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FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING AND FINANCE

TREASURY MANAGEMENT BBF 3203

INDIVIDUAL ASSIGNMENT 1 ID 01212359712

GORATA MODISENYANE

LECTURER MR JAMBANI

DUE DATE 30 AUGUST 2023

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QUESTION 1 (100 marks)

ASSIGNMENT 1
QUESTION 1 (100 marks)
Assess the extent to which both the Russia-Ukraine War and international trade
challenges disputes between the US-China affected the following markets in Botswana:
(i) The foreign exchange market.
(ii) The money markets.
(iii) Proceed to analyse tools which are being employed by banks’ treasury
management in Botswana to mitigate foreign exchange risk, interest rate
risk and credit risk emanating from these challenges.
Your analysis will benefit from financial market evidence drawn from academic
literature, practitioner literature, and a case involving local banks complete with data
and statistics.

INTRODUCTION

Russia’s invasion of Ukraine in February 2022 has had a negative effect on global
energy market; there was price volatility, supply shortages, security issues and
economic uncertainty. All this contributed to what is known as the first truly global
energy crisis, with the impact that will be felt for many years to come by the
International Energy Agency (IEA).

However, this Russia-Ukraine War and the International trade challenges disputes
between the US and China have had a significant impact on the foreign exchange
markets and money markets in Botswana economy.

COMMODITIES PRICES

The on-going war between Russia and Ukraine had caused a sharp rise in price of oil
and gas, which are major exports for economy of Botswana. However this has led to a
depreciation of currencies of other countries that used to trade with such countries.
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Russia is the world’s second largest oil exporter after Saudi Arabia and the world’s
biggest exporter of natural gas, wheat, nitrogen fertiliser and palladium.

Many African countries including Botswana, they heavily relied on commodity exports.
Therefore, if commodities prices drop due to events like Russia-Ukraine conflict or
trade disputes between major economies, countries that depended on exporting could
face reduced exports revenues. This can result in trade imbalances and impact the
supply and demand for their currency in the foreign exchange market.

For instance, the value of the South African rand has fallen by about 10% against US
what about the Pula
dollar since the start of the war in Ukraine. This is due to the fact that South Africa is a
major exporter of commodities and the war has disrupted global commodity markets.

In short after Russia’s invasion of Ukraine, international oil prices spiked to their
highest levels since the records of 2008. Russia cut gas flows by around 80%, leaving
the bloc with a significant shortfall in its energy mix. Since Russia’s former
international partners have cut ties with the country, Russia has broadly kept its oil
production and exports at close to pre-invasion levels by increasing exports
everywhere, including China.

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SUPPLY CHAIN DISRUPTION

The war has also disrupted global supply chains and resulted in increasing prices and
inflation, among other things. It made it more difficult and expensive for African
countries to import goods and services. This has led to higher prices for consumers
and businesses

The supply chain disruptions also led to delays, increased costs and shortage of
imported goods. As the costs of production rise due to these disruptions, it can lead to
higher inflation. Now central banks might respond by adjusting interest rates and
influencing the currency’s attractiveness to foreign investors.

Supply chain has caused increased volatility in the foreign exchange market and
money market. For example, the COVID -19 pandemic caused widespread supply
chain disruptions which led to increased volatility in foreign exchange market and
money market. Hence, the US dollar appreciated against many other currencies as
investors sought the safety of the US dollar during the uncertain times like these ones.

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ENERGY SECURITY

Disruptions in global energy markets due to geopolitical events affected energy prices
and availability in African countries, impacting economic activities and development.
The spike in energy prices following the start of the war directly impacted consumers
and industries with energy intensive costs. Mostly the countries with large energy
imports from Russia were heavily affected.

The war triggered a massive shock to global economy especially to energy and food
markets which also pushed prices up to unprecedented levels. Since euro depended
strongly on energy imports, it accounted for more than half of the euro areas energy
use in 2020. Furthermore, Russia was a key supplier to the euro area before the war.
The war added heavily to the inflationary pressure building up in the euro area during
the post pandemic recovery and pushed up consumer prices especially for energy and
food.

