MF0007 – Treasury Management

Assignment Set-1

Q.1Describe all the tasks of Treasury Management in large Company.

Ans:
Functions of Treasury Management
The functions of Treasury Management very depending upon the nature of the organisation,
operation, quality of management etc. However, the following functions are generally
attributable to Treasury management.
(1) Framing Treasury Policies: Policies are to be framed regarding borrowing, investment,
and payment of expenses like salary, purchase of raw materials. Many areas
regarding cash sales, receipts from debtors etc., are also to be considered and
suitable policies are framed. Policies regarding cash sale and the terms of cash sale
are to be framed. Borrowing long-term funds to meet the capital expenditure also
needs framing policies. These of borrowing. Policy regarding the source of finance
and the instrument used to borrow for the capital expenditure will make a sever impact
on the future cash flows of the corporate for a long time to come. Therefore, the
policies are to be framed carefully.
(2) Establishing a Treasury System: A suitable system should be established to account
for all the income, expenses, payments and receipts. These are necessary, not only to
avoid misuse of funds, but also to ensure a proper system of accountability. In
addition, the increasing powers of regulatory agencies both in India and abroad call for
maintenance of a system that will stand the scrutiny of any government agencies like
Securities & Exchange Commission in the USA. In the wake of accounting scandals of
Enron and WorldCom, Sarbanes-Oxley Act was passed in the USA, giving greater
powers to the regulator, SEC. In India, securities Exchange Board of India (SEBI) is
also vested with a lot of powers regarding the financial intermediaries and listed
companies. Where the institution involved is banking institution, it should be able to
stand the scrutiny of the Reserve Bank of India. If it is operating in the financial
market, the bank is subject to the scrutiny of SEBI, apart from the scrutiny of the RBI.
(3) Liquidity Planning: The size of modern corporations has gone up either due to
persistent capacity expansion, international operations or mergers and acquisitions.
This brings about acute problems of cash flow. At every point of time, sufficient
liquidity is to be ensured so that the corporate does not run into the problem of
shortage to liquidity. To achieve this without sacrificing profitability, corporate are
relying on investment in money market instruments more and more. For large-scale
operations, the problem is always temporary shortage of cash and its surplus.
Temporary shortages are to be met through additional sourcing of cash. Temporary
surplus of cash has to be invested in order to avoid the presence of idle funds.
(4) Portfolio Management: As the corporates are investing heavily in the capital market
securities like equity shares, preference share, bonds or debentures, portfolio
management also becomes and important function of the Treasury. Right from the
selection of the portfolio, its designing continuous monitoring and constant churning
for an active investment strategy, it is the Treasury that plays a vital role. Various risk
management products in the form of derivatives are available in every type of
organised market. In currency markets, stock markets, foreign exchange markets,
sophisticated techniques are available to manage the risk. These derivatives can also
be used to increase the profit from operations in these organised markets.
 (5) Identification of Funding Agencies: With Liberalisation, funds are moving globally. The
skill and the comprehensive effort in tapping the source of finance and funding
agencies will bring down the cost of capital considerably. The Treasury manager must
work out various scenarios and the suitable fund-agency matrix. In the future, this will
reduce the time involved in the research in order to tap the source. Apart from the
traditional sources like banks and international monetary organisations, there is a new
breed of financiers in the form of venture capitalists, private equity partners, High Net
worth individuals, Hedge Funds etc. the Treasury Manager has to establish and
maintain contacts with every type of financiers in order to raise the funds readily and
at cheap cost.
(6) Foreign Exchange Dealings: Certain industries like the Indian software industry,
engineering industry, textiles and a host of others may be dependent upon exports.
