Treasury and Fund Management
Commercial Banks
&
Asset Management
An Intro….
■
With the growth of International business and the spread of Multinational Enterprise,
the treasury function has acquired a new meaning.
■
No longer the treasury operations restricted to borrowing and lending of funds only to
one money market.
■
The treasury function now includes a diversity of currencies which can be converted
into one another through the exchange markets and which are transacted in money
markets.
The Role….
■
Managing Asset & liabilities of the bank.
■
Managing 'gaps' and the 'risks'.
■
Maximizing profits operating within acceptable risk parameters,
■
Maximizing yield on treasury/inter bank investment.
■
Providing rates to branches and customers.
Inter-Dept Chart….
Treasurer
Head of M.M
Head of Equity
Head of FX
C. Desk



Repo and Rev Repo
Transaction.
SLR and CRR management.
Govt. Securities.




Investment in Shares.
CFS/Badla Transaction.
IPO’s and Pre IPO’s.
Ready Future Arbitrages.




Spot and Forward Transaction.
FX Swaps.
Third Currencies.
Nostro Management.

Dealing with branches and
clients.
Functionality….
Lending to
Branches
Borrower
Spread
•
•
•
•
•
•
•
•
•
•
Excess
Liquidity
Borrowing
Funding
Branch
TREASURY
Front Office
Investment
Depositor
Reserve
Requirement
Treasury
Back Office
Functions
Branches Receive Deposits
Branches Lend To Customers
Branches Remit Excess liquidity to try at an average rate (Pool Rate)
Try maintenance reserve with SBP.
Invest in MM Instruments
Invest in Govt. Securities
Invest in Debt Securities
Capital Market
Fund FCY Trade Nostro Account
Lend to Other Branch
Interest Rate….
■
The interest rate used in determining the present value of future cash flows.
OR
■
The interest rate that an eligible depository institution is charged to borrow short-term
funds directly from a Central Bank.
Yield….
■
The income return on an investment. This refers to the interest or dividends received
from a security and is usually expressed annually as a percentage based on the
investment's cost, its current market value or its face value.
■
There are two stock dividend yields. Cost Yield & Current Yield.
■
Bonds have following yields: Coupon (the bond interest rate fixed at issuance),
current (the bond interest rate as a percentage of the current price of the bond), and
Yield to maturity (an estimate of what an investor will receive if the bond is held to its
maturity date).
■
Yield Curve….
A line that plots the interest rates, at a set point in time, of bonds having equal credit
quality, but differing maturity dates”. OR “The yield curve is the relationship between
an interest rate and the time to maturity for a given debt”.
Yield
■
Maturity
■
The shape of the yield curve is closely monitored because it helps to give an idea of
future interest rate change and economic activity.
■ Normal Yield Curve: Is one in which longer maturity bonds have a higher yield
compared to shorter-term bonds due to the risks associated with time.
Interest Rate
Yield Curve
17%
16%
15%
14%
13%
12%
11%
10%
9%
8%
Maturity Cycle
■ Inverted Yield Curve:
Is one in which the shorter-term yields are higher than the
longer-term yields, which can be a sign of upcoming recession.
Interest Rate
Yield Curve
17%
16%
15%
14%
13%
12%
11%
10%
9%
8%
Maturity Cycle
■ Flat Yield Curve:
Is one in which the shorter- and longer-term yields are very close
to each other, which is also a predictor of an economic transition.
Yield Curve
10.50%
10.45%
10.40%
Interest Rate
10.35%
10.30%
10.25%
10.20%
10.15%
10.10%
10.05%
10.00%
Maturity Cycle
Money Market….
■
The money market is a wholesale market for low risk, highly liquid, short-term & long
term debt instruments.
■
It serves as an avenue through which banks and financial institutions can offload their
excess liquidity or meet their funding requirements.
■
To the government an organized money market represents a means for it to
implement it’s monetary policies in a more efficient manner. Moreover, it provides it
with a liquid market for securities through which it can finance it’s own borrowing
requirements.
■
The large role of commercial banks in the money market can be easily envisioned by
looking at their assets and liabilities.
■
A major portion of their liabilities are demand deposits. Another large portion of bank
liabilities are time deposits.
■
On the asset side, in addition to loans banks have part of their assets invested in
marketable securities.
M.M Objective….
■
Managing liquidity and interest risk.
■
Coordinating with corporate/retail banking departments for assets/liability pricing.
■
To deploy excess funds in order to save liquidity wastage
■
To manage funding requirements which may arise from time to time keeping in view
the cost and interest scenario.
Purpose of M. M….