Studies indicate that food prices increased by 14.1% in January 2023 compared with
previous year. As food production is quite energy intensive, the high rates of food
inflation contributed to the bad effects.

The IEA indicated high fuel costs which accounted for 90% of the rise in average costs
for electricity generation worldwide. This means that many people around African
countries would no longer afford to access electricity. And many people will no longer
hos is this of
be able to make food with clean fuels, returning instead to biomass, says the IEA. concern to the
case at hand

Here are some of the tools employed by banks treasury management in Botswana to
mitigate foreign exchange risk, interest rate risk and credit risk emanating from the
Russia-Ukraine War and the international trade challenges disputes between the US
and China.

FOREIGN EXCHANGE MITIGATION

Forward exchange contracts

Before treasury managers manage foreign exchange exposures, there are several
different types of risk that they must identify and measure. They include:

Economic risk- This is where treasury managers should monitor the macroeconomic
conditions that may impact foreign exchange rates such rises in interest rate or
political uncertainty.
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Translation risk-arises when currency variations occur between the time in which
funds are received or exchanged and when a firm reports its quarterly or annual
financial statements.

Transaction risk- This arises when a company is importing or exporting.

According to London Institute of Banking and2 Finance, forward exchange contracts are
agreements to buy or sell a currency at a specified price on a specified date in the
future. Exchange rates contracts are used by local banks to lock in an exchange rate
for a future date, and protecting them from currency fluctuations. The rate at which
the treasury manager agrees to sell or buy with is fixed at the time the contract is
entered into, providing certainty about the future exchange rate.

Forward contracts are used to hedge against the risk of adverse currency movements
affecting their future transactions. For instance, if a company knows it will need to
make a payment in a foreign currency several months from now, hoping to enter into
a forward contract to ensure that the payment amounting to their home currency
remains relatively stable.

Currency Swaps

Currency swaps can be used to exchange cash flows in different currencies which
reduce foreign exchange risk. These swaps are financial transactions in which two
parties exchange currencies, but also pre-agree to exchange them back at a future
date. Treasury managers may also have incoming and out-going cash flows in different
currencies. And by using currency swaps, they can match these cash flows to avoid
exposure to currency volatility.

If a bank has long term transactions denominated in a foreign currency such as

imports and exports, they can use currency swaps to hedge against exchange rate
fluctuations over the life of the transaction.

Leading and lagging

Leading refers to when a company increases its payment of its foreign exchange
currency obligations. This strategy is used when the company expects the foreign
currency of another country to weaken, making the domestic currency more valuable.

Lagging involves delaying the payment of foreign currency obligations. Basically,

treasury managers implement this strategy for companies anticipate the foreign
currency to strengthen, making the domestic currency weaker.
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For instance, assume one plans to go to Spain and believe that the euro will
strengthen against their own currency. Hence one can decide to change spending
money into euros now. That would be ‘leading’ because one expect the euro to
weaken.

Risk management policies

It is very important for treasury managers in banks to have clear risk management
policies in place to identify measures and mitigate risk. This policy includes set of
procedures and guidelines that help organizations identify, assess and mitigate risk.
Hence helps in assessing both internal and external risk faced by banks in Botswana.
This also helps treasury managers in making
3 informed decisions and implementing
appropriate controls.

The central bank (Bank of Botswana) would establish clear exchange rate policies that
align with the country’s economic goals. These policies might involve choosing a
specific exchange rate regime, such as a fixed peg or a managed floating exchange
rate, to guide their interventions in the market.

INTEREST RATE RISK MITIGATION

Interest rate swaps

Banks can use interest rate swaps convert variable-rate debt or assets into fixed rate
instruments to manage interest rate fluctuation. Interest rate swaps are financial
contracts between two parties that involve exchanging specified period of time. These
swaps are commonly used by banks to manage interest rate risk, which arises from
fluctuations in interest rate that can impact then banks profitability and balance sheet.

