Unit 1 Context Of Treasury Flashcards
Role of the treasurer:
Cash Funding and liquidity Credit Banking relationships Financial risk Foreign exchange
Key Treasury Tasks:
- identifying and evaluating financial risks
- assisting the company’s wider risk management function
- managing the company’s capital structure and weighted cost of capital
- identifying appropriate risk management strategy in light of the treasury policy
3 main treasury roles:
Advisory (decentralised)
Agency (centralised)
In house bank
Types of treasury structure:
- cost centre (efficient use of cash)
- cost saving centre (minimise financial volatility)
- profit centre (active approach to risk mgmt)
Centralised Treasury
Supported by:
- Technology
- Regulatory environment
Pros: Single financial status Cost saving Control Synergy of expertise
Cons:
Profit centre manager not in control of own finances
Understanding of local environments
Decentralised Treasury Structure
Pros:
Local autonomy
Alignment of policy with local needs
Head office costs reduced
Cons: Duplication Loss of economies of scale Loss of control Need for suitably qualified staff
5 major areas of treasury responsibility:
- Corporate financial management
- Capital markets and funding
- Cash and liquidity management
- Risk management
- Treasury operations and controls
Role of Central Banks
- Supervise the market
- Control the supply of money
- Set domestic interest rates
- May seek to smooth out fluctuations in currency by buying and selling across the world
Discount Instruments and return to investors
Sold at a discount to their face value. Investors achieve a return when paid at maturity they will receive the face value which is greater than the price they will have paid
Time value of money
A fixed sum of cash received today is worth more than exactly the same sum receivable in the future. Amounts held today can be invested and will be worth more than the original amount due to investment gains.
Key point: generation of returns
FX Pricing
Base currency = left
Market maker’s price = right
Special arrangement for corporate to transact FX with a market maker
Credit line
Components of Capital Structure
- Equity in the form of share capital
2. Borrowings in the form of loan capital
Nominal rate calculation
1+ real rate = 1+ nominal rate / 1+ inflation rate
Effective annual return (EAR)
R = periodic interest rate N = number of time a period fits into calendar year
EAR = (1+R ^n) -1
Examples of annuities
- fixed rate loan interest payments
- Pension payment
- finance lease
Advantages of electronic dealing platforms vs. Telephone dealing:
- no misunderstanding
- immediate confirmation
- competitive pricing
- straight through processing
Back office Functions
- ensure deals have been accurately recorded
- ensure deals meet internal policies
- ensure deals have been confirmed by counterparties
- validate internal process
- manage a deal through to settlement
- account for the transaction
- Control and report on dealing
- monitor controls and provide reassurance to management that activities are properly carried out
Middle office
Generally in larger companies
Internal control and compliance
Responsibilities:
- design of control framework
- treasury reporting
- systems development
Internal Rate of Return (IRR)
Internal Rate of Return is the cost of capital that results in a set of cash flows having a net present value of 0
Yield Curve
Summary of market yield for comparable instruments over time
Difference between yield and interest
Yield is an impied return which not only takes into account interest payment but also the market value and any redemption value
Theory of a positive yield curve
Market expectations - market expects that rates will rise
Liquidity preference - suggests investors demand a risk premium or compensation that increases the longer their funds are tied up
Market segmentation - suggests the yield curve at any point reflects the supply and demand for funds at any particular time point
Par yield curve
Plots the rates of coupon paying bonds redeemable at par over time
Par rates can be used for determining the coupon rate on a new bond redeemable at par or the fixed leg rate of a new interest rate swap
Key features of an FX market
- Trading volumes for liquidity
- due to number of participants and size of market profit margins are low on any individual transaction
- increasingly technological
- no physical market place
- facilitate movement of capital around the world
- globalisation of business has increased demand
Strategic elements of risk management
- which markets to enter
- organic growth vs acquisition
- determine which risks to avoid and which to insure against if unavoidable
- identify financing or hedging profile
Tactical elements of risk management ( delegated to the treasurer)
