Treasury and Fund Management

Commercial Banks
&
Asset Management

An Intro.

With the growth of International business and the spread of Multinational Enterprise, the treasury
function has acquired a new meaning.

No longer the treasury operations restricted to borrowing and lending of funds only to one money
market.

The treasury function now includes a diversity of currencies which can be converted into one another
through the exchange markets and which are transacted in money markets.

The Role.

Managing Asset & liabilities of the bank.

Managing 'gaps' and the 'risks'.
Maximizing profits operating within acceptable risk parameters,
Maximizing yield on treasury/inter bank investment.
Providing rates to branches and customers.

Inter-Dept Chart.

Functionality.
Lending to
Branches

Borrower

Spread

Branch

Depositor

Excess
Liquidity

Borrowing
Funding

TREASURY
Front Office

Investment

Reserve
Requirement

Treasury
Back Office
Functions

Branches Receive Deposits

Branches Lend To Customers
Branches Remit Excess liquidity to try at an average rate (Pool Rate)
Try maintenance reserve with SBP.
Invest in MM Instruments
Invest in Govt. Securities
Invest in Debt Securities
Capital Market
Fund FCY Trade Nostro Account
Lend to Other Branch

Interest Rate.

The interest rate used in determining the present value of future cash flows.

OR

The interest rate that an eligible depository institution is charged to borrow shortterm funds directly from a Central Bank.

Yield.

The income return on an investment. This refers to theinterest or dividends

received from a security and isusually expressed annually as a percentage
based on the investment's cost,its current market value orits face value.

There are two stock dividend yields.Cost Yield & Current Yield.

Bonds have following yields: Coupon (the bond interest rate fixedat issuance),
current (the bond interest rate as a percentage of the current price of the
bond), and Yield to maturity (an estimate of what an investor will receive if the
bond is held to its maturity date).

Yield Curve.

Yield

A linethat plots theinterest rates, at aset point in time,of bonds having equal
credit quality, but differing maturity dates. OR The yield curve is the
relationship between an interest rate and the time to maturity for a given
debt.

Maturity

The shape of the yield curve is closely monitoredbecause it helps to give an idea
of future interest rate change and economic activity.

 Normal Yield Curve:

Is onein which longer maturitybonds have a higher yield

compared to shorter-termbonds due to the risks associated with time.

Inverted Yield Curve:

Is one in which the shorter-term yields are higher than

the longer-term yields, which can be a sign of upcoming recession.

 Flat Yield Curve:

Is one in which the shorter- and longer-term yields are very

close to each other, which is also a predictor of an economictransition.

Money Market.
The money market is a wholesale market for low risk, highly liquid, short-term &
long term debt instruments.

It serves as an avenue through which banks and financial institutions can offload
their excess liquidity or meet their funding requirements.

To the government an organized money market represents a means for it to

implement its monetary policies in a more efficient manner. Moreover, it
provides it with a liquid market for securities through which it can finance its
own borrowing requirements.
The large role of commercial banks in the money market can be easily envisioned
by looking at their assets and liabilities.
A major portion of their liabilities are demand deposits. Another large portion of
bank liabilities are time deposits.
On the asset side, in addition to loans banks have part of their assets invested in
marketable securities.

M.M Objective.
Managing liquidity and interest risk.
Coordinating with corporate/retail banking departments for assets/liability pricing.

To deploy excess funds in order to save liquidity wastage

To manage funding requirements which may arise from time to time keeping in
view the cost and interest scenario.

Purpose of M. M.
The need for financial institutions to indulge in money market transactions arises
primarily from the reserve requirements imposed by the State Bank.

All commercial banks are required to maintain 25% Statuary Liquidity

Requirements (SLR) of their Demand and Time Liabilities (DTL).

Commercial banks also have to maintain a certain portion of their DTL in a cash
reserve maintained with the SBP at 0% interest. This ratio is known as the CRR
(Cash Reserve Requirement) and stands at 5.00%.

M.M Instruments & Transactions.

Pakistan Investment Bonds

Treasury Bills
Repo / Rev. Repo Transactions
Call / Clean Money
Term Finance Certificate
Certificate of Investments
Commercial Papers

M.M Instruments & Transactions.

