit after
appropriation to Statutory Reserve.
 The IFR, consisting of realised gains from the sale of investments from the two categories,
viz., ‘Held for Trading’ and ‘Available for Sale’, would be eligible for inclusion in Tier II
capital.
 Transfer from IFR to the Profit & Loss Account to meet depreciation requirement on
investments would be a ‘below the line’ extraordinary item.
 Banks should ensure that the unrealised gains on valuation of the investment portfolio are
not taken to the Income Account or to the IFR.
 Banks may utilise the amount held in IFR to meet, in future, the depreciation requirement
on investment in securities.
 Creation of IFR as per the above guidelines is mandatory for primary (urban) co-operative
banks having aggregate Demand and Time Liabilities of Rs. 100 crore and above, and
optional for smaller banks.
 Distinction between IFR and IDR It may be noted that Investment Fluctuation Reserve (IFR)
is created out of appropriation from the realised net profits / out of profits earned on
account of sale of investments initially held under HTM category but subsequently shifted
to AFS or HFT category, and forms part of the reserves of the bank qualifying under Tier II

capital, whereas Investment Depreciation Reserve (IDR) is a provision created by charging

diminution in investment value to Profit & Loss Account. While the amount held in IFR
should be shown in the balance sheet as such, the amount held in IDR should be reported as
Contingent provisions against depreciation in Investment.

Financial Instruments
With an integrated independent treasury, Bank of India deals in four types of market
instruments i.e. money market, capital, debt market and forex market instruments. An attempt
has been made, in this project, to portray in brief the various treasury transactions undertaken
by the bank for investment and trading purposes to gain profit.
Call/Notice Money Market
The money market is a market for short-term financial assets that are close substitutes
of money. The most important feature of a money market instrument is that it is liquid and can
be turned over quickly at low cost and provides an avenue for equilibrating the short-term
surplus funds of lenders and the requirements of borrowers. The call/notice money market
forms an important segment of the Indian Money Market. Under call money market, funds are
transacted on overnight basis and under notice money market; funds are transacted for the
period between 2 days and 14 days and money lent for 15 days to 1 year is called “Term
money”. Intervening holidays and/or Sundays are excluded for this purpose.
Features:
 The call market enables the banks and institutions to even out their day-to-day deficits
and surpluses of money.
 To fill the gaps or temporary mismatches in funds
 To meet the CRR & SLR Mandatory requirements as stipulated by the Central bank
 To meet sudden demand for funds arising out of large outflows
 Commercial banks, Co-operative Banks and primary dealers are allowed to borrow and
lend in this market for adjusting their cash reserve requirements.
 Specified All-India Financial Institutions, Mutual Funds and certain specified entities are
allowed to access Call/Notice money only as lenders.
 It is a completely inter-bank market hence non-bank entities are not allowed access to this
market.
 Interest rates in the call and notice money markets are market determined.
 In view of the short tenure of such transactions, both the borrowers and the lenders are
required to have current accounts with the Reserve Bank of India.
 It serves as an outlet for deploying funds on short-term basis to the lender having steady
inflow of funds

Participants:
Participants in call/notice money market currently include banks (excluding RRBs) and
Primary Dealers (PDs), both as borrowers and lenders
Prudential Limits:
The prudential limits in respect of both outstanding borrowing and lending transactions in
call/notice money market for banks and PDs are as follows:-
Sr.No. Participant Borrowing Lending

1 Scheduled On a fortnightly average basis, On a fortnightly average
Commercial borrowing outstanding should basis, lending outstanding
Banks not exceed 100 per cent of should not exceed 25 per
capital funds (i.e., sum of Tier cent of their capital funds;
I and Tier II capital) of latest however, banks are allowed
audited balance sheet. to lend a maximum of 50
However, banks are allowed to per cent of their capital
borrow a maximum of 125 per funds on any day, during a
cent of their capital funds on fortnight.
any day, during a fortnight.
2 Co-operative Borrowings outstanding by No Limit.

Banks State Co-operative
Banks/District Central Co-
operative Banks/ Urban Co-op.
Banks in call/notice money
market on a daily basis should
not exceed 2.0 per cent of their
aggregate deposits as at end
March of the previous
financial year.
3 Primary PDs are allowed to borrow, on PDs are allowed to lend in

Dealers (PDs) average in a reporting call/notice money market,
fortnight, up to 200 per cent of on average in a reporting
their net owned funds (NOF) fortnight, up to 25 per cent
as at end-March of the

previous financial year. of their NOF.
 Non-bank institutions are not permitted in the call/notice money market with effect
from August 6, 2005.
Interest Rate:
 Eligible participants are free to decide on interest rates in call/notice money market.
 Calculation of interest payable would be based on FIMMDA’s (Fixed Income Money
Market and Derivatives Association of India) Handbook of Market Practices.
Dealing Session:
Deals in the call/notice money market can be done up to 5.00 pm on weekdays and 2.30
pm on Saturdays or as specified by RBI from time to time.
Documentation:
Eligible participants may adopt the documentation suggested by FIMMDA from time to
time.
Reporting Requirement:
All dealings in call/notice money on screen-based negotiated quote-driven system (NDS-
CALL) launched since September 18, 2007 do not require separate reporting. It is mandatory for
all Negotiated Dealing System (NDS) members to report their call/notice money market deals
(other than those done on NDS-CALL) on NDS. Deals should be reported within 15 minutes on
NDS, irrespective of the size of the deal or whether the counterparty is a member of the NDS or
not. In case there is repeated non-reporting of deals by an NDS member, it will be considered
whether non-reported deals by that member should be treated as invalid.
The reporting time on NDS is up to 5.00 pm on weekdays and 2.30 pm on Saturdays or
as decided by RBI from time to time.
With the stabilisation of reporting of call/notice money transactions over NDS as also to
reduce reporting burden, the practice of reporting of call/notice/term money transactions by
fax to RBI has been discontinued with effect from December 11, 2004. However, deals between
non-NDS members will continue to be reported to the Financial Markets Department (FMD) of
RBI by fax as hitherto.
In case the situation so warrants, Reserve Bank may call for information in respect of
money market transactions of eligible participants by fax.
Platforms:
Call money market operates through 3 platforms:

1) Call money
2) CBLO
Call Money Market (NDS Platform)

Call Money Market (NDS Platform) is an independent platform where banks can lend or
borrow money for a short period. Collateral securities are not required. Interest rates are
higher than the CBLO platform due to absence of any collateral securities. Volumes traded on
NDS platforms are lower than those in CBLO platform.
Procedure for dealing in call market-

 Before any call transactions availability of surplus or deficit cash with the bank is ensured.
 If there is surplus then the money is lent, and if there is any deficit then money is borrowed
from the call market.
 If a lending transaction is intended to be closed in on the NDS, then desired interest rate
and the amount is quoted to the pre-specified counter parties.
 If the counter party accepts the quote on the NDS, then deal is confirmed. But if the counter
party shows an interest for the amount but is not satisfied with the rate of interest, then
telephonic negotiation is done and deal is confirmed when the agreed rate is arrived at.
 On confirmation a deal ticket is generated specifying the deal id, date, time, counter party,
amount, interest rate period of lending and the reversal date etc.
 After the generation of deal ticket, it’s signed by the respective authority and finally by the
head of treasury dept.
 Then the RTGS department is notified to transfer the deal amount to the counter party’s
account.
 Now the Deal Ticket is transferred to the Back office and record is maintained through a
register entry.
 It’s important to note here that for a transaction a reversal transaction is also made at the
expiry of the specified time (i.e. for a T+0 settlement, a reversal transaction is done after 1
day).
 Settlement for call transactions generally happens in 1 day, but if money is lent on Friday, or
any holiday then settlements could take 2/3 days.
CBLO Market:
CBLO market has been developed by CCIL (clearing corporation of India ltd) with the
help of RBI for the purpose of facilitating liquidity through interbank transactions. BOI qualifies

for trading in CBLO market as it’s a member of CCIL and has a CSGL a/c with CCIL. Unlike call
market, in CBLO market the counter party is totally anonymous and CCIL takes responsibility of
payment in case of default by holding securities (G-sec) of the borrowing banks. Interest rates
are lower than the Call Money Market (NDS Platform) as there is zero risk of default. Volumes
traded on CBLO platforms are higher than those in Call Money Market (NDS Platform).
Procedure for dealing at CBLO market-