For instance, assume Absa bank has issued a substantial amount of fixed –rate loans
to borrowers. If the interest rate in the market increase, the bank might face a
situation where its paying out more interest on its liabilities (customer deposits) than
its receiving on its assets (fixed rate loan). However this could affect the banks profit
margin.

Asset and Liability Management

Banks monitor and manage the maturity and re-pricing profiles of assets and liabilities
to minimize interest rate risk. Asset and Liability management is a strategic approach
that banks use to mitigate interest rate risk by managing the composition and maturity
profile of their assets and liabilities.
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CREDIT RISK MITIGATION

Credit scoring and assessment

Banks employ thorough credit evaluation processes to assess the creditworthiness of

borrowers and manage lending risks. Credit scoring involves assigning a numerical
score to individual borrowers based on their credit worthiness. The financial factors
include the borrower’s credit history, outstanding debt, and income and payment
behaviour.

Credit assessment involves a clear evaluation of the borrower’s financial health and
repayment capacity. Hence, banks gather information from credit reports, income
documents, bank statements and other relevant sources to assess the borrower’s
ability to repay the loan.
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Credit scoring and assessment helps treasury managers make informed lending
decisions and allocate capital more effectively. The main aim of this mitigation is to
minimize the likelihood of default and the associated financial losses.

Collateral and guarantees

Both local and international banks may require collateral or guarantees for high risk
loan to mitigate potential losses in case of default. Treasury managers assess the
credit risk of borrowers by considering their financial health, credit history and
repayment capacity.

If collateral is to be used, treasury manager evaluate the value of the assets being
offered as collateral. The value should be sufficient to cover the loan amount in case
of default. Therefore, collateral and guarantees provide a safety net for banks. If the
borrower defaults, the bank can liquidate the collateral or call upon the guarantor to
cover the outstanding amount, reducing the banks financial loss.

In conclusion, banks in Botswana, like those in other countries, typically they employ a
combination of financial tools and strategies to mitigate risks stemming from
geopolitical events and international trade challenges. To address foreign exchange
risk, they might use currency derivatives like forward contracts or options to lock in
exchange rates.

While for interest rate risk, they could use interest rate swaps to manage fluctuations.
Credit risk could be managed through careful assessment and diversification of
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lending portfolios. Also to deal with geopolitical events like these ones, banks may
closely monitor the situation, assess potential impacts and adjust their risk
management strategies accordingly.

REFERENCES

Baschuk, B. (2020, June 12). ''A Trade Collapse that's Heading Into the History Books''
Bloomberg. Retrieved from http://www.bloomberg.com/news/articles/2020-03-
26/supply-chain-latest-a-trade-plunge-worty-of-the-history=books

BLINKEN, A. (2022, May 26). The Administrations Approach to the peoples Republic of China.
Retrieved from www.state.gov>the-administrations-approach-to-the-peoples-of-
republic-of-china

By bound-team. (2023, August 24). FX risk management software and tools for treasurers.
Retrieved from www.bound.co/blog/tools-for-the-foreign-exchange

Lusigi, A. (2022, June 30). ECONOMIC DEVELOPMENT. Retrieved from

https://bit.ly/AfricaNewsletter

OECD. (2017, April 6). Making Trade Work for All. Retrieved from
https://www.oecd.org/trade/understanding-the-global-trading system/making-trade-
work-for-all
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Riggins, N. (2019, May 16). TREASURY RISK MANAGEMENT. Retrieved from
www.theglobaltreasurer.com>2019/05/16

Ruta, M. (2022). The impact of the War in Ukraine on Global Trade Investment. Retrieved from
http://hdi.handle.net/10986/37359

Thomson, E. (2022, NOVEMBER 8). WORLD ECONOMIC FORUM. Retrieved from

www.weforum.org/agenda/2022/russian-ukrainewar