Question 1 Give the meaning of treasury management.

Explain the need

for specialized handling of treasury and benefits of treasury.
Answer
Treasury management is the planning, organising and control of funds
required by a corporate entity. Funds come in several forms:
cash, bonds, currencies, financial derivatives like futures and options etc.
Treasury management covers all these and the intricacies of choosing the
right mix. According to Teigen Lee E, Treasury is the place of deposit
reserved for storing treasures and disbursement of collected funds.
Treasury management is one of the key responsibilities of the Chief
Financial Officer (CFO) of a company.
Need for specialised handling of treasury
Treasury management should be practised as a distinct domain within
the Finance function of an organisation for the following reasons: One of
the most consistent demands on the CFO of a company is that money
must be available when needed, and this becomes a 24/7 task.
1. The cost of money raised for the business is probably the most crucial
metric in a company for many of its investment and operational decisions.
Hence cost of funds has to be tracked diligently.
2. Internal financial management in a multi-national corporate entity
requires monitoring of several global currencies.
3. Globalisation of business has thrown up an unbelievable basket of
opportunities for the CFO to optimise the utilisation of funds and minimise
its costs. This requires expert handling.
4. Globalisation has also brought in unexpected risks that are not visible
to the untrained eye but can even destroy a business. Who would have
thought that the crash of Lehman Brothers could impact business houses
in interior India? But that was what happened in 2009.
5. With increasing financial risk shareholders have become jittery about
their holdings and need reassurance often. For a company the Treasurer is
probably the best spokesperson to allay the concerns of stockholders and
other interested
parties.
Benefits:
Managing treasury as an expert subject has many benefits:
1. Valuable strategic inputs relating to investment and funding decisions
2. Close monitoring and quick effective action on likely cash surpluses and
deficits

3. Systematic checks and balances that give early warning signals of likely
liquidity
issues
4. Significant favourable impact on the bottom line for global corporations
through effective management of exchange fluctuation
5. Better compliance with the increasingly complicated accounting and
reporting standards on cash and cash equivalents.
Question 2 Explain foreign exchange market. Write about all the types of
foreign exchange markets. Explain the participants in foreign exchange
markets.
Answer 2
Foreign Exchange market (forex market) deals with purchase and sale
of foreign currencies. The bulk of the market is over the counter (OTC)
i.e. not through an exchange which is well regulated. International trade
and investment essentially requires foreign markets. Banks act as
intermediaries and perform currency exchange transactions by quoting
purchase a selling prices.
In India the Foreign Exchange Management Act (FEMA) 1999 is the law
relating to forex transactions and its aim is to develop, liberalise and
promote forex market and its effective utilisation.
Types of foreign exchange market
1. Spot market Spot market is a market in which a currency is bought or
sold for immediate delivery or delivery in the very near future. Trading in
the spot market is for execution on the second working day. Both the
delivery and payment take place on the second day. The rate quoted is
called as spot rate, the date of settlement known as value date and the
transactions called spot transactions.
2. The forward market involves contracts for delivery of foreign exchange
at a specified future date beyond the spot date and the transaction is
called a forward transaction. The rate that is quoted at the time of the
agreement is called the forward rate and it is normally quoted for value
dates of one, two, three, six or twelve months.
3. Unified and dual markets Unified markets are found where there is
only one market for foreign exchange transactions in a country.
They have greater liquidity, increased price discovery, lower short-run
exchange rate volatility and reliable access to foreign exchange. In
contrast, dual markets are found in countries with multiple exchange
markets. For example, a country may consider forex market for current
account transactions and a different exchange for capital transactions or
market for trade transactions and another market for regulated