- selection of counterparties
- timing of actions in markets
- selection of borrowing/ hedging / investment instruments
Interest Rate Parity theory
Interest Rate parity links 4 market rates:
Spot FX
Forward FX
Interest rates in both currencies
Under efficient market conditions the theory predicts that the current forward FX rate can be calculated from the spot rate adjusted for the difference in Interest rates between the 2 currencies
Examples of market takers in an FX market
- Non financial corporates including importers and exporters
- banks dealing with each other
- pension funds
- central banks
- insurance companies
- hedge funds
General risk responses:
Avoid
Accept and retain
Accept and reduce
Accept and transfer
Key Treasury objectives:
- Ensuring liquidity
- Cost effective funding of business activities
- Managing financial risks
- Developing a culture of sound financial practice
Key feature of a growing perpetuity
Series of payments of receipts that grow at a constant periodic rate and last forever
Real interest rate
Has been adjusted for the effect of inflation
Zero coupon bond
A bond which pays no periodic coupons but only a redemption amount at maturity
Key tasks of a corporate finance team
- developing strategies that positively affect the value of the corporate
- Minimising the organisations weighted average cost of capital (wacc)
- providing a complete and accurate contribution to external reporting
- ensuring the organisation is fairly evaluated by investors
- Ensuring the organisation provides investors with returns in line with the risk they take on
Key responsibilities:
Arranging long-term funding
Evaluating potential mergers and acquisitions
Evaluation of potential divestment and business development
Arbitrage
The simultaneous purchase and sale of assets in multiple markets in order to exploit a temporary discrepancy in prices
In money markets arbitrage could arise if a borrower could borrow currency at a favourable agreed fixed interest rate and exchange it at the spot FX rate and invest the proceeds at an agreed fixed rate to be reexchanged on maturity at a contracted favourable forward FX rate
Opportunities for arbitrage are short lived and small because markets eliminate these possibilities. This is achieved through close alignment of spot, FX and interest rates which leads to parity I.e. no risk free profit opportunities
4 elements of risk management process
Identifying
Assessing
Evaluating
Managing
Workflow process for treasury transaction
Identify need for a trade Analysis to gain pre trade authority Deal and confirm Arrange settlement Account for it
Reasons for outsourcing treasury activities
Lack of specialist skills in house
More efficient, lower cost of processing transactions
Freeing up more time for strategic decision making
Saving costs on technology
Factors that may influence a company’s treasury department structure
Size and international scope
Level of financial risk
Culture of business
Degree of centralisation and need for control
Spot FX trade
Settles T+2
Eurocurrency Market
Is an international market where participants borrow and deposit currencies outside of their country of origin
If borrowing in this market, you would require the offer rate to determine costs
Treasury acting as a cost centre
Pros:
Enables commercial decisions to be taken against reasonable certain financial background
No reason for the treasurer to take additional risk in the hope of adding value
Cons
There are few incentives for the treasurer to be innovative in approach
The company may miss out on taking opportunities where taking an acceptable level.of risk can add value to the company
Risk management commitee
Subcommittee of the board
Consistency in managing risk
Integrated approach to risk taking into account the wider picture
Maintaining Liquidity
Ensuring cash is in the right place at the right time to meet liabilities
Safeguarding the value of short term assets and ensuring they can be liquidated when necessary
Identifying and managing financial risks which could erode financial strength
Developing a culture of sound financial practice
Ensuring access to liquidity in order to meet all current and future liabilities via appropriate borrowing facilities
Working capital analysis
Is the understanding and management of how cash is consumed and released from the business cycle. It is important to a business because as payments and receipts in transit take time to reach the cash balance. An organisation must understand what represents cash and is therefore available to meet financial liabilities
Effective cash management activities
Payments and collections Day to day cash control Bank account structuring Short term investment Short term borrowing Cash flow forecasting Organising trade finance