 At the beginning of the day the CCIL assigns a limit to the bank as per the request of the
bank and within the purview of the pre specified guidelines of CCIL and RBI.
 Securities of the limit’s worth are transferred to the CSGL a/c of the bank in CCIL.
 With the help of the NDS intended lenders and borrowers quote their bids.
 One buys CBLO to lend money and one sells CBLO to borrow. CBLO here means an
instrument to enable the member either to borrow or to lend.
 Once the quote i.e. the buy n sell of CBLO is done, automated matching of buying to selling
happens through NDS platform.
 When the bid/quote/offer is matched against another it’s confirmed by production of a
ticket having the details of the transaction made which is printed at the member’s terminal
bearing member’s name, user number, trade date, time, order number, trade number,
market type, trade type (sell/buy), settlement type, CBLO id, face value, yield %, price
consideration (the amount to be given after interest adjustments) etc.
 This deal ticket is then transferred to the back office for record keeping purposes.
 T+0 and T+1 instrument are only available in a CBLO market, which are settled in 1 and 2
day respectively.
 After the deal is struck, money is transferred from the lenders a/c to the borrower’s a/c and
a lien on the same amount of security of borrower is created by CCIL for the lender.
 When the borrower returns the money to the lender, the lien on those securities is
removed.
 At the time of lending the borrower deducts the interest and lends the remaining. But at
the time of repayment the borrower repays the whole amount.
[For example, if a lender buys a CBLO to lend 5 cr at an int. rate of 10% p.a (yield).
Then 13698(5cr * 10% divided by 365 days as we assume repayment in 1day) as int. will be
deducted and the rest amount, i.e. 49986302 will be forwarded to the borrower. But at the
time of repayment the borrower repays 5cr. In the deal ticket % of money lent is expressed i.e.
99.97 in this case.]

Repo/Reverse-Repo Market:
In addition to call and CBLO market BOI deals in repo and reverse repo transactions also.
Repo, short for repurchase agreements, is contracts for the sale and future repurchase of a
financial asset, most often sovereign securities. On the termination date, the seller repurchases
the asset at the same price at which he sold it, and pays interest for the use of the funds.
Interest is fixed by RBI. Legally a sequential pair of sales, a repo is essentially a short-term
interest-bearing loan against collateral. All Repo contracts are settled through the current
account maintained with the RBI, and the transactions are done through NDS platform. Repo
can sometimes be done through telephone as it requires negotiation between the two parties.
Procedure for Repo:

 In a repo transaction, the securities are sold in the first leg at market related prices and re-
purchased in the second leg at the derived prices. The sale and repurchase is accounted in
the repo account.
 The balance in the Repo Account is netted from the Bank’s Investment account for balance
sheet purposes.
 The difference between the market price and the book value in the first leg of the repo is
booked in Repo Price adjustment account. Similarly the difference between the derived
price and the book value in the second leg of the repo is booked in the Repo Price
Adjustment Account.
Procedure for Reverse Repo:

 In a reverse repo transaction, the securities are purchased in the first leg at prevailing
market prices and sold in the second leg at the derived price. The purchase and sale is
accounted for in the Reverse Repo Account.
 The balances in the Reverse Repo Account is transferred to the Investment Account for
balance sheet purposes and is then reckoned for SLR purposes if the securities acquired
under reverse repo transactions are approved securities.
 The security purchased in the reverse repo is then entered in the books at the market price
(excluding broken period interest). The difference between the derived price and the book
value in the second leg of the reverse repo is lastly booked in the Reverse Repo Price
Adjustment Account.

Debt Market
The main aim of the desk is to maintain the SLR statutory requirements, liquidity in the
firm and earn profits. Bank Of India deal in various debt market securities like SLR Securities
(Government Securities (G-Secs), Sate Development Loans (SDLs), Treasury Bills(T-Bills) & Other
approved securities) and Non-SLR Securities (PSU & Corporate Bonds and Corporate
Debentures).
G-Secs & T-Bills: G-Secs are dated long-term debt obligation of Central Government while
the Treasury Bills are short-term debt obligations of the Central government. G-Secs are coupon
based securities while the T-Bills are discounted instruments. Generally only three types of
treasury bills are issued: 14-day, 182-day, and 364-day.
At the beginning of every half of the financial year government announces an issue
calendar for G-Secs and T-Bills. Closer to the dates specified in the calendar, RBI announces the
quantum, coupon, date of issue, date of redemption, calendar interest payments, etc... of the
respective instruments. G-Secs and T-Bills are issued by the way of auction process.
The securities are accounted in the dematerialized form in the Subsidiary General
Ledger (SGL).
SDLs: The State Government issues securities termed as State Development Loans (SDLs),
which are medium to long- term maturity bonds floated to enable fund their budget deficits.
RBI notifies the quantum, coupon, date of issue, date of redemption, calendar interest
payments, etc… Normally SDL are issued at a fixed coupon which is accounted for the issue.
SDLs also issued on auctioned mechanisms. On the issue date the successful bidders are
required to deposit money at the counters of the RBI. On the basis of the amount RBI decides
to retain the notified amount and refund the excess received or to retain the entire
subscription and allots. The securities are accounted in the dematerialized form in the
Subsidiary General Ledger (SGL).
All the investments are classified into 3 categories: Available for Sale (AFS), Held to
Maturity (HTM) and Held for Trading (HFT). Investments in HFT cannot be kept for more than
80 days while the investments in AFS can be more than 80 days or till maturity in case of HTM.
Investment day to day trading is done through 2 platforms: GOMS or OTC(NDS).
Procedure for day to day trading:
 Front-Office Executives undergoes trade issues the deal slips.

 Back-Office Executives verifies the deal in terms of limits and sanctioned the deal.
 The integrated software manages the stock account.
Basic Concept:
Coupon: It is the rate of interest stipulated payable on a security

Current Yield (CY): Current yield is the effective rate of interest paid on a bond, calculated by
the coupon rate divided by the bond's market price.
Yield to Maturity (YTM): YTM is the rate of return anticipated on a bond if it is held until the
maturity date. YTM is considered a long-term bond yield expressed as an annual rate. The
calculation of YTM takes into account the current market price, par value, coupon interest rate
and time to maturity.
Yield Curve: Yield curve is the relation between the interest rate (or cost of borrowing) and the
time to maturity of the debt for a given borrower.
Types of Yield Curve: In general yield curves are of three types- normal yield curve, inverted
yield curve and flat yield curve. Let’s analyze three of them separately.
The Normal Yield Curve: Normal yield curve is sometimes referred to as "positive yield curve".
A yield curve in which short-term debt instruments have a lower yield than long-term debt
instruments of the same credit quality is called a normal yield curve. This yield curve is
considered "normal" because the market usually expects more compensation for greater risk.
Longer-term bonds are exposed to more risks such as changes in interest rates and an increased
exposure to potential defaults. Also, investing money for a long period of time means an
investor is unable to use the money in other ways, so the investor should be compensated for
this through the time value of money component of the yield.
Flat or Humped Yield Curve: A flat yield curve is observed when all maturities have similar
yields, whereas a humped curve results when short-term and long-term yields are equal and
medium-term yields are higher than those of the short-term and long-term. A flat curve sends
signals of uncertainty in the economy. This mixed signal can revert back to a normal curve or
could later result into an inverted curve.

Inverted Yield Curve: An interest rate environment in which long-term debt instruments have

a lower yield than short-term debt instruments of the same credit quality. This type of yield
curve is the rarest of the three main curve types and is considered to be a predictor of
economic recession.
Partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have
higher yields than the 30-year Treasuries do. An inverted yield curve is sometimes referred to
as a "negative yield curve". Historically, inversions of the yield curve have preceded recessions.