transactions like India had in the early 1990s, when dual exchange rates
prevailed.
4. Offshore and onshore markets During the earlier stages of financial
development, forex market operated onshore i.e. within India. But after
liberalisation of the economy, offshore markets have developed and
instruments based on foreign currencies issued by Indian firms are traded
in foreign markets.
Participants:
The participants in forex market are the RBI at the apex, authorised
dealers (ADs) licensed by the central bank, corporates and individuals
engaged in exports and imports.
1. Corporates Corporates operate in the forex market when they have
import, export of goods and services and borrowing or lending in foreign
currency. They sell or buy foreign currency to or from ADs and form the
merchant segment of the market.
2. Commercial banks Banks trade in currencies for their clients, but much
larger volume of transactions come from banks dealing directly among
themselves.
3. RBI RBI intervenes in forex market to ensure reasonable stability of
exchange rates, as forex rates impact, and in turn are impacted, by
various macro-economic indicators like inflation and growth.
4. Exchange brokers They facilitate trade between banks by linking the
buyers and sellers. Banks provide opportunities to broker in order to
increase or decrease their selling rate and buying rate for foreign
currencies. Exchange brokers also specialise in specific currencies that
have lower demand and supply to add value to banks. In India, many
banks deal through recognised exchange brokers.
Question 3 Write an overview of risk mitigation. Explain the processes of
risk containment. Write about the tools available for managing risks.
Answer 3
Risk Mitigation: It is important that an organisation is not only aware of
the risks before it impacts their bottom line, but has well-laid action plans
to meet the risks and mitigate its adverse impact. The overall
responsibility for risk management lies with the top management and the
board of directors of the enterprise.
Risk mitigation can be handed in four ways:
a) Risk avoidance: We can withdraw from an activity perceived to be risky,
and elect not to go through with it.

b) Risk transfer: We can insure ourselves against the risk and transfer it
to another party called the insurer.
c) Risk sharing: We can disperse the risk element in an activity and reduce
its impact, by the use of derivative instruments,
d) Risk acceptance: We can build our competence and capability to deal
with the risk by detailed study, research and methods developed
specifically for the concerned activity and its risk component.
As you can see, the four approaches listed above start with the simplest
(and the least profitable) to the toughest (but the most profitable). Derisking by the first approach of simply avoiding the activity is the easiest
answer but you also stand to lose the money
you could have made. At the other end the fourth approach where you
analyse the risk carefully and find specific solutions can bring great gains,
but needs spending time and effort.
Processes for risk containment
The basic steps in a typical risk containment process are:
1. Establishing the context i.e. analysing the strategic and organisational
context in which risks occur
2. Identifying risks i.e. defining the risks associated with business, to have
a fundamental understanding of the activities causing risk of loss
3. Quantifying risks i.e. measuring the probability, frequency and hence
the value of the risks, besides listing non-quantifiable effects of the risks
4. Formulating policy i.e. providing a framework to handle risks, which lays
down standard levels of exposure and policy guidelines for each level
5. Evaluating risk i.e. ranking the risks based on priority, and aligning
action and cost thereof with the rank
6. Treating risk i.e. development and implementation of a plan with
specific methods to handle the identified risks
7. Monitoring risk i.e. reviewing the methods regularly vis--vis their
efficacy in controlling risk, and updating methods from time to time in
keeping with changes in the organisation and the environment
Tools available for managing risks
Risk management tools do analysis and implementation of methods for
mitigating risks.
The major tools available for risk are:
1. Failure Mode Effects Analysis (FMEA): This tool is used for identifying
the cost of potential failures in business. This method can be applied