Pakistan Investment Bonds:

These are long term bonds of three, five, ten,

fifteen, twenty & 30 years, maturity issued at market price and carrying a
different coupon rate according to the interest rates scenario. Moreover,
another reason for issuing PIBs is to set up a yield curve and corporate, mutual
funds etc. to invest in long term.

Treasury Bills:

T-Bills are short term securities issued by the State Bank on

behalf of the Ministry of Finance through auctions. They are zero-coupon bonds
issued at a discount, have a par value of Rs 100 and a maturity of three, six or
twelve months. Bank borrowing is one of the various measures the government
takes to fill its budgetary deficit and this bank borrowing currently takes place
against T-Bills.

Term Finance Certificate:

TFCs are redeemable capital instruments and may

be issued by a company directly to the general public, which includes
institutions. Unlike straight bonds, they are redeemable capital and are of long
tenors. Issued by corporate to raise long-term fund.

M.M Instruments & Transactions.

Repurchase Transactions:

Borrowing secured by collateral in the form of

securities.

Rev. Repo Transactions:

Lending secured by collateral in the form of

securities.

Call Money:

Call transactions consist of non-collateralized lending and

borrowing of Funds.

Clean Money:

Clean funds are similar to call funds in the sense that this is
unsecured lending/ borrowing of funds. The only difference is that this sort of
borrowing is done by investment banks and leasing companies.

FX MARKET.

Domestic markets trade in local currency and operate under regulations governing
domestic market. When funds in any other currency are traded outside the
regulations governing domestic markets, then we have the transaction of
Foreign Exchange Markets.

Nostro Management.

Exposure Management

Blotter Management

FX TRANSACTION.

Any financial transaction that involves more than one 'convertible' currency is a
foreign exchange transaction.

Most important characteristic of a foreign exchange transaction is that it involves

foreign exchange risk/Exposure.

The exchange rate is determined by the market forces of demand & Supply.

Exchange Rate is the price of one currency in terms of another.

Net Open Position

A measure of foreign exchange risk.
NOP is the Net Asset/Net Liability position in all FCs together
Net Asset Position is also called "LONG" or "Overbought" position.
Net liability Position is also called "SHORT" or "Oversold" position
NOP is a single statistic that provides a fairly good idea about exchange risk
assumed by the bank.

Net Open Position

Currency-wise NOP in equivalent PKR

NOP calculating in the following manner.

TOTAL
NOP

-549/84
-6.53

Foreign Exchange Exposure Limit

FX Exposure is the higher of the long and short positions in Foreign Currency.

FEEL is the 10% of the paid-up capital of the bank or PKR1.5bln whichever is
higher.

FEEL(PKR)
= -1389/84

FEEL(USD)
= -16.53

Corporate Desk.
Dealing with branches and large clients.
Treasury acts as a separate profit unit versus branches.
FORWARD RATES: Forward rates depend upon interest rate differential between
the two currencies.
Currency with higher interest rates is at discount w.r.t currency having lower
interest rate.

Currency with lower interest rates is at premium w.r.t currency having higher
interest rate.

Equity Market.
The investment of the bank will be structured around passive management with
majority of the portfolio invested for a medium to long term horizon based on
the fundamental developments in the economy.

E.M Objective.

The key investment objective behind developing an equity portfolio for the bank is
to create and manage an investment portfolio that allows earning of superior
yields in comparison to other alternate investment opportunities.

Risk Mitigation.
The risk of the equity portfolio will be managed through:

Comprehensive focus on fundamental research and equity analysis;

Diversification of the investment portfolio;
Rigorous investment review procedures; and
Development of controls and procedures for the trading portfolio.

Equity Trading Mechanism

KSE Clearing House

Buyer

Broker
Payment

T+2 Settlement

Broker

Seller
Shares

ARBITRAGE
Opportunity taken for higher return to avoid market risk. This opportunity arises
from inefficiency of the market.

ARBITRAGE OPPURTINUITIES IN EQUITY MARKET

There are mainly two types of arbitrage in equities.
Simple Arbitrage
Ready Future Arbitrage

SIMPLE ARBITRAGE
Price differential between two exchanges or market of the same instrument.

PTC Rs. 30

PTC Rs. 32

1.
Buy

K.S.E

T+2 Settlement

Sell

L.S.E

READY FUTURE ARBITRAGE

Price differential between ready and future contracts of the same instrument in
the same exchange or market.
PTC (ready) Rs.
30

PTC (future) Rs.

