TREASURY MANAGEMENT



TREASURY MANAGEMENT

NOVEMBER 2013 SOLUTIONS

MODEL SOLUTIONS

SECTION A

1. Dealing limits (page 71-72)

i. Authority limits – determines who may authorize

ii. Counterparty limits – what amounts may be traded with whom.

iii. Approved instruments

iv. Instrument limits

v. Portfolio limits

vi. Currency limits

vii. Liquidity limits

viii. Open position limits

ix. Rate limits

2. Financial terms

i. Nostro account (pg 87) is an account that a bank keeps with a correspondent bank. Exist for two essential reasons for the sake of correspondent relationship or as compensatory balances for existing transactions and as clearing accounts for foreign transactions

ii. Negotiable Certificates of Deposit (pg 102) - a fixed deposit receipt issued by a bank that is negotiable in the secondary money market as a financial asset. The issuer undertakes to pay the amount deposited plus interest to the holder of the certificate on maturity date

iii. Bill of exchange (pg 109) – An unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person whom addressed it is addressed to pay on demand, or at a fixed or determinable future time, a sum certain in money to a specified person or his order or to bearer.

iv. Bankers’ acceptance (pg 110) – a bill of exchange drawn on and accepted by a bank, an instrument of high quality and great simplicity and can be negotiated with ease in a developed secondary market that exists for such a paper.

v. Open market operations (page 119) - entails the buying and selling of government securities by the reserve bank in the open market at the bank’s discretion in order to influence conditions in the money market or level and pattern of interest rates

3. (a) (i) JPY100,000 to MWK on 8 November

Rate = 318/80.0310

= 3.9735

MWK = 3.9735 X 100,000

= MWK397,350.00

(ii) GPY35 to MWK on 1 November

Rate = 313.2300 X 1.6127

= 505.1460

MWK = 505.1460 X 35

= MWK17,680.11

(b) The EUR because it has been stable (did not change)

c) Made a profit (called revaluation profit). (K318.0000-313.2300) X $120,000 = K572, 400.00 profit.

d) On 1 November 2012, CAD was weaker than USD in that CAD1.0003 was equal to USD1.00. On 8 November 2012, CAD was stronger than USD in that CAD0.9111 was equal to USD1.00.

4. (i) Liberalized economy is an economy where there are fewer government regulations and restrictions in the economy in exchange for greater participation of private entities.

(ii) Yes we still need RBM for the following:

• Government’s banker

• Banker of other banks

• Custodian of banks’ cash reserves

• Clearance and settlement of inter-institutional claims

• Provision of accommodation and lender of last resort

• Open market operations

• Monetary policy and exchange rate policy

• Supervision of banks

5. (a) Factors that influence changes in rates (pg 45-47)

i. Movement in the USD –USD is a pivotal currency against which other currencies are measured. Any event that affects the dollar will in likelihood affect the exchange rate of the other currencies.

ii. Supply and demand- the basic economic principle. When there is a demand by prospective buyers (importers) the price of the respective currency will go up.

iii. Market sentiments – the perceptions (speculation) of the future movements of the exchange rate. This results in a flurry of buying and selling within a short period.

iv. Market triggers – effect of actions such as announcement of economic data, interest rates adjustments, central bank intervention, scandal and unethical behavior and events affecting world (or regional) peace and stability.

(b) A free floating regime - A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the forex market. And how it is applying to the Malawi situation, i.e. constant increase in the rates, holding of FX by suppliers in anticipation of further increases, challenge in pricing of commodities, etc

6. An article for the Bankers’ Magazine on the general financial system in Malawi

a) Financial system – a frame work of intricate and complex arrangements and procedures that have developed and are continuously to develop, in order to satisfy the needs of all participants in the economy as they enter into financial transactions such as savings, investment and the diverse and numerous methods of monetary payments and transfers.

b) the four sectors of the financial system

• Household sector – consists of individuals and families, private charitable, religious and non-profit bodies serving households.

• Corporate sector (wholesale or private sector) – all companies not classified as financial institutions and therefore covers business enterprises directly or indirectly engaged in production and distribution of goods and services.

• General government sector – consists of the central government and local government.

• Foreign sector – organizations, persons and assets resident or situated in the rest of the world.

c) How individually each sector is affecting the Malawi economy. Provide clear example

• Household sector – one of the driving forces of an economy. The propensity to consume of this sector has an impact on how trade is consumed. It also provides the labor force that drives the production mechanism of an economy.

• Corporate sector – the efficiency and effectiveness of this sector, determines the amount of goods available to the economy, exports, demand of raw materials both locally and imported, as well as the levels of credit in an economy.

• Government sector – provides direction and attractiveness of conducting business in an economy. Examples on policies include foreign exchange rate regime, inflation and interest rates policies, etc.

• Foreign sector - the ability to repatriate back to the local country proceeds of foreign earnings by individuals in Diaspora, foreign companies demand for local products, etc.

7. Assets and Liability Management

a) Assets and Liability Management (ALM) – involves the managing of the pricing and mix assets and simultaneous management of liabilities within given legal and practical constraints, in order to maximize the bank’s margins.

b) The goals

• Controlling interest rate risk within predetermined limits

• Maintaining adequate levels of liquidity

• Achieving profitable spreads and adequate returns on capital and assets

• Achieving adequate levels of capitalization

c) The ALCO strategy process typically follows a special sequence that has four elements as follows:

• Identifying and quantifying the risks

• Estimating interest and exchange rates

• Projecting future income

• Testing strategies to arrive at a strategy that is considered most appropriate for the institutions

8. Presentation at the financial dealers AGM at Club Mak

Title : Risk

Presented by : Xxxx Yyyy

Date : 13 May 2013

i) Risk and its impact on businesses – risk is the probability of an adverse effect, the possibility that an outcome or event will not meet expectations. The changing environment exposes a business to different risks so that it is possible for the business not to achieve the planned goals. Risk can even reach to a point whereby businesses can be closed or paralyzed.

ii) 4 (four) types of financial risk

• Exchange rate risk – the risk of losing money because of changing exchange rates. This can seriously distort the amounts of inflows in terms of receipts and out flows in terms of payments.

• Interest rate risk – the exposure of an institution to adverse movements in of interests thus it deals with the possibility of loss arising from a fluctuation in the level of interest rates.

• Liquidity risk – the risk of being unable to repay deposits on demand or when they fall due, through holding insufficient cash or near cash assets.

• Capital or solvency risk – arises when a bank does not manage other financial risks prudently and the resultant effect is the erosion of the bank’s capital.

• Price risk (investment risk) – the possibility of loss resulting from a change in the market prices of assets and liabilities.

• Credit risk – the risk of counterparties in defaulting on their obligations. These counterparties include on loans, overdrafts, credit cards, derivatives, etc.

iii) Instrument or method on each of the above financial risk that will help reduce the impact of the risk

• Exchange rate risk – forward exchange, currency options, currency futures, currency swaps.

• Interest rate risk – interest rate swaps, forward rate swaps, caps, floors, collars, Swaptions.

• Credit risk – credit derivatives, security against the loan, borrower credit analysis.

• Price risk – fundamental analysis, technical analysis, immunization.

• Capital risk – maintain capital adequacy, manage liquidity risk, prudent management of all financial risks

• Liquidity risk – prudent liquidity management, prudent management of all financial risks.

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