Model solutions Treasury Management 1 May 2013
Answer one
a.
The segments are
i.
Household sector (retail): individuals and families, private charitable, religious and non-profit
bodies serving households, unincorporated business like farmers and professional partnerships;
ii.
Corporate sector: comprise all non-financial companies engaged in the production and
distribution of goods and services;
iii.
General government sector: central and local government;
iv.
Foreign sector: all organizations, persons and assets situated in the rest of the world;
b.
Direct claims are claims financial institutions make for themselves when placing funds with deficit units,
and indirect claims are claims issued by financial institutions to surplus units;
Answer two
Memo detailing the following
a. Policies are important in a treasury environment because
i.
Treasury environment is where monetary deals and transactions are done;
ii.
Numerous risks are encountered;
iii.
Huge amounts can be lost if policies are not in place;
iv.
Workable policies are crucial for the survival of the bank;
b. The following are the essentials:
i.
A policy must be aligned to the overall business strategy;
ii.
A policy must be translated into procedures which include delegation of duties and
responsibilities;
iii.
A policy should include various controls mechanisms and limits to facilitate effective operations;
iv.
Rules must be concisely documented like in form of a handbook, or job-aid, and must be kept
updated;
v.
It must encapsulate the risk management outlook f the bank, and contain the bank’s risk
attitude towards instrument, countries, counterparty, currency, etc;
Answer three
a. Transaction risk is a risk arising in the fluctuation of exchange rate from the time a foreign currency
transaction (that results in an account receivable or payable) is contracted and settled while a translation
risk is the risk arising from the conversion of overseas assets and liabilities into the local currency;
b. The non-financial risks are
i.
Natural disasters like earthquakes;
ii.
Operational risks like fraud, system failures, errors;
iii.
E-commerce liabilities such as tax liabilities, defamation, false advertising;
iv.
Employment risks like wrongful termination, discrimination;
v.
Other risks influencing profitability like crime which is costly, environment exposure, violence in
workplace, alcohol and drug abuse;
c. The three measures are:
i.
Undertaking thorough borrower credit analysis;
Treasury management IOBM: D-201_May 2013
Page 1 of 4
ii.
iii.
Answer four
i.
ii.
iii.
Getting tangible asset as security of loans from borrowers;
Credit derivatives;
A dealer buys (positive position) and sells (negative position) foreign currency in the course of
the day. At end of business, the dealer has to net off the two positions to zero, this is squaring
position. (2 marks)
It is important to square position by close of day in order to avoid exposing the bank to any
foreign currency risks that arise due to movements in exchange rates (2marks);
Currency
Opening position ‘m
USD
3.0
GBP
0.1
ZAR
1.5
EUR
1.0
CAD
0.15
Add the local currency
Divide by USD revaluation rate
USD equivalent
iv.
Revaluation rate
355.0
501.3
35.75
457.0
354.0
Local currency
equiv ‘MWK’m
1,065.0
50.13
53.625
457.0
53.1
1,678.855
355.0
4.7292
Dealing code of ethics is a set of rules to be adhered to by all dealers in the market which
originates from national and international organizations, self-regulatory bodies, professional
bodies, and specific rules and procedures (2marks)
The importance of dealing code of ethics (1 mark each)
a.
It outlines the behavior expected of all dealers in the market;
b.
It instills confidentiality and trust into the market;
c.
It protects the customers and maintain the integrity of the market;
Answer five
Memo (20marks)
a. Scarcity of foreign exchange has been caused by:
i.
Donor pull out;
ii.
Poor performance of tobacco which is the main foreign currency earner;
iii.
Increased demand for oil import bill;
iv.
Illegal externalization of foreign exchange;
v.
General uncompetitive country export base;
vi.
Increased demand for foreign exchange due to (subsidy) fertilizer importation;
vii.
Importation of trivial non-essential items;
b. Possible solutions include:
i.
Reduce dependence on oil usage, introduce new energy sources like ethanol, and solar power;
ii.
Diversifying the agricultural export base, not relying on tobacco alone but to include other crops;
iii.
Help private sector investment in processing (adding value) of agricultural commodities like
tomato, mangoes, fish, etc;
iv.
