Master of Business Administration - MBA Semester 4

MF0007 – Treasury Management

Assignment Set- 1

Q1. 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 organised 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.

a) 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.
b) 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.
c) Asset- Liability Management (ALM): The ALM has the objectives of achieving all the
organisational objectives of the bank. The organisational 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.
d) Risk Management: As the bank is operating in all the organised 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.
e) 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. Corporates can make a
hefty profit with the fluctuations in the interest rates.
3. Securities & Commodities Markets: Either directly or through Investment Trusts,
corporates invest in equities, bonds, or debentures. These are held either for long term or
churned often to maximize the returns. In addition, organisations like banks sell gold by
importing them directly leading to the profit on sale. Investment in equities offers twin
benefits to the corporates. 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 organisation.

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
at which the institutions are willing to buy.
• Preparation of a Red Herring Prospectus and Filing it with SEBI along with the
Information Memorandum.
• Enabling the Companies to appoint other financial intermediaries like Registrar to the
Issue, Bankers to the Issue etc.,
• 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
bids received.
• 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.

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 payee’s 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 firm’s 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 month’s 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.
 Master of Business Administration - MBA Semester 4
MF0007 – Treasury Management
Assignment Set- 2

Q1. Explain loanable fund theory and liquidity preference theory.

Ans:- Loanable Funds Theory

Loanable Funds theory makes an improvement on the classical theory. Money can play a
decisive role in saving and investment. In turn, the saving and investment determine the income
level. According to this theory, rate of interest is the price that equates the demand and supply of
loanable funds.

Loanable funds are defined as ‘the sums of money supplied and demanded at any time in the
money market’. Classical theory talked about money supplied as a result of savings of the
people. This theory takes into account money resulting from savings of the people and money
resulting from credit creation of the banks. Thus, Loanable Funds Theory redefines the supply
side.

Demand side is also redefined by this theory. Demand for money comprises demand for
investment (as per classical theory) and the demand arising from need to hoard the money.
Money borrowed may not be invested immediately. It may be hoarded and invested in the near
future at an opportune moment for investment. Classical Theory held the rate of interest as a
determinant of saving and investment. Loanable Funds Theory holds that savings, investment,
credit creation in the economy and the demand for money arising out of a need to hoard the
money determines interest.

Liquidity Preference Theory

J.M.Keynes propounded this theory. He held that interest is a purely monetary phenomenon in
that the rate of interest is determined by demand and supply of money. Interest is considered to
be the reward for making the people to part with liquid money i.e., cash. People prefer to hold
their wealth in the form of cash rather than in the forms of assets like bonds and securities.
Demand for money arises due to demand to hold cash. Demand to hold cash arises due to the
role of money as a medium of exchange and as a store of value. It is used as a medium of
exchange for transaction motive and as a precautionary motive. Store of value arises due to
speculative motive. The demand for money is the total of money needed for all these there
motives.

The liquidity preference schedule expresses the functional relation between the quality of money
demanded for all these motives and the rate of interest. As per the Liquidity Preference Theory,
the equilibrium rate of interest is decided by the interaction between liquidity preference function
and the supply of money. Any change in the liquidity preference alters the demand for money
and thus causes a change in the interest rate. In the same way, any change in money supply also
has its effect on the interest rate.

Prof. Hansen criticizes Keynes’ Theory on the same ground on which Keynes criticized Classical
Theory. The liquidity preference function depends upon level of income. To know the level of
income, we should know the rate of interest.

Q2. Explain the objectives of foreign exchange control and management.

Ans:- Objectives of Foreign Exchange Control and Management

Generally, the central banks have the following objectives in foreign exchange control and
management.

• Facilitating Economic Development: Developing the economy and country through

providing infrastructure, strengthening the defence of the country and establishing basic
industries require import of machinery, equipment and technology. The foreign exchange
is controlled so as to make it available for strengthening the country basically in all its
requirements. Even during abnormal conditions as war, the country needs to import a lot
of equipment including a higher quality of import of crude oil for the movement of troops
and defence equipment. By managing the foreign exchange, the central bank makes it
available for such unavoidable purpose.
• Rationing Foreign Exchange: Developing countries generally import more than what
they export. Therefore, there is always insufficiency of foreign exchange to meet the
import demands. For that matter imports cannot be curbed blindly. Many of the exporters
import raw material, base metals, equipments, technology and such other things in order
to manufacture and export. Therefore, the central bank intervenes in order to control the
imports without affecting the exports. This is done by way of rationing the foreign
exchange among the various segments of the country that are in need of importing one or
the other thing.
• Supplementing Trade Controls of Government: Trade Control aims at the control of
foreign companies entering India. The trade control has the objective of ensuring that
foreign companies entering India are not setting up an adverse position against the
interest of the economy. While the trade controls regulate physical transfer of goods,
equipment and technology, the central bank supervises the method of payment for
imports and repatriation of proceeds of exports through foreign exchange control. Trade
control is concerned only with imports and exports. Exchange control is more
comprehensive encompassing all exports and imports, capital transactions and the
invisibles.
• Managing Excess Inflows of Foreign Funds: Excess inflows of foreign funds pose as
many problems as shortage of foreign exchange. In the year 2007, the problem for the
RBI is to manage the huge inflow of foreign exchange into the country. India is regarded
as a favoured destination for investment by major investors in almost all the countries.
 This is causing a huge inflow of foreign investments into the country. In addition to that,
the remittances made by NRIs have increased so much that India is accounting for about
20% of the total remittances taking place in the entire world in 2006-07. When the funds
are coming in, the RBI has to release an equal amount in rupees to the recipient in India.
This will result in inflationary pressure on the economy. Moreover, the external value of
rupee may go up affecting the exports of the country adversely. Therefore, the central
bank must encourage liberal usage of foreign exchange to meet such a situation.
• Control of Hawala Transactions: Hawala market is a market for conversion of rupees
into foreign currency illegally. The Hawala market creates a distortion in the legal
market. It will act as a parallel market defeating the efforts of the central bank. Through
exchange control, the central bank attempts to curb such activities.
• Curbing Activities of Terrorists’ Organisations: Both the World Bank and the IMF are
very much concerned about the flow of the money of the terrorist organisations through
the legal channel like banks through benami accounts. Most of the transactions involve
foreign exchange for buying the arms and ammunitions from different foreign countries.
Both the world bodies introduced the ‘Know Your Customer’ concept to prevent such
transactions. With foreign exchange controls, the RBI can do a good job in this respect.