34
T+15 Settlement

T+2 Settlement

K.S.E

EQUITY PORTFOLIO MANAGEMENT

Introduction

The equity portfolio of the bank envisages a passive portfolio management strategy
Focused on developing a fundamentally strong and truly diversified portfolio. However,
a trading portfolio will be maintained to supplement and enhance the overall yield of the
equity portfolio.

The Equity Portfolio is to be distributed between growth stocks and income s

the initial indication is to equally distribute the portfolio however this would d
on the overall performance of the sector and sub-sectors.

Every transaction or trade should be based on strong reasoning and shou

justifiable on fundamental, valuation and/or market expectations;

Generate recurring income through dividend yield from specific securities

is higher than the yields on Government securities; and

Reduce the cost and undue risk through maintaining an appropriate balance be
volumes and duration of the transaction.
q
q

Portfolio Management Guidelines

The general guidelines with regards to portfolio management are as hereunder:
1.

2.
3.

Every equity investment has to be classified as Overnight Portfolio,

Short Term Portfolio, Investment Portfolio or Strategic Portfolio based
on the asset allocation policy and departmental strategy for execution of a
certain trade;
The above mentioned portfolio classifications are defined as:

a) Overnight Portfolio: Daily Trading Positions;

b) Short Term Portfolio: Any trading position with more than overnight horizon
but less than a 3 months horizon;
c) Medium to Long Term Portfolio: The stocks purchased based on th
fundamental earnings or valuation strength. The investment exits will be
down in terms of the target price and/or time horizon, which will be at le
90 days. The initial time horizon can be extended based on investm
committees approval; and
d) Strategic Investment Portfolio: The stocks purchased for either a horizon
more than 2 years and/or acquiring significant stake to allow the bank to t
around the company and/or any company which fits the strategic focus of the b

WORKFLOW
The overall department will be divided into two sub units: Front Office and Back Office.
Typically the equity market unit should be able to manage the following activities:
1. Strategy Formulation

Yearly Asset Allocation Strategy Paper;

Target Yield Setting on the Investment and Trading Portfolio;
Quarterly Review of the Asset Allocation Strategy;
Management of Research Resources; and
Daily Trading Guidelines.

2. Front Desk Trading

Execution of the investment decisions;

Distribution of stocks for trading;
Identification of trading opportunities; and
Delivering on the trading yield targets.

WORKFLOW

The overall department will be divided into two sub units: Front Office and Back Office.
Typically the equity market unit should be able to manage the following activities:
3. Risk Management

Development of Standard Operating Procedures (SOPs);

Development of Risk Management Policies and Alert Mechanism;
Ensuring Adherence to the Policies and Procedures; and
Development of discretionary investment and trading authorities.

4. Settlements

Settlement of the T+2 and Futures transaction;

Assistance in managing the badla book;
Providing counter trading reports to management to reconcile with Front Office repor
Providing value date cash flow statement to the accounts / finance department
Ensuring compliance with the prudential and other related regulations.

Myths about the stock market

The market will collapse!

Investing in stocks is just like gambling.
Stocks should be bought when they have momentum.
Heavyweights manipulate the market.
To begin investing, I need to accumulate a lot of money first.

Inflation gradually erodes the value the

Rupee
Nominal
Value of
PkR 1,000 :
PkR 6,727

Today:
PkR
1,000

Inflation
Adjusted
Value of PkR
1,000: PkR
122

Investments provide protection from inflatio

The market will collapse!

zoomed-in view of the crash of 2005

It pays to stay invested

Riding out short-term depression in the market can pay off in the long-run

Gambling/ Trying to catch the momentum

Investing in stocks is not like gambling.

Investments are made using a systematic approach based on studies of business
dynamics.

Scrips are selected on the basis of their potential for long-term earnings growth
driven by fundamentals.

Portfolio allocations are adjusted periodically to reflect a change in the underlying

dynamics of the company.

Do heavyweights manipulate the market?

Yes!
Speculators facilitate price discovery in any market financial institutions look to
take advantage of any pricing opportunity created by the actions of the
speculators.
However, manipulation doesnt last long
In the long-run, its earnings and cash flows that move stock prices not the
punters

To begin investing, I need to

accumulate a lot of money first.

No, A person can make investment with only PKR 500 in a mutual fund and
gradually build its investment through SIP.

To begin investing, I need to

accumulate a lot of money first.