Due to this historical correlation, the yield curve is often seen as an accurate forecast of the
turning points of the business cycle.
Clean Price: The clean price is the price payable for the face value of the bond.
Dirty Price: Bond prices are usually quoted 'clean', that is, without accrued interest, and then
settled 'dirty', that is, with accrued interest. So the dirty price is dirty because it contains an
additional cost that was not mentioned in the quoted price. Whenever a coupon payment is
made, the dirty price immediately falls by the amount of the coupon.
Duration: The term duration has a special meaning in the context of bonds. It is a measurement
of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows. It is
an important measure for investors to consider, as bonds with higher durations carry more
risk and have higher price volatility than bonds with lower durations.
Modified Duration: Modified duration is a modified version of the Macaulay model that
accounts for changing interest rates. Because they affect yield, fluctuating interest rates will
affect duration, so this modified formula shows how much the duration changes for each
percentage change in yield. For bonds without any embedded features, bond price and
interest rate move in opposite directions, so there is an inverse relationship between
modified duration and an approximate 1% change in yield. Because the modified duration
formula shows how a bond's duration changes in relation to interest rate movements, the
formula is appropriate for investors wishing to measure the volatility of a particular bond.
Modified duration is calculated as the following:
OR,
Valuation
Held to Maturity: Investments classified under Held to Maturity category need not be marked
to market and will be carried at acquisition cost, unless it is more than the face value, in which
case the premium should be amortised over the period remaining to maturity. Banks should
recognise any diminution, other than temporary, in the value of their investments in

subsidiaries/ joint ventures which are included under Held to Maturity category and provide
therefore. Such diminution should be determined and provided for each investment
individually.
Available for Sale: The individual scripts in the Available for Sale category will be marked to
market at quarterly or at more frequent intervals. Securities under this category shall be valued
scrip-wise and depreciation/ appreciation shall be aggregated for each classification referred
above. Net depreciation, if any, shall be provided for. Net appreciation, if any, should be
ignored. Net depreciation required to be provided for in any one classification should not be
reduced on account of net appreciation in any other classification. The book value of the
individual securities would not undergo any change after the marking of market.
Held for Trading: The individual scripts in the Held for Trading category will be marked to
market at monthly or at more frequent intervals and provided for as in the case of those in the
Available for Sale category. Consequently, the book value of the individual securities in this
category would also not undergo any change after marking to market.
Market value
The ‘market value’ for the purpose of periodical valuation of investments included in the
Available for Sale and Held for Trading categories would be the market price of the scrip as
available from the trades/ quotes on the stock exchanges, SGL account transactions, price list of
RBI, prices declared by Primary Dealers Association of India (PDAI) jointly with the Fixed Income
Money Market and Derivatives Association of India (FIMMDA) periodically. In respect of
unquoted securities, the procedure as detailed below should be adopted.
Unquoted SLR securities
Central Government Securities: Banks should value the unquoted Central Government
securities on the basis of the prices/ YTM rates put out by the PDAI/ FIMMDA at periodical
intervals. Treasury Bills should be valued at carrying cost.
State Government Securities: State Government securities will be valued applying the YTM
method by marking it up by 25 basis points above the yields of the Central Government
Securities of equivalent maturity put out by PDAI/ FIMMDA periodically.
Other ‘approved’ Securities: Other approved securities will be valued applying the YTM method
by marking it up by 25 basis points above the yields of the Central Government Securities of
equivalent maturity put out by PDAI/ FIMMDA periodically.
Unquoted Non-SLR securities

Debentures/ Bonds: All debentures/ bonds other than debentures/ bonds which are in the
nature of advance should be valued on the YTM basis. Such debentures/ bonds may be of
different companies having different ratings. These will be valued with appropriate mark-up
over the YTM rates for Central Government securities as put out by PDAI/ FIMMDA periodically.
The mark-up will be graded according to the ratings assigned to the debentures/ bonds by the
rating agencies subject to the following: -
(a) The rate used for the YTM for rated debentures/ bonds should be at least 50 basis points
above the rate applicable to a Government of India loan of equivalent maturity.
(b) The rate used for the YTM for unrated debentures/ bonds should not be less than the rate
applicable to rated debentures/ bonds of equivalent maturity. The mark-up for the unrated
debentures/ bonds should appropriately reflect the credit risk borne by the bank.
(c) Where the debenture/ bonds is quoted and there have been transactions within 15 days
prior to the valuation date, the value adopted should not be higher than the rate at which the
transaction is recorded on the stock exchange.
Zero Coupon Bonds: Zero coupon bonds should be shown in the books at carrying cost, i.e.,
acquisition cost plus discount accrued at the rate prevailing at the time of acquisition, which
may be marked to market with reference to the market value. In the absence of market value,
the zero coupon bonds may be marked to market with reference to the present value of the
zero coupon bond. The present value of the zero coupon bonds may be calculated by
discounting the face value using the Zero Coupon Yield Curve with appropriate mark up as per
the zero coupon spreads put out by FIMMDA periodically. In case the bank is still carrying the
zero coupon bonds at acquisition cost, the discount accrued on the instrument should be
notionally added to the book value of the scrip, before marking it to market.
REPORTING
Commercial banks are required to submit a statement containing information on their
investments in approved securities and money market instruments, etc. on quarterly basis. The
statement as at the end of each calendar quarter should reach RBI, Central Office, Commercial
Banks Department within 10 days from the close of the quarter.
Foreign Exchange Market

Foreign Exchange Markets are dynamic round the clock markets. The world currency
market are marked by the presence of currencies like US Dollar (USD), Great British Pound

(GBP), Euro (EUR), Swiss Franc (CHF), Japanese Yen (JPY), etc… besides the other continental
and exotic currencies. Currencies of the countries that have taken capital account convertibility
are deemed to be freely tradable or they are said to float freely in FX markets. E.g. USD, GBP,
EUR, JPY, etc… Currencies of countries whose economies are partially open on the capital
account and fully or partially open on the current account follow a managed float. E.g. INR
Factors influencing exchange rates:

 Demand and Supply for the individual currency.
 Relative strengths of the economies fir a given pair of currencies
 Trade- surplus/ deficit vis-à-vis the currencies of the countries concerned
 A host of economic factors like GNP, Fiscal Deficit, BOP position, Industrial production data,
etc…
 Monetary Policies of the Government/ Central Bank
 Political and the security climate
 Inflation and Interest rate differential
The role of banks in Indian FX market comes into focus as the customers cannot deal in
the FX market without banking medium. Banks while catering clients FX requirements also
ensures that all the transactions are well within the ambit of the provisions the Exchange
Control Regulations under Foreign Exchange Management Act,1999. RBI is the regulatory
authority for the Indian FX market. RBI issues guidelines/regulations/instructions from time to
time which govern the functioning of the market.
BOI’s Foreign Exchange Management

Bank of India is the Authorized Foreign Exchange Dealer with RBI. BOI maintains Foreign
Currency Accounts (Nostro A/c) at the foreign centers and simultaneously maintains Indian
Rupee Account (Vostro A/c) of the foreign correspondents in India. BOI FX dept earns from:
Exchange income, Interest Income, Fee Based Income, Consultancy Income and Certification
Income.
Exporters sell foreign currency while the importers buy the foreign currency. Apart from
the trade transactions there are inward or outward remittances of foreign currency. Customers’
requirement for purchase of foreign currency also arise from capital account transactions such
as Foreign Currency Borrowings or their repayment, issue of ADRs/GDRs, acquisition of
domestic companies by an overseas entity or acquisition of overseas companies by domestic
entity.
Bank of India Forex Dept consists of “Merchant Desk” and “Inter-Bank Desk”.
 Merchant Desk: Merchant Desk is concerned with merchant trading, which refers to
entering of a particular transaction in the books of Banks on behalf of a client. Merchant
Desk is concerned with trading with the customers or BOI branches on behalf of the
customers. Here the merchant dealers immediately cover the operations in respect of such

deals so that they are insulated from any risk arising out of adverse exchange rate
movements against the quotes already offered to the client. Hence Merchant Desk is
supposed to earn profit and never book a loss.
 Inter-Bank Desk: Inter-Bank Desk is concerned with inter-bank trading, which refers to
entering a particular transaction for bank. Inter-Bank Desks concerned with trading with
other banks, financial institutions or PD. Here the Inter-Bank dealers have to quote
according to the prevailing market rate and their position. ALCO committee sets open
position stop limit, day limit and overnight limit for the Inter-Bank Desk to avoid heavy
losses due to high fluctuation in exchange rate and to avoid the greed of the dealers.
Activities undertaken by BOI forex dept

