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ASSIGNMENTS Subject code: MF0007 (2 credits) Set 1 Marks 30 SUBJECT NAME: TREASURY MANAGEMENT Note: Each Question carries

10 marks
1. What are the diverse functions of an integrated treasury as compared to a convertional treasury? Ans: Functions of Integrated Treasury of a Bank : The banks have the compulsions of operating in almost all the organized markets. Apart from this, they also have to manage the risks arising from liquidity, interest rates, foreign exchange etc. Therefore, the functions of an Integrated Treasury of a bank cover most of the functions of a modern Treasury. Statutory Investment Management: Every bank has to maintain a Cash Reserve Ratio (CRR) and statutory liquidity ratio (SLR). The law requires every bank to maintain the investment and its form in order to ensure the liquidity of the banks. Treasury has the basic duty of statutory compliance by making suitable investment and maintaining sufficient cash reserves in the manner prescribed. Funds Management: It is also necessary to determine the suitable mix of deposits and other borrowings. This will determine the cost of funds and the liquidity position of the banks. It is also necessary to design the assets mix, which will include the investment and loans mix, designing the investment portfolio, and designing the loan portfolio in line with the social banking policies of the government. Such a planning of assets will determine the liquidity of the bank and its profitability.

Asset- Liability Management (ALM): The ALM has the objectives of achieving all the organizational objectives of the bank. The organizational objectives of the bank are solvency (survival in the long-term), profitability and sufficient liquidity. In performing the necessary functions to achieve the objectives, the Treasury decides on important aspects like designing deposit products, loan products etc. Risk Management: As the bank is operating in all the organized markets, it is subject to every type of risk like currency risk, interest rate risk, market risk etc. Ever since the RBI liberalized interest rates and the banks started offering floating rate loans, the banks are subject to the risk arising from the changes in the interest rates. It becomes necessary for the banks to use every type of derivative to manage the risk like interest rate swap, arbitrage and hedging. Capital Adequacy: The Treasury must ensure that the bank has sufficient TIER I capital i.e., equity share capital and reserves & surplus. This is to ensure long-term solvency of the bank, as only the equity share capital will bear the loss of bad loans ultimately. Reserve Bank Of India has also prescribed the deadline of March 31,2009 to comply with capital adequacy norms. In the light of this, Treasury has the responsibility to raise the necessary equity capital through the issue of equity shares. We have already noted that Treasury, instead of being a conventional cost center has become a profit centre. The main source of profit for the Treasury arises from the following dealings: 1. Foreign Exchange Dealing: By using the export income judiciously, a corporate can make a huge profit. Movements in foreign exchange market reflect the developments from countries all over the world. Thus, the fluctuations under the free float or managed free float are very high. A brilliant Treasury makes profit that is directly proportional to the fluctuations in the market. 2. Money Market Dealings: Treasury can invest in money market instruments like Treasury Bills, Commercial Paper, and Certificate of Deposit. In addition, they can also operate in the CBLO (Collateralized Borrowing and Lending Obligations discussed in subsequent modules) with huge funds flowing into the market. Corporate can make a hefty profit with the fluctuations in the interest rates.

3. Securities & Commodities Markets: Either directly or through Investment Trusts, corporate invests in equities, bonds, or debentures. These are held either for long term or churned often to maximize the returns. In addition, organizations like banks sell gold by importing them directly leading to the profit on sale. Investment in equities offers twin benefits to the corporate. It contributes to the profits on frequent purchase and sale. Equities accumulated in large quantities can help in taking over the concerned Joint Stock Company at a later date. In this manner, Treasury operations add to the strategic plans of the organization. In short, Treasury has come to occupy a significant position in a modern organisation. This is due to the maturing of financial markets with complex instruments like derivatives for risk management. This importance will continue to grow with more financial sector reforms and a more intense level of globalization. Q.2 Explain the features of book-building and different stages involved in book building.
Ans: Features

of Book-building:

1. Quantity Assessment: The number of shares to be issued so that company can get the maximum price is assessed and determined. Larger quantity of shares may reduce the share premium. To avoid this, the quantity is assessed by collecting the opinions of institutional investors. 2. Price Discovery: The investors are given a choice to bid different quantities at different prices. As happens in a public auction, the investors bid at different prices. Before public does this, the price preference of institutional investors is collected to determine the price band. 3. Documents: Instead of relying on a single document called prospectus as in the fixed price public offer, different documents can be used like notice, circular, Information Memorandum or a Red-Herring Prospectus (A prospectus that is incomplete regarding the price). The final prospectus is prepared after the allotment by including the issue price (cut-off price). 4. Category: The issue can be divided into two categories:

a) Private Placement Portion: It is the portion that is offered to the syndicate members and to the institutional investors. Institutional Investors are called "Qualified Institutional Buyers (QIB)". They comprise mutual funds, financial institutions, foreign institutional investors etc.