■
The need for financial institutions to indulge in money market transactions arises
primarily from the reserve requirements imposed by the State Bank.
■
All commercial banks are required to maintain 25% Statuary Liquidity Requirements
(SLR) of their Demand and Time Liabilities (DTL).
■
Commercial banks also have to maintain a certain portion of their DTL in a cash
reserve maintained with the SBP at 0% interest. This ratio is known as the CRR (Cash
Reserve Requirement) and stands at 5.00%.
M.M Instruments & Transactions….
■
■
■
■
■
■
■
Pakistan Investment Bonds
Treasury Bills
Repo / Rev. Repo Transactions
Call / Clean Money
Term Finance Certificate
Certificate of Investments
Commercial Papers
M.M Instruments & Transactions….
■ Pakistan Investment Bonds:
These are long term bonds of three, five, ten,
fifteen, twenty & 30 years, maturity issued at market price and carrying a different
coupon rate according to the interest rates scenario. Moreover, another reason for
issuing PIBs is to set up a yield curve and corporate, mutual funds etc. to invest in long
term.
■ Treasury Bills:
T-Bills are short term securities issued by the State Bank on behalf of
the Ministry of Finance through auctions. They are zero-coupon bonds issued at a
discount, have a par value of Rs 100 and a maturity of three, six or twelve months.
Bank borrowing is one of the various measures the government takes to fill it’s
budgetary deficit and this bank borrowing currently takes place against T-Bills.
■ Term Finance Certificate:
TFCs are redeemable capital instruments and may be
issued by a company directly to the general public, which includes institutions. Unlike
straight bonds, they are redeemable capital and are of long tenors. Issued by
corporate to raise long-term fund.
M.M Instruments & Transactions….
■ Repurchase Transactions:
Borrowing secured by collateral in the form of
securities.
■ Rev. Repo Transactions: Lending secured by collateral in the form of securities.
■ Call Money:
Call transactions consist of non-collateralized lending and borrowing
of Funds.
■ Clean Money:
Clean funds are similar to call funds in the sense that this is
unsecured lending/ borrowing of funds. The only difference is that this sort of
borrowing is done by investment banks and leasing companies.
FX MARKET….
■
Domestic markets trade in local currency and operate under regulations governing
domestic market. When funds in any other currency are traded outside the
regulations governing domestic markets, then we have the transaction of Foreign
Exchange Markets.
■
Nostro Management.
■
Exposure Management
■
Blotter Management
FX TRANSACTION….
■
Any financial transaction that involves more than one 'convertible' currency is a
foreign exchange transaction.
■
Most important characteristic of a foreign exchange transaction is that it involves
foreign exchange risk/Exposure.
■
The exchange rate is determined by the market forces of demand & Supply.
■
Exchange Rate is the price of one currency in terms of another.
Net Open Position
■
A measure of foreign exchange risk.
■
NOP is the Net Asset/Net Liability position in all FCs together
■
Net Asset Position is also called "LONG" or "Overbought" position.
■
Net liability Position is also called "SHORT" or "Oversold" position
■
NOP is a single statistic that provides a fairly good idea about exchange risk assumed
by the bank.
Net Open Position
■
Currency-wise NOP in equivalent PKR
■
NOP calculating in the following manner.
USD
+10
84
+840
POUND
-10
138
-1380
YEN
-10
0.9
-9
TOTAL
-549/84
NOP
-6.53
Foreign Exchange Exposure Limit
■
FX Exposure is the higher of the long and short positions in Foreign Currency.
■
FEEL is the 10% of the paid-up capital of the bank or PKR1.5bln whichever is higher.
■
FEEL(PKR)
=
-1389/84
■
FEEL(USD)
=
-16.53
Corporate Desk….
■
Dealing with branches and large clients.
■
Treasury acts as a separate profit unit versus branches.
FORWARD RATES: Forward rates depend upon interest rate differential between the
two currencies.
■
Currency with higher interest rates is at discount w.r.t currency having lower interest
rate.
■
Currency with lower interest rates is at premium w.r.t currency having higher
interest rate.
CALCULATING FORWARD RATE
Interest rate of USD
Interest rate of PKR
Spot Rate
Tenure
=
=
=
=
4.75%
9%
59.95
Six Month
Six month Forward Rate = spot rate + (spot rate * Int. rate differential * Tenure/365)
Six month Forward Rate = 59.95 + (59.95 * (9% - 4.75%) * 180 / 365)
Six month Forward Rate = 61.20
Equity Market….
■
The investment of the bank will be structured around passive management with
majority of the portfolio invested for a medium to long term horizon based on the
fundamental developments in the economy.
E.M Objective….