There are manufacturing industries, which are dependent upon import of raw materials
like petroleum refineries, thermal power stations, and industries using base metals for
their operations. There are also industries, which are dependent upon both exports
and imports, as in the case of polished diamonds industry. It values of the currencies
are volatile. After liberalization of most of the economies, funds are moving very
quickly from one set of countries to the other. In such a scenario, it is the function of
the Treasury to see that such fluctuations contribute to the profits of the corporate
rather than becoming a loss. Unexpected fluctuations will make the firms to incur
losses. Well-planned operations will provide for taking hedge against a possible loss in
the future.
(7) Planning for Organic & inorganic Growth: It has become quite common that successful
corporates are going on a global on a global level expansion. They do it by way of
organic growth (which is called
Greenfield project) In the form the capacity expansion. They may also do it by way of
inorganic growth (know as Brownfield Project) through mergers and acquisitions. Both
the routes call for mobilizing huge funds. Unlike in the normal operations, funds
needed for organic and inorganic growth are required on a mammoth scale. There is
also a trend with Indian companies like Tata Steel and Tata Tea taking over
companies that are larger than the acquires. Corus taken over by Tata Steel is bigger
than the latter many times. The funds needed naturally are very huge in size. It may
be on an unprecedented scale in the history of the company. The Treasury Manager
must gear up for such challenges. The Treasury has to be ready with the funds as and
when such an organic or inorganic growth takes place. In certain organisations, it
takes place continuously and the Treasury must always be planning for raising
resources again and again.
(8) Risk Management for Derivatives: Many corporates cover every type of risk they are
exposed to. Depending upon the nature of the organisation like banking,
manufacturing, security trading etc, risks exist in most of the operations. As long as
the financial markets remained underdeveloped, the corporates had to bear the loss.
With the International Organisation of Securities Commissions (IOSCO) bringing about
uniformity in practices in financial markets and accounting practices, the facility is
provided to the corporate to cover their risks through hedging and forward dealings.
Treasury has the important task of such risk management however, derivatives are
not everyone’s cup of tea. It involves quite a lot complicated, derivatives may
contribute to heavy losses being incurred by the organisation.
Q.2 What is Qualified Institutional Placement? Do you think it is injustice on retail
investors of the Company?
Ans : Qualified institutional placement (QIP) is a capital raising tool, whereby a listed company
can issue equity shares, fully and partly convertible debentures, or any securities other than
warrants, which are convertible into equity shares, to a qualified institutional buyer (QIB). Apart
from preferential allotment, this is the only other speedy method of private placement for
companies to raise money. It scores over other methods, as it does not involve many of the
common procedural requirements, such as the submission of pre-issue filings to the market
regulator.
To enable listed companies raise money from domestic markets in a short span of time, market
regulator Sebi introduced the concept of QIP in 2006. This was also done to prevent listed
companies in India from developing an excessive dependence on foreign capital. Prior to
introduction of QIPs, the complications associated with raising capital in the domestic markets
had led many companies to look at tapping overseas markets via foreign currency convertible
bonds (FCCB) and global depository receipts (GDR). This has also helped issuing companies
price their issues closer to the prevailing market price.
I don’t think it is injustice on retail investors of the Company because there is a portion of share
is reserved for Retail Investor in each and every issue and we have seen in recent times Retail
Portion of IPOs are not fully subscribed and then QIB comes to the rescue of companies to
make the IPOs successful.
Q.3What is risk involved in investment in debt funds where more than 90% investment is
in Government bonds? Which short term option (90days) you will choose for your
Company for investment of liquid surplus and why?

