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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.
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:
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
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.
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
Brainstorming
Interviewing
Root cause analysis for identifying a problem, discovering the causes that
led to it and developing preventive action
Checklist analysis
Diagramming techniques
SWOT analysis
Risk Analysis
Tools and Techniques for Qualitative Risk 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.
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
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.
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.
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.
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.
Micro factors
Micro factors, meaning factors specific to the borrower, which play a role in
the interest rate, are:
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
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.
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:
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.
Deploying surplus funds in securities with low risk and moderate profits
Managing the sum total of treasury risks with some balancing actions as
between the three markets
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.