Treasury Management

Question 1

Areas of Treasury Management

Answer 1

Funding, Liquidity Management, Corporate Finance, Currency Management

Question 2

Liquidity Management

Answer 2

This is the short-term management of cash and is the foundation of treasury management.

Question 3

Funding

Answer 3

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

Question 4

Corporate Finance

Answer 4

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

Question 5

Currency Management

Answer 5

Managing the impact of currency movements on gearing and the net worth of the company if it holds overseas assets.

Question 6

Treasury department can act as

Answer 6

Advisor, Agent, In-house bank

Question 7

Advisor

Answer 7

sets policy, advices on implementation

Question 8

Agent

Answer 8

sets policy, executes deals as agent for subsidiaries

Question 9

In-house bank

Answer 9

manages aggregate positions via external markets and deals with all subsidiaries in a similar way to a bank

Question 10

Treasury department can be set up as

Answer 10

cost centre, cost saving centre, profit centre

Question 11

Cost centre

Answer 11

Hedges 100%

Question 12

Profit Centre

Answer 12

Where a treasury department creates a speculative position

Question 13

Cost saving centre

Answer 13

Where partial hedges are used and residual risk is managed within limits.

Question 14

Treasury department can have different level of authority, they can be

Answer 14

Decentralised or Centralised or Balanced

Question 15

Decentralised treasury

Answer 15

Decisions about the company’s financial operations are taken by different teams in different locations

Question 16

Centralised treasury

Answer 16

All the decisions about the company’s financial operations are made and controlled by unique team to obtain financial efficiencies and tight control.

Question 17

Treasury department set up as a cost centre

Answer 17

Managers are motivated to keep costs within a budget. Treasury is there to perform service to other department rather than make profit

Question 18

Treasury department set up as profit centre

Answer 18

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.

Question 19

Advantages of centralised treasury department

Answer 19

• 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.

Question 20

Advantages of decentralised treasure department

Answer 20

• 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.

Question 21

Ways to manage risk

Answer 21

• 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

Question 22

Risks faced by treasurers

Answer 22

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

Question 23

Controls required to ensure the effective and secure functioning of a treasury department

Answer 23

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.

Question 24

Dealing room risks

Answer 24

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.

Question 25

Ways to manage dealing room risks

Answer 25

- 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.

Question 26

Dealing room controls

Answer 26

-Employing right people through detailed and thorough interviews and taking two or three references

Question 27

Dealing room risks : System risk

Answer 27

-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.

Question 28

Dealing room risks: Quality of information

Answer 28

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.

Question 29

Dealing room risks: Recording of Transactions

Answer 29

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.

Question 30

Dealing room risks: Security

Answer 30

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.

Question 31

Dealing Risk

Answer 31

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.

Question 32

The nature of controls over telephone dealing

Answer 32

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.

Question 33

Counterparty Risk

Answer 33

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.

Question 34

Derivatives risk

Answer 34

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.

Question 35

Managing Derivatives risks

Answer 35

1. The board of directors should establish and approve effective policy for use of derivatives; 2. Senior management should establish clear written procedures for implementing the derivatives policy set by the board; 3. Senior management should ensure that derivative activities are properly supervised and are subject to an effective framework of internal controls and audits; 4. Senior management should establish a sound risk management function; 5. 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 6. Procedures should be in place for the monitoring and management of legal risk