b) Public Issue: It is that portion which is offered to the public for bidding. It is known, as "net offer to the public" Originally 25% of the issue size was to be reserved for net offer to the public. From 2005, this portion is increased to a minimum of 35%. 5. Lead Book Running Manager: The main Merchant Banker is appointed as Lead Book Running Manager (LBRM). Other merchant bankers are called Co-Book Runners. For collecting the bids on behalf of their customers, syndicate members are appointed. Syndicate Members are those financial intermediaries who are eligible to be appointed as underwriters. Different stages involved in book building Financial Intermediaries involved: The number of financial intermediaries involved in book-building is less in comparison with fixed price public issue of shares. The activity is more focused with a lesser number of intermediaries operating under a sophisticated system of office management. As time of completion is very crucial, all the intermediaries operate under a system of a high-level Information Technology absorption. Total net worked system is essential for the successful operation of the system. Important financial intermediaries and their functions are presented briefly. A. Merchant Banker as a Book Runner A Merchant Banker is appointed as the Lead Book Runner. Other Merchant Banker may be appointed as Co-Book Runners. The Lead Book Runner has the following responsibilities: Advising the company in the appointment of other Book Runners Enabling the appointment of Syndicate Members Preparation and circulation of Information Memorandum among Syndicate Members.

Through the Syndicate Members, collecting information about the quantity and the price Preparation of a Red Herring Prospectus and Filing it with SEBI along with the Enabling the Companies to appoint other financial intermediaries like Registrar to the Filing Due Diligence Certificate with SEBI declaring the satisfaction of all the regulation. Determining the Price Band. Announcing the opening of the subscription and arranging the graphic presentation of Closure of Bid Collection. Allotment of shares through Registrar after deciding the cut-off price. Getting the shares listed on the stock exchange. Preparing the Final Prospectus and filing it with SEBI and Registrar of Companies.

at which the institutions are willing to buy. Information Memorandum. Issue, Bankers to the Issue etc.,

bids received.

B. Syndicate Members: The issuing company, on the advice of the Merchant Bankers, appoints the Syndicate Members. Only those financial intermediaries who are registered with SEBI as underwriters can be appointed as the Syndicate Members. The Syndicate Members perform the following basic functions. 1. Facilitating Quantity Assessment: From various institutions (QIB), Syndicate Members collect the various prices and the respective quantities the institutions are willing to buy. They pass on this information to the Merchant Banker to assess the total demand for the shares and the price- band at which the shares are to be offered. 2. Underwriting: They underwrite that portion of the shares which will be offered to the public for subscription. The net offer to the public should be compulsorily underwritten, which is done by the syndicate members.

3. Collection of Bid-Cum-Application Forms: Once the public issue is open, the syndicate members ensure the availability application forms to the public. They do this through their branch offices or through franchisees. In turn, the Application Forms are collected from the public and uploaded in to the IT online system of a stock exchange. This will help the Lead Book Runner to make available a graphic presentation of the details of bids received for the benefit of the public. 4. Registrar to the Issue: The Lead Book Runner helps the company in appointing a Registrar who generally discharges the following functions. a) Appointment of Bankers: The Registrar helps the company in appointing bankers and opening Escrow A/Cs for accepting the Application money. b) Printing & Supply of Forms: He arranges to print the Application cum Bid Forms, Red Herring Prospectus. The same is supplied to various Syndicate members and their branch offices. c) Allotment: The net-public offer portion of public issue is allotted by the Registrar to the retail investors in consultation with the Lead Book Runner, the Company and the Stock Exchange officials. d) Other Procedure: The Registrar also arranges to credit the Demat accounts of the allottees and dispatch allotment letters or refund orders.

Q.3 Explain the concept of float. How float can be managed effectively? Ans: Concept of Float Float is the delay in the credit or debit of bank accounts regarding cheques and other instruments already issued or deposited for collection. It is also defined as the difference between the bank balance as per cash book of the firm and bank balance as per bank records. There are three types of delays that create the difference.
a)

Mailing Float: Even though cheques or drafts are posted, it takes a few days for it to

reach the payee. This is called a mailing float.

b)

Processing Float: The efficiency of the payees organization will determine the delay

between receiving the cheques and depositing it with the bank for collection. A bureaucratic set up and lethargic employees may cause delay to the extent of even more than 10 days, in recording the details of the cheques in the records of the firm and depositing them into the bank account.
c)

Collection Float: Where the cheques are drawn on some other bank or some other

branch, it will take a few days for the collection of the instrument. If the bank branch and its staff are known for inefficiency, it may take as much as even a month for the collection. Total of these three delays constitutes the float. The float can be positive or negative. If the firm has deposited the cheques for collection and delay is caused for crediting the effects, we call it a negative float. On the other hand, the firm has issued cheques to its suppliers or others and delay is caused in debiting the firms bank account, it is called a positive float. The firm can do its best to see that the positive float increases and the negative float decreases. The float can be managed effectively by way of: A. Accelerating Cash Inflows B. Decelerating Cash Outflows A)

Accelerating Cash Inflows: Organizing an Effective Cash Department: The function of Cash Department should be organized well. Arrangements should be made to bring in the mail early in the morning by opening a separate mail box. Instead of relying upon the employee of the postal department, an employee of the firm should collect it early in the morning. It must be made clear that the cheques received should be recorded in the books and sent to the bank well before the time the banks carry the cheques for the clearing. Scanners can be installed to catch the digital image of cheques from which entries can be made in the books after sending the cheques to the bank.