 Issuing “Forex Card” every morning as a reference to branches, clients, etc…
 Undertaking buying and selling (Trading) transactions in forex markets.
 Entering into futures and options trade for hedging the exchange risk of the bank and its
clients
 Undertaking International Trade Transactions
 Handling international collection bills
 Opening import letters of credit
 Opening Indian rupee and foreign currency accounts for NRI and local customers
 Offering inward/outward remittance service
 Offering encashment service for clients/ tourists of foreign currency notes and travelers
cheques
 Issuing foreign currency notes and traveler cheques to tourists and clients.
Forex Card issued by BOI treasury dept on 26/6/2008
Forex Rates
Sr.No. Currency TTS TTB TCS TCB
1 AUD 41.32 40.51 41.55 40.15
2 CAD 42.64 41.8 42.85 41.4
3 CHF 41.57 40.75 41.8 40.4
4 DKK 9.05 8.87 9.1 8.7
5 EUR 67.38 66.32 67.7 65.75
6 GBP 84.82 83.65 85.25 83.05
7 HKD 5.52 5.41 5.55 5.35

8 JPY 39.85 39.2 40.05 38.85
9 NOK 8.49 8.33 8.55 8.25
10 NZD 32.6 31.96 32.8 31.6
11 SEK 7.18 7.04 7.2 6.9
12 SGD 31.55 30.93 31.7 30.65
13 USD 42.86 42.49 43.05 42.1
Note : These are indicative rates & subject to change according to market movement
Procedure of forex deals:

 Customers approach the bank to ask for the best quote of offer for the required currency.
 Front-office executives quote the best possible rates with an intention to get the deal done.
( Merchant Dealers checks the current market rate add appropriate spread and quotes,
while the Inter-Bank Dealers checks the banks current position along with the inter-bank
rate and quotes)
 If the quantum of the deal is more than 1 million cross desk transaction takes place. Inter-
bank executives check the rate in the inter-bank market, add some spread and quote the
rate. It is done cause inter-bank rate are usually lower the market rate and hence customer
will get the lowest rate or to avoid the market rate risk.
 If the customer accepts the deal, front-office executive feeds the details regarding the type
of contract, quantum of money, rate applicable, etc… and enters the deals into the system.
 Deal slip is forwarded to the back office.
 Back-office executives sanction the deal by verifying quoted rate through the recorded
conversation and the market rate at the moment of transaction.
 Back-office executives verifies the inter-bank transactions in terms of the prescribed limits
in terms of the open position stop limit, day limit and overnight limit
 After sanctioning the transaction back office executive settles the transactions through CCIL,
RTGS or SWIFT system
Forward Contracts:
Forward Exchange Contract is an agreement whereby the exporter/importer hedges his
position by entering into an agreement with the bank to sell/buy the foreign currency at a
specified exchange rate on or during specified future date/dates. The dealer quotes the forward

contract rate by adding a spread to the ongoing forward market rate. Through forward
contracts bank also hedge their open position by crystallizing the currency at a specific rate. If
bank has a positive balance, they short the currency futures and if the banks have a negative
balance they long the currency futures
Capital Market
Priory banks were not allowed to participate in the capital market due to high risk
embedded in the equity trading. Further to develop the capital market banks were allowed to
trade in the capital market. Banks do invest in large amount in the high yielding capital market
both in primary and secondary market. Banks are not allowed to perform intraday trading and
arbitrage in the market.
Investments are classified into 3 categories:
1) Available for Sale(AFS)
2) Trading
3) Old Available for Sale(Old AFS)
Available for Sale (AFS):

 Only BSE-200 or Nifty-50 scripts which have good potential and momentum are hold under
this category.
 Stocks received through primary capital market (IPO subscription) are also hold under this
category.
 Maximum investment per script is Rs.15 crores. Investment can be further increased by the
consent of AGM and Executive Director.
 Stop loss limit is 15%, AGM can increase the stop loss limit to 17%, and Executive Directors
can further increase the stop loss limit 27%.
 Script can be held as long as the script is in profit or has not reached the stop loss limit.
Trading:
 Non BSE-200 or Non Nifty-50 scripts which have good potential and momentum are hold
under this category.
 Maximum investment per script is Rs.5 crores. Investment can be further increased by the
consent of AGM and Executive Director.
 Script can be held for maximum 90 days. Holding period can be increased by the consent of
AGM and Executive Director

Old Available for Sale (Old AFS):

 This category consists of script taken from AMCs and other financial institutions.
 Scripts taken from financial institution are valued and their potential is determined prior to
their purchase.
 Script can be held as long as the script is in profit or has not reached the stop loss limit.
Bank of India utilizes the Reuter and Net Wire for its equity portfolio management. Bank
of India has a network of around 200 brokers and sub brokers. Equity management is confined
to front and back office.
The equity shares in the bank's portfolio should be marked to market preferably on a
daily basis, but at least on a weekly basis.
Procedure for dealing in capital markets:

 Front office executives regularly receive the fundamental analysis from various brokers and
other sources.
 Front office executives regularly receive calls from the brokers regarding the potential
script.
 Front office executives verify the brokers’ information through technical and fundamental
analysis and arrive at the decision.
 Front office executives place the order to buy/sell the script.
 Front office executives manually feed the rate, quantity and the amount of the transaction.
 Back office executives validate the transaction by verifying the transactions details with the
broker.
 In case of buying the script back office executives calculate the brokerage and transfer the
funds (Cost + Brokerage) in the evening.
 In case of sale, back office executives evaluates the front office operation in terms of stop
loss limit, then calculates the amount receivable ( Sale price – Brokerage ) and informs the
broker about the same.
 Settlement is done in T+2 days.
 Back office executives also monitor and collect the dividends on the scripts.
 Entire port folio in mark to market on a weekly basis and the loss or profit is taken into
consideration by the back office executives. In case of equity shares for which current
quotations are not available or where the shares are not quoted on the stock exchanges,
should be valued at break-up value (without considering ‘revaluation reserves’, if any)
which is to be ascertained from the company’s latest balance sheet (which should not be
more than one year prior to the date of valuation). In case the latest balance sheet is not
available the shares are to be valued at Re.1 per company.

Certificates of Deposits
Certificates of Deposit (CDs) are rupee denominated short-term borrowings in the form
of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one
year. They are similar to the traditional term deposits but are negotiable and can be traded in
the secondary market. They are often referred to as Negotiable Certificate of Deposit. Though
RBI has allowed CD’s up to one year maturity, they are generally issued for 90 days.
Since CD’s are not homogenous in terms of issuer, maturity, interest rate and other
features, the secondary market for this instrument does not have much depth but the
instrument itself is highly secure.
Eligibility: CDs can be issued by (i) scheduled commercial banks excluding Regional Rural
Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have
been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.
Aggregate Amount & Minimum Size of Issue and Denominations: Banks have the
freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall
umbrella limit fixed by RBI, i.e., issue of CD together with other instruments, viz., term money,
term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent
of its net owned funds, as per the latest audited balance sheet. Minimum amount of a CD
should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber
should not be less than Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.
Subscription: CDs can be issued to individuals, corporations, companies, trusts, funds,

associations, etc. non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-
repatriable basis which should be clearly stated on the Certificate. Such CDs cannot be
endorsed to another NRI in the secondary market.
Maturity: The maturity period of CDs issued by banks should be not less than 7 days and not
more than one year. The FIs can issue CDs for a period not less than 1 year and not exceeding 3
years from the date of issue.
Discount/ Coupon Rate: CDs may be issued at a discount on face value. Banks/FIs are also
allowed to issue CDs on floating rate basis provided the methodology of compiling the floating
rate is objective, transparent and market-based. The issuing bank/FI is free to determine the
discount/coupon rate. The interest rate on floating rate CDs would have to be reset periodically
in accordance with a pre-determined formula that indicates the spread over a transparent
benchmark.
Reserve Requirements: Banks have to maintain the appropriate reserve requirements, i.e.,
cash reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.