Ans:

Debt funds invest in instruments that carry a fixed rate of interest or are guaranteed, in many
cases, by the issuer. As a result, debt funds are often perceived by the investor as being
completely risk-free. However, the reality is different. Debt funds may be less risky than equity
funds, but they certainly aren't risk-free. Debt fund NAVs can change with interest rates,
changes in the portfolio's ratings or tenure.

There are two types of gains — one is the interest that a debt security accrues or earns which
is also called the coupon; and the other is the capital appreciation, which it earns due to a
change in market interest rates. The following risks are associated with Debt Funds.

Interest rate risk: The price of the bond is not only based on the current interest rates but also
the expected future interest rate. The NAV of a debt fund is calculated based on the price of
the underlying bond/securities. If market interest rates fall, the price of the bond rises, thereby
increasing the NAV and vice versa.

The extent of the fall or rise will also depend on the tenure of the bond the fund is holding. The
longer the tenure, the more sensitive it is to change in interest rates. Assume a debt fund has
invested in a certificate of deposit, which carries an interest rate of eight per cent and will
mature in five years.

After a month, the central bank announces a cut in interest rates and as a result the same
deposit is now available at say 7.5 per cent. What it means is that all fresh investments will
earn 0.5 per cent lower. As the earlier deposit is earning 0.5 per cent more than the current
rates the markets will pay more for the same resulting in an increase in valuation of the
deposit, and thereby, increasing the NAV.

When the fund manager is expecting the rates to come down, he increases the tenure of the
bonds that he is holding to increase capital appreciation and reduces the tenure, if he is
expecting the rates to go up. That is why bond funds give higher returns when interest rates
are expected to go down and lower returns when it is expected to go up.
If interest rate risk is one type of risk, bond funds also carry credit risk.

Credit quality: Most securities held by debt funds have a credit rating assigned by rating
agencies, suggesting the ability of the security to meet its payment obligations. The higher the
credit rating (P+ or AAA or A1+), the lower is the perceived risk of default, and hence, lower is
the rate that one earns, and vice-versa.

Funds also take exposure in securities with lower ratings either to get higher interest rates or
with the hope that the rating will be upgraded in near future. In case the rating of a bond goes
up from say AA to AAA, there will be some capital appreciation resulting in increase in NAV. In
case of a default, the NAV will come down as the money invested in the bond cannot be
recovered from the company the fund has invested in. Therefore, it is important for an investor
to not only look at the returns generated by the fund but also the credit quality of the portfolio.

Liquidity: It is important that the bonds invested in by the fund are liquid enough to be sold
when the money is required. In case bonds are not liquid, they have to be sold at a discount,
resulting in a lower NAV.

All the above risks are manageable and can be reduced if the investor is prudent in choosing
his bond funds. If the surpluses that you have are for less than three months, you should be
investing in liquid funds that have shorter portfolio tenure.

If you have the money for more than a year, you should be investing in funds with longer
portfolio tenure or maturity like income funds. By doing this, you are aligning your investment
objective with the fund's objective, and thereby, neutralizing the volatility that the fund may go
through due to any of the risks mentioned above.

Short Term Option

Liquid funds are used primarily as an alternative to short-term fix deposits. Liquid funds invest
with minimal risk (like money market funds). Most funds have a lock-in period of a maximum
of three days to protect against procedural (primarily banking) glitches, and offer redemption
proceeds within 24 hours. The minimum investment size in a liquid fund varies from Rs.
25,000 to Rs 1 lakh.

Liquid funds invest in short-term debt instruments with maturities of less than one year.
Therefore, they invest in money market instruments, short-term corporate deposits and
treasury. The maturity of instruments held is between three and six months. A liquid fund
provides good liquidity, low interest rate risk and the prevailing yield in the market. Liquid
funds have the restriction that they can only have 10 per cent or less mark-to-market
component, indicating a lower interest rate risk.

Liquid funds have an exit load if the investor redeems before the lock-in period. But in most
cases, the lock-in period is quite low - varying from 7 to 10 days. Liquid funds score over
short term fix deposits. Banks give a fixed rate in the range 5%-5.5% p.a. for a term of 15-30
days. Returns from deposits are taxable depending on the tax bracket of the investor, which
considerably pulls down the actual return. Dividends from liquid funds are tax-free in the
hands of investor, which is why they are more attractive than deposits. The sole disadvantage
liquid funds is that investors cannot take the advantage of higher returns being offered by
long-term instruments.
 MF0007 – Treasury Management

Assignment Set-2

Q.1 Give any three measures taken by RBI in the recent past (1 year) to liberalise
exchange control?
Ans:

Over the past year, there has been a burst of exchange control liberalization. The Reserve
Bank of India (RBI) does not see merit in big bang relaxations. It swears by relaxation of
Lilliputian controls one by one to pinpoint any wrong sequencing. The three measures taken
by RBI in the recent past to liberalize exchange control are:

1. Payments for Imports: Authorized Dealers are permitted to make payment for
imports into the country. However, there should be a valid import license or the goods must
have been covered under Open General License. The authorized dealers are also permitted
to open letters of credit for imports. Sometimes, import of machinery and equipment may be
made under deferred payment system. Under the system, payments are made in a series of
installments spread over a long period of time. Instances of such transactions call for
obtaining permission of RBI in advance by furnishing bank guarantee or opening letters of
credit. Advance remittances for imports are not permitted except in case of import of capital
goods. Special procedure is adopted for imports made under credit given by a foreign
government or an international institution. The RBI advises the authorized dealers from time
to time in respect of such transactions,

