Treasury Management Flashcards
Areas of Treasury Management
Funding, Liquidity Management, Corporate Finance, Currency Management
Liquidity Management
This is the short-term management of cash and is the foundation of treasury management.
Funding
Making arrangements with banks and capital market debt. It involves deciding on how to best resource debt in terms of its maturity, instrument, currency, interest rate and documentation. Managing its day to day relationship with debt provided
Corporate Finance
Treasurer manages financial structure of the company in a way that minimised the cost of capital.
Treasurer appraises projects, evaluated subsidiaries and implements the funding and details of mergers and acquisitions
Currency Management
Managing the impact of currency movements on gearing and the net worth of the company if it holds overseas assets.
Treasury department can act as
Advisor, Agent, In-house bank
Advisor
sets policy, advices on implementation
Agent
sets policy, executes deals as agent for subsidiaries
In-house bank
manages aggregate positions via external markets and deals with all subsidiaries in a similar way to a bank
Treasury department can be set up as
cost centre, cost saving centre, profit centre
Cost centre
Hedges 100%
Profit Centre
Where a treasury department creates a speculative position
Cost saving centre
Where partial hedges are used and residual risk is managed within limits.
Treasury department can have different level of authority, they can be
Decentralised or Centralised or Balanced
Decentralised treasury
Decisions about the company’s financial operations are taken by different teams in different locations
Centralised treasury
All the decisions about the company’s financial operations are made and controlled by unique team to obtain financial efficiencies and tight control.
Treasury department set up as a cost centre
Managers are motivated to keep costs within a budget. Treasury is there to perform service to other department rather than make profit
Treasury department set up as profit centre
Treasury department can make money from its activities. It is only appropriate to run treasury department as a profit centre if a company has a high level of foreign exchange activities and department does not become too speculative.
Advantages of centralised treasury department
- Borrowing can be arranged in bulk
- The organisation avoids having a mix of overdrafts and cash surpluses
- Combined cash surpluses can be invested on a short-term basis in the money markets
- Experts can be employed with knowledge of futures, options, swaps and eurocurrency markets
- Foreign currency risk management is likely to be improved as it will be possible to match receipts and payments in a given currency across all the subsidiaries. The need for more expensive hedging methods such as forwards is therefore minimised
- A centralised precautionary balance (a cash balance kept to cover contingencies) is likely to be lower than the sum of individual decentralised precautionary balances
- It is easier to measure the performance of the treasury team in financial terms;
- Transaction costs should be reduced with fewer transfers between different currencies, due to there being only one group current account in any given currency; and
- Centralisation provides a means of exercising better control through the use of standardised procedures and risk monitoring.
Advantages of decentralised treasure department
- Sources of finances can be diversified
- Greater independence can be given to subsidiaries and divisions
- Decentralised department can be more responsive to the needs of individual users.
Ways to manage risk
- Transfer risk by hedging 100% or hedging selectively
- Retain risk - do nothing
Use commercial techniques:
- A Avoid risky transactions altogether
-P (O) - Prevent risks by renegotiating transactions
-CO - Control risks by enforcing limits and policies
M (manage) Mitigate risk by imposing business practices
Risks faced by treasurers
Operational - The risk that procedures (including computer-based procedures), are inadequate or are poorly implemented.
Compliance - The risk that regulations and guidelines which govern the conduct of treasury are not observed
Fraud - The risk that controls do not prevent/detect fraudulent behaviour.
Policy inadequacies- The risk that treasury activity policies are not comprehensive or rigorous enough
Control inadequacies - The risk that controls are not comprehensive or rigorous enough
Controls required to ensure the effective and secure functioning of a treasury department
Control environment - A key treasury organisation issue is whether to operate as a cost centre, cost-saving centre or profit centre.
Risk assessment - Due to the risks to be managed and the instruments available to manage them, there is scope in treasury to use statistical techniques.