Transferability: Physical CDs are freely transferable by endorsement and delivery. Dematted
CDs can be transferred as per the procedure applicable to other demat securities. There is no
lock-in period for the CDs.
Loans/Buy-backs: Banks/FIs cannot grant loans against CDs. Furthermore, they cannot buy-
back their own CDs before maturity.
Format of CDs: Banks/FIs should issue CDs only in the dematerialised form. However,
according to the Depositories Act, 1996, investors have the option to seek certificate in physical
form. Issuance of CDs will attract stamp duty. There will be no grace period for repayment of
CDs. If the maturity date happens to be holiday, the issuing bank should make payment on the
immediate preceding working day. Banks/FIs may, therefore, so fix the period of deposit that
the maturity date does not coincide with a holiday to avoid loss of discount / interest rate.
Payment of Certificate: Since CDs are transferable, the physical certificate may be
presented for payment by the last holder. The question of liability on account of any defect in
the chain of endorsements may arise. It is, therefore, desirable that banks take necessary
precautions and make payment only by a crossed cheque. Those who deal in these CDs may
also be suitably cautioned.
The holders of dematted CDs will approach their respective depository participants
(DPs) and have to give transfer/delivery instructions to transfer the demat security represented
by the specific ISIN to the ‘CD Redemption Account’ maintained by the issuer. The holder
should also communicate to the issuer by a letter/fax enclosing the copy of the delivery
instruction it had given to its DP and intimate the place at which the payment is requested to
facilitate prompt payment. Upon receipt of the Demat credit of CDs in the "CD Redemption
Account", the issuer, on maturity date, would arrange to repay to holder/transferor by way of
Banker’s cheque/high value cheque, etc.
Accounting: Banks/FIs may account the issue price under the Head "CDs issued" and show it
under deposits. Accounting entries towards discount will be made as in the case of "cash
certificates". Banks/FIs should maintain a register of CDs issued with complete particulars.
Documentation: Bank of India mid office operates on the prescribed policy by Fixed Income
Money Market and Derivatives Association of India (FIMMDA) for operational flexibility and
smooth functioning of the CD market. Banks should include the amount of CDs in the
fortnightly return under Section 42 of the Reserve Bank of India Act, 1934 and also separately
indicate the amount so included by way of a footnote in the return. Further, banks/FIs should
submit a fortnightly return, as per the format given in Annex II, to the Chief General Manager,
Financial Markets Department, Reserve Bank of India within 10 days from the end of the
fortnight date.
Risks

 Price risk – as exposed to interest rate risk

 Credit risk - Counterparty risk is minimal since CD is a secure instrument.

Commercial Paper (CP)

Commercial Paper (CP) is an unsecured money market instrument issued in the form of
a promissory note. CP was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers to diversify their sources of short-term borrowings and to provide an
additional instrument to investors.
Eligibility: Highly rated corporate borrowers, primary dealers (PDs) and satellite dealers (SDs)
and all-India financial institutions (FIs) which have been permitted to raise resources through
money market instruments under the umbrella limit fixed by Reserve Bank of India are eligible
to issue CP.
A company shall be eligible to issue CP provided - (a) the tangible net worth of the
company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working
capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore
and (c) the borrowal account of the company is classified as a Standard Asset by the financing
bank/s.
Rating Requirement: All eligible participants should obtain the credit rating for issuance of
Commercial Paper, from either the Credit Rating Information Services of India Ltd. (CRISIL) or
the Investment Information and Credit =Rating Agency of India Ltd. (ICRA) or the Credit Analysis
and Research Ltd. (CARE) or the Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India) or such
other credit rating agency as may be specified by the Reserve Bank of India from time to time,
for the purpose. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by
other agencies. Further, the participants shall ensure at the time of issuance of CP that the
rating so obtained is current and has not fallen due for review.
Maturity: CP can be issued for maturities between a minimum of 15 days and a maximum up
to one year from the date of issue. If the maturity date is a holiday, the company would be
liable to make payment on the immediate preceding working day.
Denominations: CP can be issued in denominations of Rs.5 lakh or multiples thereof.

Investment in CP: CP may be issued to and held by individuals, banking companies; other
corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional Investors (FIIs). However, investment by FIIs would be
within the 30 per cent limit set for their investments in debt instruments.
Mode of Issuance: CP can be issued only in a dematerialized form through any of the
depositories approved by and registered with SEBI.CP can be held only in dematerialized form.
CP will be issued at a discount to face value as may be determined by the issuer. Banks and All-
India financial institutions are prohibited from underwriting or co-accepting issues of
Commercial Paper.

Payment of CP: On maturity of CP, the holder of the CP will have to get it redeemed through
the depository and receive payment from the IPA.
Risks involved
 Liquidity risk : this risk is managed be laying down deal size limits for the dealers, heads
of desk and heads of groups.
 Credit risk : This risk is managed by laying down counterparty limits based upon the
financial strength of the counterparty
Commercial Bills
Bills of exchange are negotiable instruments drawn by the seller (drawer) of the goods
on the buyer (drawee) of the goods for the value of the goods delivered. These bills are called
trade bills. These trade bills are called commercial bills when they are accepted by commercial
banks. If the bill is payable at a future date and the seller needs money during the currency of
the bill then he may approach his bank for discounting the bill. The maturity proceeds or face
value of discounted bill, from the drawee, will be received by the bank. If the bank needs fund
during the currency of the bill then it can rediscount the bill already discounted by it in the
commercial bill rediscount market at the market related discount rate.
The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later
modified into New Bills Market scheme (NBMS) in 1970. Under the scheme, commercial banks
can rediscount the bills, which were originally discounted by them, with approved institutions
(viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealer,
etc.).
With the intention of reducing paper movements and facilitate multiple rediscounting,
the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). So the
need for physical transfer of bills has been waived and the bank that originally discounts the
bills only draws DUPN. These DUPNs are sold to investors in convenient lots of maturities (from
15 days up to 90 days) on the basis of genuine trade bills, discounted by the discounting bank.
Risks involved
 Interest rate risk: market forces dictate the Bill Rediscounting rate. However the interest
rates in the BRDS are less volatile than in the call money market.
 Liquidity risk: this risk is managed be laying down deal size limits for the dealers, heads
of desk and heads of groups.
 Credit risk: This risk is managed by laying down counterparty limits based upon the
financial strength of the counterparty.

