Q1. Give the meaning of treasury management.

Explain the need for

specialized handling of treasury and benefits of treasury.
Solution: Treasury management (or treasury operations) includes management of
an enterprises holdings, with the ultimate goal of managing the firms liquidity and
mitigating its operational, financial and reputational risk. Treasury Management
includes a firms collections, disbursements, concentration, investment and funding
activities. 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 specialized handling of treasury
Treasury management should be practiced as a distinct domain within the Finance
function of an organization 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.

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.

Internal financial management in a multi-national corporate entity requires

monitoring of several global currencies.

Globalization of business has thrown up an unbelievable basket of

opportunities for the CFO to optimize the utilization of funds and minimize its
costs. This requires expert handling.

Globalization 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.

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 of Treasury
Managing treasury as an expert subject has many benefits:

Valuable strategic inputs relating to investment and funding decisions

Close monitoring and quick effective action on likely cash surpluses and
deficits

Systematic checks and balances that give early warning signals of likely
liquidity issues

Significant favorable impact on the bottom line for global corporations

through effective management of exchange fluctuation

Better compliance with the increasingly complicated

reporting standards on cash and cash equivalents

accounting

and

Q2. Explain foreign exchange market. Write about all the types of foreign
exchange markets. Explain the participants in foreign exchange markets.
Solution: 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 and selling prices.
In India the Foreign Exchange Management Act (FEMA) 1999 is the law relating to
forex transactions and its aim is to develop, liberalize and promote forex market and
its effective utilization.
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.
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.
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.
Offshore and onshore markets During the earlier stages of financial
development, forex market operated onshore i.e. within India. But after
liberalization of the economy, offshore markets have developed and instruments
based on foreign currencies issued by Indian firms are traded in foreign markets.

Participants in foreign exchange markets

The participants in forex market are the RBI at the apex, authorized dealers (ADs)
licensed by the central bank, corporates and individuals engaged in exports and
imports.

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.
Commercial banks Banks trade in currencies for their clients, but much larger
volume of transactions come from banks dealing directly among themselves.
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.
Exchange brokers They facilitate trade between banks by linking the buyers and
sellers. Banks provide opportunities to brokers in order to increase or decrease their
selling rate and buying rate for foreign currencies. Exchange brokers also specialize
in specific currencies that have lower demand and supply to add value to banks. In
India, many banks deal through recognized exchange brokers.
Q3. Write an overview of risk mitigation. Explain the processes of risk
containment. Write about the tools available for managing risks.
Solution: Risk mitigation: Risk mitigation is the act of decreasing the riskiness of a
project. Read what this writer has to say about what type of risks are involved in a
project and how a project manager can mitigate these risks. Risk Mitigation, within
the context of a project, can be defined as a measure or set of measures taken by a
project manager to reduce or eliminate the risks associated with a project. Risks can
be of various types such as technical risks, monetary risks and scheduling-based
risks. The project manager takes complete authority of reducing the probability of
occurrence of risks while executing a project.
When delegating tasks to individuals, the technical competency of those individuals
might be overlooked. If so, it increases the chances of the project being delayed
Plan and not meeting the deadline. Such delays can be avoided by increasing the
communication frequency between the team members and monitoring their work.
Another alternative is to divide a complex task between team members and then
delegate each part to a single individual. By reducing a complex technical task into
smaller simple tasks, the execution time may increase but the chances of missing

the deadline for task completion can be managed as the risk involved in the task is
being diversified by the project manager among multiple individuals.
Steps in a typical risk containment process
Risk mitigation is defined as taking steps to reduce adverse effects. There are
four types of risk mitigation strategies that hold unique to Business Continuity and
Disaster Recovery. Its important to develop a strategy that closely relates to and
matches your companys profile.