during analysis and design phases of new business to identify the risk of
failure. The FMEA method is divided into three steps:
a. The first step is identifying the elements causing failure.
b. The second step is studying the modes of failure.
c. The last step is assessing the probability and effects of failure
2. Fault Tree Analysis (FTA): The tool is used as a deductive technique to
analyse reliability and safety of an organisation. It is usually implemented
for dynamic systems. It provides the foundation for analysis and
justification for changes and additions of various actions to reduce risks.
3. Process Decision Program Chart (PDPC): The tool identifies the different
levels of risk and the countermeasure tasks. The process of planning is
essential before the tool is used for measuring risks. It includes identifying
the element causing risk. The next process consists of identifying the
context of problem and measures to reduce risks.
4. Risk calculations: This method is the continuous scanning of risks at
various phases of the business, to identify the most common ones and
assigning high priority to them. This calculation is obtained by the
following methods:
a. Risk exposure: The probability of the risk occurrence and total loss to
the organisation provides the overall exposure of specific risk. Risk
Exposure (RE): Probability of risk occurring x Total loss due to the risk
b. Risk reduction leverage (RRL): The value of the return on investment for
countermeasures is obtained. The reduction in the risk exposure and cost
of countermeasure helps in prioritising the possible
countermeasures.
Risk reduction leverage (RRL) = Reduction in Risk Exposure Cost of
countermeasure
c. Managing risk: Once the risks are identified and calculated the best plan
which reduces risk exposures is chosen. If abandonment is considered,
the risk management chooses alternative actions to counterpart the risk.
If it is reduction method, it changes the current action by adding new
action to reduce the risk. The contingency planning depends upon the risk
exposure and reduction leverage.
Question 4 What is Interest Rate Risk Management (IRRM)? Write the
components and features of IRRM. Explain the macro and micro factors
affecting interest rate.
Answer 4
Interest Rate Risk Management (IRRM)

Interest Rate Risk is the risk

to the earnings from an asset portfolio caused by interest rate changes
to the economic value of interest-bearing assets because of changes in
interest rates
to costs of fixed-rate debt securities from falling bank rates
to impact of interest rates on cost of capital used by the firm as hurdle
rate for capital investment
Components of IRRM
IRRM can be broken into three parts: term structure risk, basis risk and
options risk. Term structure risk also called yield curve risk is the risk of
loss on account of mismatch between the tenures of interest-bearing
monetary assets and liabilities. For example, if investments are held in 7year assets yielding a fixed 7% return, funded by a 5-year bond costing
6%, but renewed at the end of 5 years at 8%, there is a loss of 1% during
the sixth year. This can also happen if either of the tenures is on floating
and not fixed rates and the rate changes adversely.
This situation is called re-pricing and can be either asset-sensitive or
liability-sensitive, depending upon which gets re-priced first. Basis risk is
the risk of the spread between interest earned and interest paid getting
narrower. Options risk is the term risk on fixed income options i.e. options
based on fixed income instruments.
Features of IRRM
Following are the features of corporate IRRM process:
1. Clarifying the policy with regard to interest rate risk
2. Constant watch on market rate fluctuations and studying its relevance
to the firms cost of capital
3. Fixing the band beyond which interest rate changes should trigger
corrective action
4. Special attention to long-term fixed exposures in investments as well as
funding decisions
5. Effective, unambiguous and timely reporting on IRRM to the CEO and
the Board
Factors Affecting Interest Rate
Interest is usually a significant component of the companys cost of capital
unless the company is funded entirely by equity. It is important to learn
the factors that impact interest rates.

Macro factors
1. Cost of living index: Increases in price levels of goods and services over
a period of time reduce real value of the rupee and push interest rates up.
2. Monetary policy changes: RBI works with monetary policy to balance
the twin objectives of economic growth and price stability for a developing
economy like ours, and interest rate is automatically affected with
increase and decrease of money supply by RBI using repo rates.
3. Condition of economy: Whether the economy is rapidly growing or its
growth rate is declining can make a difference.
4. Global liquidity: Global economic environment and availability of funds
across the world does have an impact.
5. Foreign exchange market activity: Foreign investor demand for debt
securities influences the interest rate. Higher inflows of foreign capital
lead to increase in domestic money supply which in turn leads to higher
liquidity and lower interest rates.
Micro factors
Micro factors, meaning factors specific to the borrower, which play a role
in the interest rate, are:
1. Individual credit and payment track record, credit rating
2. Industry in which the business is operating
3. Extent of leveraging of the company viz. debt-equity ratio
4. Quality of prime security and collateral
5. Loan amount
Question 5 Explain the contents of working capital. Write down the need
for working capital.
Answer 5
As stated above, working capital comprises the working assets of a firm.
What are these assets? Look at the items in these examples.
1. A trading business for instance may have to purchase and store
products to be sold, paying for them before they can be sold and cashed.
A factory that produces and sells products has to store raw materials and
finished goods, besides having some unfinished materials under process.
2. A company may also need to allow the customers to pay later instead
of insisting on cash at the point of delivery.
3. Payments in advance may be required for certain expenses
like annual insurance, deposit for renting the office, foreign currency and