BONDS & DEBENTURES

Long-term debt securities issued by the Government of India or any of the State
Government’s or undertakings owned by them or by development financial institutions are
called as bonds. Instruments issued by other entities are called debentures.
A Bond is a loan given by the buyer to the issuer of the instrument. Bonds can be issued
by companies, financial institutions, or even the government. Over and above the scheduled
interest payments as and when applicable, the holder of a bond is entitled to receive the par
value of the instrument at the specified maturity date.
The corporate bond market consists of issuers of three different categories- government
owned financial institutions (FIs), government owned public sector units (PSUs) and private
corporate -
 Financial institutional bonds: The FIs, which do not have access to retail deposits like banks,
depend on bond issues for raising funds. There are highly rated and hence quote the lowest
rate of funds.
 Public sector unit bonds: PSUs bonds are in the high-risk category due to their poor
financial condition, only the better managed PSUs approach the markets to raise the funds.
The PSUs are also given an advantage in terms of tax breaks for the investors on
investments in specified PSU bonds. These bonds referred to as tax-free bonds, obviously
get traded at lower yields. Investments in rest of PSU bonds are taxed like any other bonds.
 Corporate bonds: Private corporate also access the bond market to raise funds. This
phenomenon has increased of late as the primary capital markets have been dull for the last
two years. This has diverted a lot of corporate to issue bonds. The investors in these
markets are mainly banks, FIs, mutual funds etc.
A Debenture is a debt security issued by a company (called the Issuer), which offers to pay
interest in lieu of the money borrowed for a certain period.
Debentures can be classified on the basis of convertibility into:

 Non Convertible Debentures (NCD): These instruments retain the debt character and
cannot be converted in to equity shares
 Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity
shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This
is normally decided at the time of subscription
 Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the
issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the
investors enjoy the same status as ordinary shareholders of the company.

 Optionally Convertible Debentures (OCD): The investor has the option to either convert
these debentures into shares at price decided by the issuer/agreed upon at the time of
issue.
On basis of Security, debentures are classified into:
 Secured Debentures: These instruments are secured by a charge on the fixed assets of the
issuer company. So if the issuer fails on payment of either the principal or interest amount,
his assets can be sold to repay the liability to the investors
 Unsecured Debentures: These instrument are unsecured in the sense that if the issuer
defaults on payment of the interest or principal amount, the investor has to be along with
other unsecured creditors of the company.
In essence it represents a loan taken by the issuer who pays an agreed rate of interest
during the lifetime of the instrument and repays the principal normally, unless otherwise
agreed, on maturity.
These are long-term debt instruments issued by private sector companies. These are
issued in denominations as low as Rs 1000 and have maturities ranging between one and ten
years. Long maturity debentures are rarely issued, as investors are not comfortable with such
maturities
The rates in these markets differ for different issuer categories. While top rated private
corporate and PSUs are treated on par, FIs pay less coupon on their issues. In line with the
general trend in the interest rates in the economy, the rates on these bonds have come down
from the high levels in 1995 and 1996. This downward trend has been mainly due to higher
liquidity with the banking system along with the new found enthusiasm of banks for bonds in
comparison to loans due to capital adequacy requirements.
The bond market though composed of government bonds and corporate bonds, is
dominated by government bonds. Bonds issued by the Government of India i.e. Central
Government, are the pre-dominant and the most liquid component of the bond market. Since
government bonds have much lower volatilities than equities, and all bonds are priced on the
same macroeconomic information, bond market liquidity is normally much higher than stock
market liquidity.

INTRODUCTION
We may define ‘Risks’ as uncertainties resulting in adverse outcome, adverse in relation
to planned objective or expectations. ‘Financial Risks’ are uncertainties resulting in adverse
variation of probability or outright losses.
Insofar as profit or loss of business depends up on the net result of all cash inflows and
cash outflows, uncertainties in cash inflows and/or outflows also create uncertainties in net
cash flow or profits. Factors that are responsible for creating uncertainties in cash outflows and
cask inflows are the risk elements. In a simple case of a trading business that involves purchase
of goods for sale with some administrative and transportation costs, cash inflows would arise
from sale. The variation in sales volume and unit price realization would create uncertainties in
cash inflows. Similarly, cash outflows would arise from purchases and administrative and
transportation costs. Uncertainties in purchase price (assuming goods are always available at a
price) and other cost would create uncertainties in cash outflows. Uncertainties in both, cash
outflows and inflows would result in uncertainties in net cash flow or profits. This can affect
profits favourably or unfavourably. If sales price and/or sales volume are more than what was
expected or purchase price decline or other expenses incurred are less, it will result in higher
profits. But if sales volume and/or sales price decline or purchase price rises or other expenses
increase, it will result in lower profits or even outright losses. Risk of the business would lie
where profits are adversely affected. This can happen due to adverse impact of uncertainties
associated with sales volume, sales price, purchase price and administrative and transportation
expenses, which are risk factors or risk elements.
Uncertainties associated with risk elements impact the net cash flow of any business or
investment. Under the impact of uncertainties, variations in net cash flow take place. This could
be favourable as well as unfavourable. The possible unfavourable impact is the “RISK” of the
business.
In the same example, suppose that the trader engages in trading of a commodity where
demand fluctuates widely and/or prices also change substantially over a short period, as is

observed in case of in trading of shares. In such cases if everything moves favourably, the trader
can earn very high profits. Reverse would be true if everything moves adversely. In other words,
variability in net cash flow would be high in such cases and because of that it may result in
higher profits or in adverse situations, higher losses. So such business is a business with higher
risk. Similarly, if variability in net cash flow is lower, it will result in lower profits and lower
losses and the business would have lower risk.
Lower risk implies lower variability in net cash flow with lower upside and downside
potential. Higher risk would imply higher upside and downside potential. Zero risk would imply
no variation in net cash flow. Return on zero risk investment would be low as compared to
other opportunities available in the market.
RISK IN BANKING BUSINESS

The major risk in banking business or ‘Banking risks’ is listed below:-
 Liquidity Risk
 Interest Rate Risk
 Market Risk
 Default or Credit Risk, and
 Operational Risks
Banking Risk
Interest Rate Liquid Risk Market Risk

Risk
Operational
Default/Credit
Risk
Risk

LIQUIDITY RISK
The liquidity risk of banks arises from funding of long-term assets by short-term
liabilities, thereby making the liabilities, subject to rollover or refinancing risk. Funding liquidity
risk is defined as the inability to obtain funds to meet cash flow obligations. For banks, funding
liquidity risk is crucial. The liquidity risk in banks manifest in different dimensions:
 Funding Risk: This arises from the need to replace net outflows due to unanticipated
withdrawal/non-renewal of deposits (wholesale and retail);
 Time Risk: This arises from the need to compensate for non-receipt of expected inflows of
funds i.e. performing assets turning into non-performing assets; and
 Call Risk: This arises due to crystallization or contingent liabilities. This may also arise when
a bank may not be able to undertake profitable business opportunities when it arises.
INTEREST RATE RISK

Interest Rate Risk (IRR) is the exposure of a Bank’s financial condition to adverse
movements in interest rates. Interest Rate Risk (IRR) refers to potential impact on Net Interest
Income or Net Interest Margin or Market Value of Equity (MVE), caused by unexpected changes
in market interest rates. Interest Rate Risk can take different forms. IRR can be viewed in two
ways; Its impact is on the earnings of the bank or its impact on the economic value of the
bank’s assets, liabilities and OBS positions.
 Gap or Mismatch Risk: A gap of mismatch risk arises from holding assets and liabilities and
off balance-sheet items with different principal amounts, maturity dates or reprising rates,
thereby creating exposure to unexpected changes in the level of market interest rates.
E.g. An asset maturing in two years at a fixed rate of interest have been funded by a liability
maturing in six months. The interest margin would undergo a change after six months, as
liability would be reprised up on maturity causing variation in net interest income.
 Yield Curve Risk: In a floating interest rate scenario, banks may price their assets and
liabilities based on different benchmarks, i.e. treasury bills’ yields, fixed deposit rates, call
money rates, MIBOR, etc. In case the banks use two different instruments maturing at
different time horizon for pricing their assets and liabilities, any non-parallel movements in
yield curves would affect the NII. The movements in yield curve are rather frequent. Thus
banks should evaluate the movement in yield curves and the impact of that on the portfolio
values and income.
E.g. A liability raised at a rate linked to say 91 days T Bill is used to fund an asset linked to
364 days Treasury Bills. In a rising interest rate scenario both, 91 days and 364 days
Treasury Bills may increase but not identically due to non-parallel movement of yield curve
creating a variation in net interest earned.