Q3. Explain the role of liquidity risk management in Asset liability management.

Ans:- Role of Liquidity Risk Management in Asset Liability Management (ALM)

The Asset-Liability mismatch can do any of the two things: it may make the bank run out of cash
leading to borrowing at a higher cost or selling the investment premature at a loss, or at a loss of
profit. If liquidity planning is not proper, the banker may run out of cash very often. To meet the
emergency, the bank may liquidate its investments at a time when the market for such securities
are depressed. Alternatively, the bank may go for emergency borrowing. This may be a worse
option, as the cost of borrowing will be very high. Such a liquidity risk will depict itself in
impairing the profitability of the bank. The second thing is that the bank may have lent at a lower
interest rate of interest, whereas the renewal of the deposit may have to be made at a higher rate.
In both the cases, a strain is created on the profit margins. The profit margins ultimately get
reflected in the Balance Sheet in shaping up thenetworth of the bank (capital+reserves). ALM
tries to preserve the networth of the bank at as a high level as possible. In other words, it strikes a
balance between the liquidity and profitability. It preserves the profitability and the networth of
the bank without endangering the liquidity position of the bank. Liquidity Risk Management
plays a very crucial role in ALM. For the banker, liquidity is a devilish angel. It can enhance
networth. At the same time, it can also destroy the networth depending upon how it is managed.

Managing liquidity through its measurement as a first step is very important for the survival of
the bank. It tries to achieve sufficient cash assets at all points of time. Through the achievement
of this objective, it reduces the chances of the bank facing a liquidity crunch in the future. It can
be ensured through liquidity risk management that enough cash is carried always without
impairing profitability so that the bank has no problem in meeting the demand of the customers.
The liquidity problem that may materialize for one bank is not confined to that bank alone. It
may spread to the whole of the banking system. As each bank is lending to other banks or
maintaining deposits with other banks, the liquidity problem of a bank will make it to withdraw
from other banks, thus creating a problem for others also. It may also create a chain effect in the
whole of the banking system. Moreover, the depositors may undergo the trauma of incredibility
of the whole banking system for some time.

It is the duty of the management to measure and manage the liquidity not only as a part of day-
to- day management, but also for planning it for different types of scenario in the future. The
Management must imagine the various scenario of adversity regarding liquidity and develop an
action plan for each one of the scenarios. The asset that is regarded as a liquid asset in the
conventional sense may turn out to be illiquid due to the market and participants having a
uniform attitude or behaviour. Organised markets run on the principle of contrarian thinking. If
an investor thinks that a security is worth buying, another one thins it is worth selling at the same
point of time. That is how buying and selling takes place. If all the investors think that it is worth
selling, then no trade will take place.

Avoiding mismatches in the cash flow, or in the maturity profile, or in the assets and liabilities
help us in carrying out liquidity risk management. The RBI has provided guidelines to the banks
to manage the liquidity risk by preparing the Statement of Structural Liquidity (refer to Annexure
13-A-I given in unit 7). An effective tool can be developed through the use of the concept
called,’ maturity ladder’. The maturity ladder can be used to measure surplus or shortage of
funds at specific maturity dates. As the statutory reserve cycle is 14 days, a time span of 14 days
is selected as relevant period for the first two legs of the maturity profile. Each time span
selected for calculating the maturity profile is called a time bucket.

According to the RBI Guidelines and the appendices provided, the time buckets for preparing the
maturity profile can be identified as given below:

i. 1 to 14 days
ii. 15 to 28 days
iii. 29 days to 3 months
iv. 3 months to 6 months
v. 6 months to 1 year
vi. 1 year to 3 years
vii. 3 years to 5 years
viii. More than 5 years

While determining the maturity buckets of specific investments, the SLR investment, which is
considerable in volume, is assumed to be not liquid. To be classified as liquid, the securities must
be included in the category, “Held for Trading”. Such securities must be included in the trading
book of the bank. The holding period of such securities should not exceed 90 days. The volume
of securities and their composition must be clearly specified. The stop-loss limit must be stated.
They should also be marked-to-market (the value of the securities should be compared to daily or
weekly market values and any increase or decrease in the market value should be recorded as
profit or loss in the books). The defeasance period of securities should also be specified.
Defeasance period is the period required to sell the securities in the secondary market or the time
taken by the securities to mature.