Risk Acceptance: Risk acceptance does not reduce any effects however it is still
considered a strategy. This strategy is a common option when the cost of other risk
management options such as avoidance or limitation may outweigh the cost of the
risk itself. A company that doesnt want to spend a lot of money on avoiding risks
that do not have a high possibility of occurring will use the risk acceptance strategy.
Risk Avoidance: Risk avoidance is the opposite of risk acceptance. It is the action
that avoids any exposure to the risk whatsoever. Risk avoidance is usually the most
expensive of all risk mitigation options.
Risk Limitation: Risk limitation is the most common risk management strategy
used by businesses. This strategy limits a companys exposure by taking some
action. It is a strategy employing a bit of risk acceptance along with a bit of risk
avoidance or an average of both. An example of risk limitation would be a company
accepting that a disk drive may fail and avoiding a long period of failure by having
backups.
Risk Transference: Risk transference is the involvement of handing risk off to a
willing third party. For example, numerous companies outsource certain operations
such as customer service, payroll services, etc. This can be beneficial for a company
if a transferred risk is not a core competency of that company. It can also be used so
a company can focus more on their core competencies.
Tools available for managing risks
Risk management is a non-intuitive field of study, where the simplest of models
consist of a probability multiplied by an impact. Understanding individual risks may
be difficult as multiple probabilities can contribute to Risk total probability.
There are many tools and techniques for Risk identification. Documentation Reviews

Information gathering techniques

Brainstorming

Delphi technique here a facilitator distributes a questionnaire to experts,

responses are summarized (anonymously) & re-circulated among the experts
for comments. This technique is used to achieve a consensus of experts and
helps to receive unbiased data, ensuring that no one person will have undue
influence on the outcome

Interviewing

Root cause analysis for identifying a problem, discovering the causes that
led to it and developing preventive action

Checklist analysis

Assumption analysis -this technique may reveal an inconsistency of

assumptions, or uncover problematic assumptions.

Diagramming techniques

Cause and effect diagrams

System or process flow charts

Influence diagrams graphical representation of situations, showing the

casual influences or relationships among variables and outcomes

SWOT analysis

Expert judgment individuals who have experience with similar project in

the not too distant past may use their judgment through interviews or risk
facilitation workshops

Risk Analysis
Tools and Techniques for Qualitative Risk Analysis

Risk probability and impact assessment investigating the likelihood

that each specific risk will occur and the potential effect on a project
objective such as schedule, cost, quality or performance (negative effects for
threats and positive effects for opportunities), defining it in levels, through
interview or meeting with relevant stakeholders and documenting the results.

Probability and impact matrix rating risks for further quantitative

analysis using a probability and impact matrix, rating rules should be
specified by the organization in advance. See example in appendix B.

Risk categorization in order to determine the areas of the project most

exposed to the effects of uncertainty. Grouping risks by common root causes
can help us to develop effective risk responses.

Risk urgency assessment In some qualitative analyses the assessment of

risk urgency can be combined with the risk ranking determined from the
probability and impact matrix to give a final risk sensitivity rating. Example- a
risk requiring a near-term response may be considered more urgent to
address.

Expert judgment individuals who have experience with similar project in

the not too distant past may use their judgment through interviews or risk
facilitation workshops.

Tools and Techniques for Quantities Risk Analysis

Data gathering & representation techniques

InterviewingYou can carry out interviews in order to gather an optimistic

(low), pessimistic (high), and most likely scenarios.

Probability distributions Continuous probability distributions are used

extensively in modeling and simulations and represent the uncertainty in
values such as tasks durations or cost of project components\ work packages.
These distributions may help us perform quantitative analysis. Discrete
distributions can be used to represent uncertain events (an outcome of a test
or possible scenario in a decision tree)

Quantitative risk analysis & modeling techniques commonly used for

event-oriented as well as project-oriented analysis:

Sensitivity analysis For determining which risks may have the most
potential impact on the project. In sensitivity analysis one looks at the effect
of varying the inputs of a mathematical model on the output of the model
itself. Examining the effect of the uncertainty of each project element to a
specific project objective, when all other uncertain elements are held at their
baseline values. There may be presented through a tornado diagram.

Expected Monetary Value analysis (EMV) A statistical concept that

calculates the average outcome when the future includes scenarios that may
or may not happen (generally: opportunities are positive values, risks are
negative values). These are commonly used in a decision tree analysis.

Modeling & simulation A project simulation, which uses a model that

translates the specific detailed uncertainties of the project into their potential
impact on project objectives, usually iterative. Monte Carlo is an example for
an iterative simulation.

Cost risk analysis cost estimates are used as input values, chosen
randomly for each iteration (according to probability distributions of these
values), total cost will be calculated.

Schedule risk analysis duration estimates & network diagrams are used
as input values, chosen at random for each iteration (according to probability
distributions of these values), completion date will be calculated. One can
check the probability of completing the project by a certain date or within a
certain cost constraint.