 Basis Risk: The risk that the interest rate of different assets, liabilities and off-balance sheet
items may change in different magnitude is termed as basis risk.
E.g. In a rising interest rate scenario asset interest rate may rise in different magnitude than
the interest rate on corresponding liability creating variation in net interest income. The
degree of basis risk is fairly high in respect of banks that create composite assets out of
composite liabilities. The Loan book in India is funded out of a composite liability portfolio
and is exposed to a considerable degree of basis risk. The basis risk is quite visible in volatile
interest rate scenarios. When the variation in market interest rate causes the NII to expand,
the banks have experienced favourable basis shifts and if the interest rate movement
causes the NII to contract, the basis has moved against the banks.
 Embedded Option Risk: Significant changes in market interest rates create the source of
risk to banks’ profitability by encouraging prepayment of cash credit/demand loans term
loans and exercise of call/put options on bonds/debentures and/or premature withdrawal
of term deposits before their stated maturities. The embedded option risk is becoming a
reality in India and is experienced in volatile situations. The faster and higher the magnitude
of changes in interest rate, the greater will be the embedded option risk to the banks’ NII.
The result is reduction of projected cash flow and income for the bank.
 Reinvestment Risk: Uncertainty with regard to interest rate at which the future cash flows
could be reinvested is called reinvestment risk. Any mismatches in cash flows would expose
the banks to variations in NII as the market interest rates move in different directions.
 Net Interest Position Risk: Where banks have more earning assets than paying liabilities,
interest rate risk arises when the market interest rates adjust downwards. Such banks will
experience a reduction in NII as the market interest rate declines and increases when
interest rate rises. Its impact is on the earnings of the bank or its impact on the economic
value of the bank’s assets, liabilities and OBS positions.
 Rate Level Risk: During a given period there is possibility for restructuring the interest rate
levels either due to the market conditions or due to regulatory intervention. This
phenomenon will, in the long run, affect decisions regarding the type and the mix of
assets/liabilities to be maintained and their maturing periods.
The present interest rate restructuring taking place in the Indian markets is a very good
example of this aspect. The Reserve Bank of India which is the apex body regulating the
Indian monetary system, has been lowering the Statutory Cash Reserve Ratio for banks in a
phased manner from 12% to 8% since 1996. Every time the CRR is lowered, there is an
increase in the liquidity which further results in lowering of the interest rate levels. A 2% cut
in the CRR from 10% to 8% in the Busy Season Credit Policy announced in October 1997 was
immediately followed by a cut in the PLR/interest rates of Banks and FI’s.
The risk that arises due to this reduction can be understood from the fact that the
revised rates of interest will be applicable to all the new deposits, which will lower the
marginal costs of funds. However, the affect will be seen on all the existing assets.

Consequently the loss of interest income on assets is likely to be higher than the reduction
in the interest cost of deposits leading to lower spreads.
 Volatility Risk: In additions to the long run implications of the interest rate changes, there
are short term fluctuations which are to be considered in deciding on the mix of assets and
liabilities, the pricing policies and thereby the business volumes. However, the risk will
acquire serious proportions in a highly volatile market when the impact will be felt on the
cash flows and profits. The 1994 volatility witnessed in the Indian call money market
explains the presence and the impact of volatility risk. The interest rate in the call money
market, which generally hovered around 5-7 %, zoomed to 95% within a couple of weeks
during September, 1994. While some banks defaulted in the maintenance of CRR, many
banks borrowed funds at high rates, which had substantially reduced their profits. Thus, it
can be seen that the affect of fluctuations in the short term have a greater impact since the
adjustment period is very short.
 Prepayment Risk: The fluctuations in the interest rate may sometimes lead to prepayment
of loans. For instance, in a situation where the interest rate is declining, any cash inflows
that arise due to prepayment of loans will have to be redeployed at a lower rate invariably
resulting in lowered yields.
 Call/Put Risk: Sometimes when the funds are raised by the issue of bonds/securities, it may
include call/put options. A call option is exercised by an issuer to redeem the bonds before
maturity, while the put option is exercised by the investor to seek redemption before
maturity. These two options expose to a risk when the interest rate fluctuate. A call option
is generally exercised in a declining interest rate scenario. This will affect the bank if it
invests in such bonds since the intermediate cash inflows will have to be reinvested at a
lower rate. Similarly, when the investor exercises the put option in an increasing interest
rate scenario, the banks, which issue the bonds, will have to face greater replacement costs.
 Reinvestment Risk: The risk can be associated to the intermediate cash flows arising due to
the payment of interest, instalments on loans etc. These intermediate cash flows arising
from a security/loan are usually reinvested and the income from such reinvestments will
depend on the prevailing rate of interest at the time of reinvestment and the reinvestment
strategy. Due to the volatility in the interest rates, these intermediate cash flows when
received may have to be reinvested at a lower rates resulting in lower yields. This variability
in the returns from the reinvestments due to changes in the interest rates is called the
reinvestment risk.
Approaches to Quantify Interest Rate Risks are as follows:
a) Maturity Gap Method

b) Rate Adjusted Gap
c) Duration Analysis

d) Hedging
e) Sensitivity Analysis
f) Simulation and Game Theory.
MARKET RISK
Market risk is the risk of adverse deviations of the mark-market-value of the trading
portfolio, due to market movements, during the period required to liquidate the transactions.
This results from adverse movements in the level or volatility of the market prices of interest
rate instruments, equities, commodities and currencies. Market Risk is also referred to as Price
Risk.
Price Risk occurs when assets are sold before there stated maturities. In the financial
market, bond prices and yields are inversely related. The price risk is closely associated with the
trading book, which is created for making profit out of short-term movements in interest rates.
The term market risk applies to (i) that part of IRR which affects the price of interest rate
instruments, (ii) Pricing Risk for all other assets/portfolio that are held in the trading book of the
bank and (iii) Foreign Currency Risk.
 Forex Risk: Forex risk is the risk that a bank may suffer losses as a result of adverse
exchange rate movements during a period in which it has an open position, either spot
or forward, or a combination of the two, in an individual foreign currency.
 Market Liquidity Risk: Market liquidity risk arises when a bank is unable to conclude a
large transaction in a particular instrument near the current market price.
DEFAULT AND CREDIT RISK

Credit risk is most simply defined as the potential of a bank borrower or counterparty to
fail to meet its obligations in accordance with agreed terms. For most banks, loans are the
largest and most obvious source of credit risk.
 Counterparty Risk: This is a variant of credit risk and is related to non-performance of the
trading partners due to counterparty’s refusal or inability to perform. The counterparty risk
is generally viewed as a transient financial risk associated with trading rather than standard
credit risk.

 Country Risk: This is also a type of credit risk where non-performance by a borrower or
counter-party arises due to constraints or restrictions imposed by a country. Here reason
for non-performance is external factors on which the borrower or the counterparty has no
control.
OPERATIONAL RISKS
Operational risk is the risk of loss resulting from inadequate or failed internal processes,
people and systems or from external events. Strategic risk and reputation risk are not a part of
operational risk.
Operational risk may loosely be comprehended as any risk which is not categorized as
market or credit risk. Scope of operational risk is very wide. It includes Fraud risk,
Communication Risk, Documentation risk, Competence risk, Model risk, Cultural risk, External
events risk, Legal risk, Regulatory risk, Compliance risk, System risk and so on. Two of these,
which are frequently used namely, transaction and compliance risk has been defined below,
which form the part of operational risk.
 Transaction Risk: Transaction risk is the risk arising from fraud, both internal and external,
failed business processes and the inability to maintain business continuity and manage
information.
 Compliance Risk: Compliance risk is the risk of legal or regulatory sanction, financial loss or
reputation loss that a bank may suffer as a result of its failure to comply with any or all of
the applicable laws, regulations, codes of conduct and standards of good practice. It is also
called integrity risk since a bank’s reputation is closely linked to its adherence to principles
of integrity and fair dealing.
As mentioned above that Strategic Risk and Reputation Risks fall outside the scope of
Operational Risk. These are defined below:

Strategic Risk:
Strategic Risk is the risk arising from adverse business decisions, improper implementation of
decisions, or lack of responsiveness to industry changes. The risk is a function of the
compatibility of an organization’s strategic goals, the business strategies developed to achieve
those goals, the resources deployed against these goals and the quality of implementation.
Reputation Risk:
Reputation risk is the risk arising from negative public opinion. This risk may expose the
institution to litigation, financial loss, or a decline in customer base.