tickets for foreign travel or advance fees/deposits for statutory

registrations.
4. And finally the business must have some idle cash and bank balances
for making spot payments.
Each of these requirements takes the form of a working asset:
1. The first is a working asset or a current asset called inventories.
2. The second item is called trade receivables or accounts receivable
3. The third set of items are prepayments, advances and deposits
4. The final item is cash & cash equivalents.
These assets together comprise the working capital of a business. It is
worth repeating here that there is a separate set of assets including land,
building, machines etc. that make up the fixed capital of the company. We
are not talking about those assets here.
Need for working capital
Can a business run without the need to invest in working assets like trade
receivables and inventories? Let us study the following case.
1. Pachai is a vendor of pani-puris in a makeshift stall of his own at the
end of the street in which he lives.
2. Every morning he goes to the market and buys the ingredients to
make pani-puris for
the day, estimating the quantity based on
anticipated sales. He buys more in the weekends, naturally.
3. He does not pay for the material as he buys on credit.
4. Through the day he does the processing of the pani-puris to the stage
needed, and at 4 pm sets up the stall and runs it till 8 30 p.m.
5. As he sells the pani-puris he collects cash, and at 8.30 or earlier,
depending upon the demand, he sells his days produce completely.
6. He goes across to the vendor from whom he bought the ingredients and
pays for the supply, and returns home with the balance money, which is
his profit.
7. The cycle is repeated day after day. Here is a businessman who, you
might say, does not require working capital at all: no idle cash, no
deposits, no receivables and no inventories. But this is an extreme case
under ideal conditions.
If the produce is not sold fully it becomes inventory for the next day. Or
the vendor might want a security deposit. Or Pachai may think about
expanding by selling a part of his produce in bulk to another stall-owner,
who will pay once a week. In all these cases he will need to worry about

working capital. All businesses small, medium or big need working

capital for survival and growth. The more widespread the activity, the
greater is the need. It is of paramount importance for the financial health
of a business to assess the requirement reasonably correctly, finance it
sensibly and control it effectively and make sure the working assets keep
working, are current and do not get stuck. This is the essence of working
capital management.
Question 6 Explain the concepts and benefits of integrated treasury.
Explain the advantages and disadvantages of operating treasury.
Answer 6
The concept of integrated treasury works on the principle that Treasury
can be a single unifying force of a companys activities in the money
market, capital market and forex market; and can help the company
derive synergy. Synergy is a powerful advantage in business because it
brings together two or more activity domains and achieves a total effect
that is greater than the sum of all the individual domains. Thus a
decision related to money market instruments, for example, is taken
after reviewing possible forex actions that could enhance the benefit of
the decision.
The Indian rupee is freely convertible on current account and partially
convertible on capital account. This has made it possible to take a
combined approach to a treasury issue.
The major functions of integrated treasury are as follows:
1. Ensuring liquidity reserve
2. Deploying surplus funds in securities with low risk and moderate profits
3. Managing multi-currency operations
4. Exploring opportunities for profitable placements in money market,
securities market and forex market
5. Managing the sum total of treasury risks with some balancing actions
as between the three markets
The benefits of integrated treasury are:
1. Improved cash planning and better monitoring of the cash position
2. Constant watch on the impact of treasury activities on the balance
sheet
3. Greater financial control by integrating budgetary control and financial
information
The advantages of operating treasury as a profit centre than as a cost
centre are:

1. Individual business units can be charged a market rate for the service
provided, thereby making their operating costs more realistic.
2. The treasurer is motivated to provide services as economically as
possible to make profits at the market rate.
The disadvantages are:
1. The profit concept is a temptation to speculate. For example, the
treasurer might swap funds from the currencies that are expected to
depreciate and risk the company cash values.
2. Management time could be wasted in arguments between Treasury and
business units over the charges for services, distracting the latter from
their main operations.
3. The additional administrative costs may be excessive.