Help reinvestment in tobacco processing and cigarette manufacturing right here in Malawi
Treasury management IOBM: D-201_May 2013
Page 2 of 4
v.
vi.
vii.
viii.
ix.
x.
xi.
Giving tax holidays/ incentives or special concessions for industries breaking into processing such
commodities as in i to iv above;
Hasten the workability of the Nsanje Inland port;
Allow the hand of demand and supply of the foreign exchange to determine its price;
Reinstatement of donor support;
Support the mining sector;
Impose a ban on some unnecessary imports that can be made locally like toothpicks, earbuds;
Revive the campaign best buy Malawian
Answer six
a. The Basel committee of bank supervision is a committee on bank supervisory authorities established by
the central bank governors of countries of Belgium, Canada, France, Germany, Italy, Japan, Luxembourg,
Netherlands, Sweden, Switzerland, UK and USA, with its secretariat in Basle.
b. Bank supervision is necessary:
i.
Banks are highly important in the economy on a country;
ii.
Maintaining confidence in the banking system: because banks are custodians of families’ futures
in for of savings and investments;
iii.
The importance of banks: they are financial intermediaries, provides a whole range of financial
services to the general public, banks are able to increase the supply of money through credit;
iv.
A business of high risk: the nature of banking business is inherently risk; taking deposits on one
hand and lending them at a profit leads to exposure to risk;
v.
Extensive utilization: this is one financial intermediary in the financial system of a country that is
utilized more than any other financial institution, by the people and businesses of a country;
c. Consequences of bank failure:
i.
If the bank assets are less than the bank liabilities, the central bank would allow it to fail;
ii.
Concern by depositors who have money invested in the bank;
iii.
A curator is appointed to ensure depositors’ funds are not lost;
iv.
The bank may be merged with another bank, or liquidator appointed;
v.
If the extent of the shortfall is so large, the Reserve Bank, in a bid to ensure confidence in the
banking system, with the concurrence of the government steps in to ensure that depositors are
paid substantial part of their deposits;
Answer seven
i.
Bank gap is interest earning assets less interest earning liabilities
Lisa Investment Bank gap
=K150.0m-K135.0m
K15.0m
Berne Bank
=K135.0m-K150.0m
-K15.0m
ii.
The net income margin
=interest earning assets*interest on assets
Less interest bearing liabilities*interest on liabilities
Lisa Investment Bank
=K150.0m*16%-K135.0m*12%
Treasury management IOBM: D-201_May 2013
Page 3 of 4
=K5.8m
Bernie Bank
=K153.0m*16%-K150.0m*12%
=(K1.6m)
iii.
The impact on both banks of a rise in interest rates by 1%
Current
1% up
Lisa
Bernie
Lisa
Bernie
Interest earned
16%
16%
17%
17%
Interest paid
12%
12%
13%
13%
Net interest
K5.8m
K1.6m
K5.95m
K1.445m
K0.05m
(K0.155m)
Change
An increase in rates, where financial institutions are running positive gaps, would increase the net
interest margin as with the case with Lisa Investment Bank whose net interest margin increase from
K5.8m to K5.95m when genera interest rates went up from by 100 basis on both assets and liabilities to
17% and 13% respectively;
Answer eight (memo format)
Functions of a risk management unit
i.
Manages price, currency, interest rate, liquidity risks;
ii.
Independently measuring limits that need to be measured;
iii.
Running stress scenarios that will involve worst case moves;
iv.
Perform risk/return analysis;
v.
Check accuracy of dealers and other reporting;
vi.
To report key information on a timely basis to management in respect of financial risks;
Functions of a compliance unit will perform the following:
i.
Review appropriateness, adequacy, and application of internal controls;
ii.
Review the extent of compliance with established policies and procedures;
iii.
Review appropriateness of limits;
iv.
Review whether action has been taken in response to limit excess;
v.
Ensure reconciliations are performed appropriately and reviewed periodically;
vi.
Ensure that the physical scrip held has been agreed and checked to the accounting records;
The end
Treasury management IOBM: D-201_May 2013
Page 4 of 4