RISK MANAGEMENT
Managing credit risk
Credit risk arises from the potential that an obligor is either unwilling to perform on an
obligation or its ability to perform such obligation is impaired resulting in economic loss to the
bank. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of
a customer or counter party to meet commitments in relation to lending, trading, settlement
and other financial transactions. Alternatively losses may result from reduction in portfolio
value due to actual or perceived deterioration in credit quality. Credit risk emanates from a
bank’s dealing with individuals, corporate, financial institutions or a sovereign.
For most banks, loans are the largest and most obvious source of credit risk; however, credit
risk could stem from activities both on and off balance sheet. In addition to direct accounting
loss, credit risk should be viewed in the context of economic exposures. This encompasses
opportunity costs, transaction costs and expenses associated with a non-performing asset over
and above the accounting loss. Credit risk can be further sub-categorized on the basis of
reasons of default.
For instance the default could be due to country in which there is exposure or problems in
settlement of a transaction. Credit risk not necessarily occurs in isolation. The same source that
endangers credit risk for the institution may also expose it to other risk.
Credit Risk Monitoring & Control

Credit risk monitoring refers to incessant monitoring of individual credits inclusive of Off-
Balance sheet exposures to obligors as well as overall credit portfolio of the bank. Banks need
to enunciate a system that enables them to monitor quality of the credit portfolio on day-to-
day basis and take remedial measures as and when any deterioration occurs. Such a system
would enable a bank to ascertain whether loans are being serviced as per facility terms, the
adequacy of provisions, the overall risk profile is within limits established by management and
compliance of regulatory limits. Establishing an efficient and effective credit monitoring system
would help senior management to monitor the overall quality of the total credit portfolio and
its trends. Consequently the management could fine tune or reassess its credit strategy /policy
accordingly before encountering any major setback. The banks credit policy should explicitly
provide procedural guideline relating to credit risk monitoring. At the minimum it should lay
down procedure relating to:
a) The roles and responsibilities of individuals responsible for credit risk monitoring
b) The assessment procedures and analysis techniques (for individual loans & overall portfolio)
c) The frequency of monitoring
d) The periodic examination of collaterals and loan covenants

e) The frequency of site visits

f) The identification of any deterioration in any loan
Managing Market Risk
Likewise other risks, the concern for management of Market risk must start from the top management.
Effective board and senior management oversight of the bank’s overall market risk exposure is
cornerstone of risk management process. For its part, the board of directors has following
responsibilities.
a) Delineate banks overall risk tolerance in relation to market risk.
b) Ensure that bank’s overall market risk exposure is maintained at prudent levels and consistent with
the available capital.
c) Ensure that top management as well as individuals responsible for market risk management possess
sound expertise and knowledge to accomplish the risk management function.
d) Ensure that the bank implements sound fundamental principles that facilitate the identification,
measurement, monitoring and control of market risk.
e) Ensure that adequate resources (technical as well as human) are devoted to market risk management.
LIQUIDITY RISK MANAGEMENT
The prerequisites of an effective liquidity risk management include an informed board, capable
management, and staff having relevant expertise and efficient systems and procedures. It is primarily
the duty of board of directors to understand the liquidity risk profile of the bank and the tools used to
manage liquidity risk. The board has to ensure that the bank has necessary liquidity risk management
framework and bank is capable of confronting uneven liquidity scenarios. Generally speaking the board
of a bank is responsible:
a) To position bank’s strategic direction and tolerance level for liquidity risk.
b) To appoint senior managers who have ability to manage liquidity risk and delegate them the required
authority to accomplish the job.
c) To continuously monitors the bank's performance and overall liquidity risk
profile.
c) To ensure that liquidity risk is identified, measured, monitored, and controlled.

Managing Operational Risk

There are 6 fundamental principles that all institutions, regardless of their size or complexity, should
address in their approach to operational risk management.
a) Ultimate accountability for operational risk management rests with the board, and the level of risk
that the organization accepts, together with the basis for managing those risks, is driven from the top
down by those charged with overall responsibility for running the business.
b) The board and executive management should ensure that there is an effective, integrated operational
risk management framework. This should incorporate a clearly defined organizational structure, with
defined roles and responsibilities for all aspects of operational risk management/monitoring and
appropriate tools that support the identification, assessment, control and reporting of key risks.
c) Board and executive management should recognize, understand and have defined all categories of
operational risk applicable to the institution. Furthermore, they should ensure that their operational risk
management framework adequately covers all of these categories of operational risk, including those
that do not readily lend themselves to measurement.
d) Operational risk policies and procedures that clearly define the way in which all aspects of operational
risk are managed should be documented sand communicated. These operational risk management
policies and procedures should be aligned to the overall business strategy and should support the
continuous improvement of risk management.
e) All business and support functions should be an integral part of the overall operational risk
management framework in order to enable the institution to manage effectively the key operational
risks facing the institution.
f) Line management should establish processes for the identification, assessment, mitigation, monitoring
and reporting of operational risks that are appropriate to the needs of the institution, easy to
implement, operate consistently over time and support an organizational view of operational risks and
material failures.


Trsry & Risk MGMT Using Derivatives

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Trsry & Risk MGMT Using Derivatives

Uploaded by

Copyright:

Available Formats

TREASURY AND RISK MANAGEMENT

Mumbai Institute of mgmt and research

2. Evolution of Treasury Management in Banks

3. Objectives of the Treasury

6. Bank Of India - Pursuit of Growth

7. Treasury Management of Bank Of India

8. Responsibilities and Elements Of BOI Treasury

9. Call/Notice Money Market

10. Repo/Reverse-Repo Market:

11. Debt Market

12. Foreign Exchange Market

13. Capital Market

14. Certificates of Deposits

15. Commercial Paper (CP)

16. Commercial Bills

17. BONDS & DEBENTURES

18. Mutual Funds

19. Risk Management in Banks

20. Managing Risks

Mumbai Institute of mgmt and research

Treasury management can be defined as “Treasury management is the management of an

The organization of finance department differs from organization to organization. There

Treasury management in banks is the management of an organization’s liquidity to

Mumbai Institute of mgmt and research

Mumbai Institute of mgmt and research

Evolution of Treasury Management in Banks

Mumbai Institute of mgmt and research

Clearcorp Dealing Systems (India) Limited (Clearcorp), a wholly owned subsidiary of

Mumbai Institute of mgmt and research

Objectives of the Treasury

Mumbai Institute of mgmt and research

Basic Treasury Functions

Domestic Operations Forex Operations

a) Maintenance of statutory reserves a) Extending cover to foreign exchange

Mumbai Institute of mgmt and research

e) Hedge and cover operations d) Trading and Arbitrage

Mumbai Institute of mgmt and research

 Balance Sheet Management:

An important aspect of balance sheet management is Liquidity management. Liquidity

Mumbai Institute of mgmt and research

Effective liquidity management requires careful attention to balance sheet

Mumbai Institute of mgmt and research

 Reserve Management & Investments:

Mumbai Institute of mgmt and research

 Trading and Distribution:

Mumbai Institute of mgmt and research

In conclusion, it is worth reiterating that in today’s fast changing market environment,

Mumbai Institute of mgmt and research

Mumbai Institute of mgmt and research

Bank Of India - Pursuit of Growth

Mumbai Institute of mgmt and research

Mumbai Institute of mgmt and research

Treasury Management of Bank Of India

Mumbai Institute of mgmt and research

Back – Office: The key functions of back-office are:

Mumbai Institute of mgmt and research

 Deal slip verification;

Responsibilities and Elements Of BOI Treasury

 Maintenance of CRR and SLR

Statutory Minimum CRR

Mumbai Institute of mgmt and research

Statutory Liquidity Ratio (SLR)