2. Other Payments: Another activity that calls for payments in foreign currency is the
citizens of the country undertaking traveling in foreign countries. Restrictions were server until
early 1970s.From then on, the restrictions have been gradually relaxed over the period.
Reasonable exchange facilities were granted for education, medical treatment and business
travel. For a long period of time, foreign exchange was not sanctioned for pleasure trips.
Repatriation of profit, interest and dividend has been allowed freely. Foreign nationals
resident in India are offered liberal remittance facilities for maintenance of their families
abroad. They were also allowed to transfer their saving on their retirement. However, Indian
citizens were not allowed to make remittances to maintain their families abroad.

3. Export Control: All the exporters have to give a declaration that the export earnings
would be disposed of in manner and within the period specified by the RBI. They should also
agree to negotiate the shipping documents through authorized dealers. Payment for the
exports can by received only in any of the permitted currencies. In order to encourage
exports, RBI gave the status of “ Export Houses” to certain firms on their application and
registration. These entities can use the blanket permit to use the foreign exchange for the
sales promotion of the products in the foreign markets. The usage may be in the form of
conducting market study in the foreign countries, traveling abroad, advertising and conducting
trade fairs and exhibitions in the foreign countries. Similarly, the procedure for payment of
commission and advertising charges in foreign exchange was relaxed in case of such Export
Houses.

In view of the difficulties experienced by exporters in raising funds locally, they were
permitted to receive advance remittances from overseas buyers or agents. However, the
rate of interest payable on such advance payment should not be very high. Besides, the
 shipments should be effected within one year from the date of receipt of such an advance.
Similarly, the procedure regarding payments of agency commission advertisement
charges etc., were relaxed in the case of established exporters.