Expert judgment used for identifying potential cost & schedule impacts,
evaluate probabilities, interpretation of data, identify weaknesses of the
tools, as well as their strengths, defining when is a specific tool more
appropriate, considering organizations capabilities & structure, and more.

Risk Response Planning

Risk
reassessment
project
risk
reassessments
should
be
regularly scheduled for reassessment of current risks and closing of risks.
Monitoring and controlling Risks may also result in identification of new risks.

Risk audits examining and documenting the effectiveness of risk

responses in dealing with identified risks and their root causes, as well as the
effectiveness of the risk management process. Project Managers
responsibility is to ensure the risk audits are performed at an appropriate
frequency, as defined in the risk management plan. The format for the audit
and its objectives should be clearly defined before the audit is conducted.

Variance and trend analysis using performance information for

comparing planned results to the actual results, in order to control and
monitor risk events and to identify trends in the projects execution.
Outcomes from this analysis may forecast potential deviation (at completion)
from cost and schedule targets.

Technical
performance
measurement
Comparing
technical
accomplishments during project execution to the project management plans
schedule. It is required that objectives will be defined through quantifiable
measures of technical performance, in order to compare actual results
against targets.

Reserve analysis compares the amount of remaining contingency

reserves (time and cost) to the amount of remaining risks in order to
determine if the amount of remaining reserves is enough.

Q4. What is Interest Rate Risk Management (IRRM)? Write the

components and features of IRRM. Explain the macro and micro factors
affecting interest rate.
Solution: 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 7-year 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 assetsensitive 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.

Factors Affecting Interest rates

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

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.

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.

Condition of economy: Whether the economy is rapidly growing or its

growth rate is declining can make a difference.

Global liquidity: Global economic environment and availability of funds

across the world does have an impact.

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:

Individual credit and payment track record, credit rating

Industry in which the business is operating

Extent of leveraging of the company viz. debt-equity ratio

Quality of prime security and collateral

Loan amount

Q5. Explain the contents of working capital. Write down the need for
working capital.
Solution: Working capital is the money invested in the working assets of a firm. A
business usually requires two kinds of capital: fixed capital invested in plant,
equipment, buildings, computers and other long-lived assets; and working
capital invested in inventories, receivables, deposits & advances.
Contents of working capital

As stated above, working capital comprises the working assets of a firm.

What are these assets? Look at the items in these examples.

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.

A company may also need to allow the customers to pay later instead of
insisting on cash at the point of delivery.

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.

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:

The first is a working asset or a current asset called inventories.

The second item is called trade receivables or accounts receivable

The third set of items are prepayments, advances and deposits

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.
Pachai is a vendor of pani-puris in a makeshift stall of his own at the end of the
street in which he lives. 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. He does not pay for
the material as he buys on credit. 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. 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. 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. 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.
Q6. Explain the concepts and benefits of integrated treasury. Explain
the advantages and disadvantages of operating treasury.

Solution:
Concept and Benefits of Integrated Treasury

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:

Ensuring liquidity reserve

Deploying surplus funds in securities with low risk and moderate profits

Managing multi-currency operations

Exploring opportunities for profitable placements in money market, securities

market and forex market

Managing the sum total of treasury risks with some balancing actions as
between the three markets

The benefits of integrated treasury are:

Improved cash planning and better monitoring of the cash position

Constant watch on the impact of treasury activities on the balance sheet

Greater financial control by integrating budgetary control and financial

information

Treasury products Banks sell risk management products and structure loans
to business organizations along with forex services in order to reduce the
interest rate or exchange risk. These can be bought by large organizations.
Example ABC Company buys a forward rate agreement from the treasury and
fixes the interest rate on a commercial paper and they plan to issue this

commercial paper after three months. In order to reduce the interest cost of the
company, the treasury offers currency swap for rupee credit loan into USD loan.
The advantages of operating treasury as a profit center than as a cost center
are:

Individual business units can be charged a market rate for the service
provided, thereby making their operating costs more realistic.

The treasurer is motivated to provide services as economically as possible to

make profits at the market rate.

The disadvantages of operating treasury are:

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.

Management time could be wasted in arguments between Treasury and

business units over the charges for services, distracting the latter from their
main operations.

The additional administrative costs may be excessive.