Comparison with fixed-income returns and

inflation

In fact, equities have outperformed all

other asset classes in the past 15 years

Drawbacks of direct investment in equities

Un-informed decision-making
Monitoring costs
Diversified exposure not possible with small amounts
Brokerage fees

How A Mutual Fund Works

A large number of people with money to invest buy shares in a mutual fund.

They pool their money for buying power.

The fund manager invests the money in a collection of stocks, bonds or other
securities.

If the manager is successful in selecting good companies that generate value,

the fund will grow.

Investors receive periodic distributions and can book capital gains by redeeming
their investments.

Why Equity Funds?

The Reasons

Diversification
Active management
Hedge against inflation
Professional Management
Benefits of automatic re-investment
Rupee-cost averaging
Investment Options: SIP, STP, SPT

Diversificatio
n
A stock fund reduces the overall risk faced by an investor through:
Diversification is the key to success with safety when investing in stocks.

A risk management technique that mixes a wide variety of investments within

one portfolio.

A well diversified portfolio is expected to yield higher average returns over the
long run while at the same time keeping your portfolio at a lower amount of
risk.

There are a number of alternative methods for building stock investment

portfolios without holding stocks directly. One such method is to use mutual
funds to gain exposure to varied market segments.

Active management
The manager of an equity fund can periodically adjust the funds allocation in
order to maximize the potential returns from the portfolio

Selection of Scrips is done on the basis of a rigorous screening criteria that will
ensure returns over the next year

Active management of a portfolio requires substantial time and energy which

the average retail investor cannot afford

The investor gets the benefit of active management of an equity portfolio at a

very low cost

Hedging against inflation

Historically, equities have generally outpaced inflation, thus ensuring that the
real-value of the investment is protected.

Professional Management

Alpha indicates the additional return that is generated through professional

management of the portfolio.
This superior performance is due to extensive research and the professional
experience of the fund manager.

Rupee-cost averaging

The Markets are volatile: they move up and down in an unpredictable manner

By using a systematic investment process such rupee-cost averaging, the investor can purchase
more units when the prices are relatively low and fewer units when prices are relatively high.

This method can provide the investor with an effective cushion against a sharp downturn in the
equity market and protect investors capital to some extent.

Rupee-cost averaging: USF

40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
FY07*
* Since inception

FY08

Lump Sum Return

FY09

FY10

Avg. Cost Return

This is especially true for investments in equities. When you invest the same
amount in a fund at regular intervals over time, you buy more units when the
price is lower. Thus, you would reduce your average cost per share (or per
unit) over time. This strategy is called 'rupee cost averaging'. With a sensible
and long-term investment approach, rupee cost averaging can smoothen out
the market's ups and downs and reduce the risks of investing in volatile
markets.

Investment Options: SIP

SIP works on the principle of regular investments. It is like your recurring deposit
where you put in a small amount every month. It allows you to invest in a MF
by making smaller periodic investments (monthly or quarterly) in place of a
heavy one-time investment.

SIP has brought mutual funds within the reach of an average person as it
enables even those with tight budgets to invest with minimum amount on a
regular basis in place of making a heavy, one-time investment.

While making small investments through SIP may not seem appealing at first, it
enables investors to get into the habit of saving. And over the years, it can
really add up and give you handsome returns

Investment Options: SIP

Investment Options: SPT and STP

STP refers to Systematic Transfer Plan where in an investor invests a lump sum
amount in one scheme and regularly transfers (i.e. switches) a pre-defined
mount into another scheme. Every month on a specified date an amount
you choose is transferred from one mutual fund scheme to another of your
choice.

SPT refers to Systematic Profit Transfer where in an investor invests a lump

sum amount in one scheme and regularly transfers profit amount into
another scheme. Every month on a specified date profit amount is
transferred from one mutual fund scheme to another of your choice.

Investment Options: SPT and STP

Final Verdict

It finally proves that equity investment through mutual fund provides best
hedge against inflation in the long term. Diversified portfolio allows superior
yields in comparison to other alternate investment opportunities. It also offer
variety of plans, such as regular investment, regular withdrawal and
dividend reinvestment plans, systematic plans like (SIP, SPT & STP) which
enhance the overall return in the longer period. These plans depending
upon ones preferences and convenience, one can invest or withdraw funds,
accordingly.

JAZAK ALLAH