Q.2 Explain various objectives of liquidity management by Banks. What steps Banks
can take to meet the impending shortage of liquidity?
Ans:
Objective of Liquidity Management
For the banks liquidity management is a main driver of many function. With an efficient liquidity
management, the banks stand to gain in many fronts. Even though there are hundreds of
banks and thousand of branches, each bank or each branch has brand equity is liquidity
management. The main objectives and the purposes of liquidity management are highlighted
through the following aspects:
1) Retaining Public Confidence: Public confidence is crucial for mobilizing deposits. Good
liquidity management helps the bank never to run short of cash. Ready meeting of
payment and maturity schedules convince the public that the bank is built upon a sound
foundation of liquidity. The State Bank of India along with its subsidiaries never runs
short of cash due to maintaining government and public sector units’ accounts. This has
created in the minds of the public that the SBI group is one big giant of infallible
strength.
2) Proper Liquidation of Investment Products: The bank invest sizeable amount of funds in
money market instruments and capital market securities. These are either held for
profitable sale or until maturity. With a good liquidity management, the bank has no
compulsion to sell these in adverse market conditions. In case of securities held for
maturity, redemption should not be made premature to avoid incurring losses. Even
securities held for sale should not be sold in emergency. The bank may incur losses or
experience a loss of profit in adverse market conditions. A good liquidity management
helps in proper liquidation of investment product at the end of the investment horizon.
3) Avoiding Emergency Borrowing: A good liquidity management enables the borrowing
programme in the money market in the normal way. The maturing of the money market
with a large number of players and also the supply of huge funds contributed to wide
fluctuations in the market. Where it creates a temporary shortage of funds for most of
the banks, the interest rates shoot up sky-high. Longer queues of bankers in emergency
borrowing will push up the cost of funds resulting in a strain on the banker’s margin.
Liquidity management makes a serious attempt in avoiding such emergency borrowing.
4) Smooth lending Programme: Bank follows a disbursement schedule of loans given go
customer. The customer on learning about the disbursement schedules make their own
payment schedule and purchase commitment. In order to ensure such schedules are
followed, the bank should have no problem with liquidity. Any such liquidity problem will
make the bank postpone the disbursement. This may not only render the customer
dissatisfied, but it may force him try to raise the finance from other banks or from
alternative sources. This will also cause and unfavourable impression in the trading and
business circles.
5) Reputation in Financial Markets: A bank with good liquidity management impresses the
financial market. The track record of a bank in repayment in time and never running
short of cash sends a strong signal in the financial market about the soundness of the
bank. Reputation in the financial markets has commercial value. It helps the bank in
borrowing at an interest rate that is lower than that of any other bank. Such a good
 image maintained consistently over the period of time impresses the overseas investors.
The impressed foreign investors may be willing to lend to the bank or may take a stake
in the equity of the firm in the future.
6) Avoiding Penalty Of RBI: Banks not maintaining the needed Cash Reserve Ration on a
weekly basis (every Friday) will be penalized by the central bank of the country. The
relation of any bank with the central bank of the country should be based on respect and
admiration. The RBI views the banks, which are defaulting in the maintenance of CRR,
unfavourably, Good liquidity management will help in maintenance of the CRR without
much difficulty. The relation with the central bank also will be smooth. As a regulator, the
RBI is very much concerned with the financial health of the banks. The financial health
of a bank is measured first by the liquidity position of the bank and then measured by
the profitability.
7) Participation in Liquidity Adjustment Facility (LAF): For the banks to participate in the
Repo and Reverse Repo. They have to satisfy certain eligibility criteria. Though every
bank was allowed to participate in the RBI, maintaining the balance with the RBI well
above the CRR,. By this bare minimum liquidity. The banks are advice to maintain it well
above the prescribed level. Good liquidity; management will help the banks in achieving
the eligibility to participate in the LAF Facility. Where the money market undergoes and
abnormal phase of high interest rates, the bank find the Repo to be a good source of
borrowing. Where the market faces a glut of funds and low interest rates, the Reverse
Repo window of the RBI becomes a good avenue of investment for the banks.
8) Attracting FII Investment: Foreign institutional investment always finds the bank stock to
be a preferred one due to the importance enjoyed by the banking sector in the economy.
Such investment is preferred so that they can take a strategic stake at later period in the
ownership of the bank. Such FIIs consider both profitability and liquidity management to
be crucial white selecting a bank for equity participation. Generally these FIIs invest a
very huge amount in the bank with the objective of making the bank to go for expansion
and diversification immediately, Such a programmed calls for huge liquidity or cash
reserves with the bank. That is why the FIIs will eye only those banks, which enjoy a
good liquidity position.
9) Absorption Of Information Technology: Banks need to absorb the IT more and more for
their basic operations and for providing sophisticated remittance facilities. This will
enable the banks to move the funds very quickly and also will enable them to act as
financial intermediaries providing sophisticated services. There is a severe competition
among the banks to absorb new systems and updating existing system. The foreign
banks operating in India have a better liquidity management and a higher level of
profitability. They could achieve this due to the absorption of a very high level of IT in
their operations. In spite of many IT-initiatives of the RBI, Indian banks are still lagging
behind in updating the systems regularly. However, such a level of IT absorption entails
huge expenses on its maintenance. A bank’s liquidity management should be
impeccable enough to meet such huge expenses of maintenance.
10)Diversification: Banks are also entering new areas of operation like sale of gold,
custodianship, investment banking, mutual funds, insurance, depository Participation,
and acting as a financial intermediary in the capital market. All new areas of endeavour
call for investment of huge amount of funds. Unless liquidity is management well, the
funds for such diversified activities and basic operations will dry up quickly. The example
of ICICI Bank, HDFC Bank, and Kotak Mahindra Bank is undertaking diversified
activities in such a short span of time speak volumes about their ability regarding
liquidity management.
For enhancing liquidity, the banks may decide to design a suitable functional set of the
following activities:

• Deposit Mobilisation

• Liquidating Money Market Instruments

• Borrowing from RBI

• Short Term Borrowing

• Long Term Borrowing

• Appointment of Recovery Officers

• Recapitalisation
Q.3What is operating cycle? How does it affect working capital management? What are
other major factors that influence working capital management?
Ans:
Operating Cycle
Operating cycle is the time involved in converting cash into raw material, raw material into
work-in-progress, work-in-progress into finished goods, finished goods into debtors and
debtors into cash. The length of the operating cycle determines the size of working capital of a
firm. Sometimes, the production process is long, as in plantations (coffee, tea, rubber), ship
building, aircraft manufacturing, assembling satellites etc. Investment in work-in-progress is
high leading to higher working capital. Compared with them, manufacturing cosmetics,
personal care products like soaps involve shorter operating cycles. Thus, working capital
needed is less.
Working Capital Management
The modern organisation incurs a huge amount of expenses for its daily operation. Some of
the expenses are basic and traditional like cost of material, labour and other usual overheads.
Many new expenses have cropped up recently like telephone expenses, broadband services,
and network maintenance, maintenance of computer and other IT systems, fee-based services
of bank etc. the capital needed for meeting these expenses is called Working Capital. Cash or
near-cash items like cash at bank or investment in money market mutual funds, commercial
paper or certificate of deposit are needed for meeting these expenses. Cash in hand and the
balances at bank do not bring in any return. However, they are needed to meet the daily
expenses. Hence, a minimum amount of cash should be maintained without running short of it
at any time.
Factors determining the size of Working Capital: The size of working capital of a firm depends
upon a myriad of factors. So much so, the working capital is determined more by experience
than by any scientific method of estimation. The following factors generally affect the size of
working capital of a firm.
1) Nature of Business: Certain business or industries need large working capital either due
to employing a large labour force or buying huge quantity of raw material or
components. The following types of undertaking need huge working capital.

• Heavy industries like Steel Industry, Cement industry etc. (Raw material & Labour)
 • Public utilities like Railway, Airway, Electricity producing or distributing companies etc
(labour)

• Mines like coal mines, copper mines, gold mines etc (labour)

• Automobiles (labour and component.

2) Scale of Operation: Large-scale industries need huge working capital for employing more
people and buying large quantity of raw material. Therefore, scale of operation is also and
important factor.
3) Length of Operating Cycle: The size of working capital varies directly with the length of
operating cycle. In case of longer operation cycle. In case of longer operating cycle like
shipbuilding, aircraft manufacturing, construction of dams, executing turnkey project, larger
investment is there in work in progress, and hence large working capital is needed
4) Rapidity of turnover: If goods get sole quickly, lesser capital is needed. In case of FMCG
goods (Fast Moving Consumer Goods) like soaps toothpastes cosmetics, the turnover is quick.
Hence, lesser working capital needed.
5) Nature of Demand: If the demand is stable the working capital is predictable. It can be
maintained relatively at a lower level. Where the demand is highly fluctuating as in the case of
readymade dresses, jewellery, automobile etc., higher size of working capital is needed.
6) Level of Automation: Higher level of automation in the industry reduces the labour force.
Hence, lesser size of working capital is needed. Lower level of automation requires larger
labour force, larger payment of wages and thus larger working capital.
7) Reliability of Supply: The nature of supply of raw material and components also decides
the size of working capital. If the supply is not certain, a larger inventory should be carried
resulting in larger working capital.
8) Operative Efficiency: Highly efficient companies carry on production with minimum raw
material and minimum labour force. Naturally, they can carry on with lesser working capital.
9) Credit Policy: Companies that sell the goods only on cash basis need minimum working
capital. When credit sale is allowed, the length of the credit period allowed determines the size
of working capital. Longer the period more will be the size of working capital.
10) Supplier’s credit: Companies buying only on cash basis need a large size of working
capital. If credit purchase is possible, the period of credit allowed decides the size of working
capital. Longer the period less will be the working capital.
11) Prices of Inputs: If costly inputs like diamonds, gold and platinum are used as in the
case of watch-manufacturing, jewellery industry etc., working capital needed is large.
12) Level of Profits: Industries that are highly profitable like computer software need lesser
working capital. Their profits themselves contribute to the working capital.
13) Banking Norms: Banks may prescribe the norms to be followed by the industry in order
to lend for the working capital requirements. If so, such norms have a great effect on the size of
working capital
14) Taxes: Heavily taxed industries like cigarette manufacturing, breweries etc, need larger
working capital just to pay the excise duty to the government.
15) Dividend Policy: Some companies like control, Punjab tractors etc declare 3 to 4 Interim
dividends in a year. Naturally, it will call for a larger working capital.