Control procedures - With the complex nature of derivatives and the opportunities for leverage, control is more difficult and more critical
Information and communication - The technical nature of treasury and the likelihood that few non-treasury senior managers will fully understand the area, makes reporting more difficult and more critical.
Dealing room risks
Risks relating to the dealers and their transactions and are: primarily the risk of money being misappropriated and the risk of unauthorised
positions.
Losses have arisen from both causes, either as a result of deliberate action or as a result of errors.
Ways to manage dealing room risks
- Establishing detailed policies on the limits for each dealer along with who may confirm transactions and
who is authorised to sign cheques and confirmation letters.
-Maintain a ‘check and control’ balance over the actions undertaken by the
treasury department personnel. This implies duality in all transactions, whereby a
second person checks, either manually or electronically, the details of each transaction
undertaken by a first person.
Dealing room controls
-Employing right people through detailed and thorough interviews and taking two or three references
Dealing room risks : System risk
-The risk that the manual and electronic systems for implementing transactions have inherent flaws. This may be because the requirements were not
clearly specified by the user or because the systems department did not understand the
business sufficiently well.
Dealing room risks: Quality of information
The centralised treasury function acts on information received internally. This
information can include forecasts of payments or receipts and currency requirements.
External information is also received. External information relates to the movements in
the money and currency markets.
An inherent risk is the quality of the information
received, particularly internally. There may be manufacturing delays, or transport
delays which will cause the forecast payment or receipt dates to slip.
Dealing room risks: Recording of Transactions
An important feature of systems is that transactions are recorded. This must be
monitored so that external parties can check that all is correct. The main way that this
is achieved is through an independent check of the bank confirmations of transactions.
Dealing room risks: Security
Security is a key issue in corporate treasury.The first level of security is typically the password to enter the system.
Then there are various levels of access allowing different people to perform different
tasks.
One person should not have all the passwords. Typically, the system administrator
would be someone external to the treasury department. The passwords for authorising
payments electronically and so sending data would only be given to an authorised
signatory.
Dealing Risk
Typically deals relating to foreign exchange or interest rate products are done over the
telephone, in order to take advantage of prices which may change from second to second. Providing there are adequate controls over this telephone dealing, this should
not represent a risk.
The nature of controls over telephone dealing
19.6.9 Counterparty Risk•most companies, and certainly all banks, record dealers’ telephone calls so that
in the event of a disagreement the call can be replayed to see what was said;
• a hard copy of deal confirmation should be produced by the treasury department;
• this confirmation should be checked with the incoming bank confirmation;
• bank mandates must be in place detailing individuals authorised to deal on the
telephone and the levels to which they can deal; and
• there will often be internal exposure limits within which the treasury must operate.
Counterparty Risk
Counterparty risk is the possibility that the entity to which money has been lent or to
whom the company is otherwise exposed will not be able to repay at maturity. The
scale of transactions for the treasury areas tends to be larger than those handled
through the accounts department. The credit limit set for deposits and other exposures
with any one institution will be the responsibility of treasury and not the credit controller.
These limits should be formally reviewed at least annually or preferably semi-annually
as rating agencies amend their ratings.
Derivatives risk
Dealing in derivatives is no different (in terms of basic controls and procedures) than
dealing in basic instruments. Losses have occurred in the past because an
organisation using derivatives did not understand the nature of the instruments and/or
did not control exposures properly. Losses have arisen in large multi-nationals and in
banks, but can also arise in small organisations.
Managing Derivatives risks
- The board of directors should establish and approve effective policy for use of
derivatives; - Senior management should establish clear written procedures for implementing
the derivatives policy set by the board; - Senior management should ensure that derivative activities are properly
supervised and are subject to an effective framework of internal controls and
audits; - Senior management should establish a sound risk management function;
- Procedures should be in place to provide for a full analysis of all credit risks to
which the organisation is exposed, and for the establishment of credit limits for
each counter party; and - Procedures should be in place for the monitoring and management of legal risk