Electronic Clearance of Cheques: Arrangements must be made with the banks to get

the cheques cleared through National Electronic Funds Transfer or Real Time Gross

settlement of the RBI. Making use of foreign banks or new generation private sector banks for clearing the cheques will reduce the time involved in collection of the cheques.

Quick Credit of Cheques: Wherever allowed, arrangements must be made with the

banks to credit the proceeds even before collection, or by way of getting the instrument discounted with the banker.

Instruments Payable at Par: Arrangements can also be made with the customers to

receive the payments by way of Demand Drafts drawn on the bank branch with which the firm has an account. Alternatively, after the adoption of core banking by the Indian banks whereby all the branches are networked, they have started issuing multi-city cheques or At Par Cheques. These cheques are payable at par at any branch of the bank immediately. More and more banks are issuing such cheques. Therefore, the delay in collection can be avoided. One more and the most effective-* way is to encourage the customers to make payments online using a credit card or debit card. This will ensure the removal of all the delays and transfer the funds from the bank account of the customer to the bank account of the firm immediately.

Cheque Truncation: Accounts can be opened with banks, which are using cheque

truncation for collecting the cheques. Truncation is a process whereby the collecting banker sends only the digital image of the cheque to the paying banker. Cheques are not sent physically for collection. ATMS are also being developed so that cheques deposited into the ATMS for collection are accepted and the digital image is sent via the network to the paying banker immediately. The credit is given instantly as soon as the cheque is cleared by the paying banker.

Using Lock Box System: Arrangements are also made with the post office to open a lock

box system from where the bank collects the cheques directly. This arrangement reduces the procedure of cheques received by the firm and sent to the bank for collection. Though conventional practice regards this system to be very effective one, the banks will charge heavily for this service. In addition, the firm my have to depend upon the efficiency of the bank staff in prompt receipt of cheques from the lock box everyday. Added to that, the firm has to depend upon the banks periodical statements in the management of accounts receivable that will create a delay in the monitoring of accounts receivable. Differences may

also arise in accounting for the cheques. Disputes may arise and rectification has to be done periodically.

Concentration Banking: A corporate having branches spread throughout the country

designates certain strategically located branches to collect the cheques on behalf of branches in different regions. The branches inform the customers to make payment directly to the designated branch; an effective system can be installed for quick and speedy collection of cheques. This system removes the disadvantage of mailing delay involved in sending the customers cheques of all the branches to the head office. The designated branches are nearer to customers than the head office. At the same time, it avoids the inefficiency of each branch receiving the cheques and sending them for collection. B) Decelerating Cash Outflows: The payments made are delayed as much as possible without attracting any extra cost or penalty.

Payment on the Last Date: Payments are not made early. They are delayed as much as

possible. For purchases, the payment is made on the last date allowed. If highest cash discount is available for payment within 15 days, payment is made only on the 14th day or 15th day. For power bill, payment is made on the last day without attracting penalty. Even for payment of taxes, they are paid only on the last permitted date.

Payment by Head Office: Payments on behalf of all the branches should be made by the

Head office. The Branch Heads are not given the powers to make payments. They have to deposit all the receipts into the accounts of the Head Office opened with a bank in the locality of the branch. For all payments, the Branch Manager must write to the Head Office. The Head Office in turn will draw cheques on the banks in the locality of the branch, and send them to the Branch Manager even for the payment of salary; the same system should be followed. Naturally, it will entail delays resulting in conservation of cash.

Cheque Kiting: Cheques can be sent to the supplier even if there is no balance in the

bank. As it involves a float on the part of the payee, it will take anything between 7 days to 10 days for the cheque to be presented by the bank. By that time, either there will be some receipts to take care of it or we can make arrangement to deposit the amount. There are many firms, which come to an understanding with the banker. On receipt of cheques by way of presentation, the bank informs the firm. After that, the firm deposits the necessary amount into the bank account or uses the overdraft facility to make payment.

Using Credit Cards for Payment: Credit cards generally give a months time for

making the payment to the bank. If payment is made within the date specified, the bank levies no interest. Payments need not be made in the month of purchase. In the second month, the bank sends the demand statement. By the end of second month, if the payment is made, interest is saved for almost two months.

Selection of Banks: The bank may be selected in such a way that we get the maximum positive float. There are banks known for very inefficient system of collection. Every collection of outstation cheque takes more than 15 days. Cheques can be drawn on accounts maintained with such banks. Again, a bank may be selected specifically because it has only a small network of branches. This will make the cheque to come through more than one bank for collection. Naturally, delay is caused and cash is conserved.