■
The key investment objective behind developing an equity portfolio for the bank is to
create and manage an investment portfolio that allows earning of superior yields in
comparison to other alternate investment opportunities.
Risk Mitigation….
The risk of the equity portfolio will be managed through:
■
■
■
■
Comprehensive focus on fundamental research and equity analysis;
Diversification of the investment portfolio;
Rigorous investment review procedures; and
Development of controls and procedures for the trading portfolio.
Equity Trading Mechanism
KSE Clearing House
Buyer
Broker
Payment
T+2 Settlement
Broker
Seller
Shares
ARBITRAGE
Opportunity taken for higher return to avoid market risk. This opportunity arises from
inefficiency of the market.
ARBITRAGE OPPURTINUITIES IN EQUITY MARKET
There are mainly two types of arbitrage in equities.
■
■
Simple Arbitrage
Ready Future Arbitrage
SIMPLE ARBITRAGE
Price differential between two exchanges or market of the same instrument.
PTC Rs. 30
Buy
K.S.E
PTC Rs. 32
T+2 Settlement
Sell
L.S.E
READY FUTURE ARBITRAGE
Price differential between ready and future contracts of the same instrument in the
same exchange or market.
PTC (ready) Rs. 30
PTC (future) Rs. 34
T+15 Settlement
T+2 Settlement
K.S.E
EQUITY PORTFOLIO MANAGEMENT
Introduction
The equity portfolio of the bank envisages a passive portfolio management strategy
Focused on developing a fundamentally strong and truly diversified portfolio. However,
a trading portfolio will be maintained to supplement and enhance the overall yield of the
equity portfolio.
■
The Equity Portfolio is to be distributed between growth stocks and income stocks;
the initial indication is to equally distribute the portfolio however this would depend
on the overall performance of the sector and sub-sectors.
■
Every transaction or trade should be based on strong reasoning and should be
justifiable on fundamental, valuation and/or market expectations;
■
Generate recurring income through dividend yield from specific securities which
is higher than the yields on Government securities; and
■
Reduce the cost and undue risk through maintaining an appropriate balance between
volumes and duration of the transaction.
Portfolio Management Guidelines
The general guidelines with regards to portfolio management are as hereunder:
1.
Every equity investment has to be classified as “Overnight Portfolio”,
“Short Term Portfolio”, “Investment Portfolio” or “Strategic Portfolio” based
on the asset allocation policy and departmental strategy for execution of a
certain trade;
2.
The above mentioned portfolio classifications are defined as:
a) Overnight Portfolio: Daily Trading Positions;
b) Short Term Portfolio: Any trading position with more than overnight horizon
but less than a 3 months horizon;
c) Medium to Long Term Portfolio: The stocks purchased based on the
fundamental earnings or valuation strength. The investment exits will be laid
down in terms of the target price and/or time horizon, which will be at least
90 days. The initial time horizon can be extended based on investment
committees approval; and
d) Strategic Investment Portfolio: The stocks purchased for either a horizon of
more than 2 years and/or acquiring significant stake to allow the bank to turn
around the company and/or any company which fits the strategic focus of the bank.
WORKFLOW
The overall department will be divided into two sub units: Front Office and Back Office.
Typically the equity market unit should be able to manage the following activities:
1. Strategy Formulation
■
■
■
■
■
Yearly Asset Allocation Strategy Paper;
Target Yield Setting on the Investment and Trading Portfolio;
Quarterly Review of the Asset Allocation Strategy;
Management of Research Resources; and
Daily Trading Guidelines.
2. Front Desk Trading
■
■
■
■
Execution of the investment decisions;
Distribution of stocks for trading;
Identification of trading opportunities; and
Delivering on the trading yield targets.
WORKFLOW
The overall department will be divided into two sub units: Front Office and Back Office.
Typically the equity market unit should be able to manage the following activities:
3. Risk Management
■
■
■
■
Development of Standard Operating Procedures (“SOPs”);
Development of Risk Management Policies and Alert Mechanism;
Ensuring Adherence to the Policies and Procedures; and
Development of discretionary investment and trading authorities.
4. Settlements
■
■
■
■
■
Settlement of the T+2 and Futures transaction;
Assistance in managing the badla book;
Providing counter trading reports to management to reconcile with Front Office report;
Providing value date cash flow statement to the accounts / finance department
Ensuring compliance with the prudential and other related regulations.
Myths about the stock market
■
“The market will collapse!”
■
“Investing in stocks is just like gambling.”
■
“Stocks should be bought when they have momentum.”
■
“Heavyweights manipulate the market.”
■
“To begin investing, I need to accumulate a lot of money first.”
Inflation gradually erodes the value the
Rupee
8,000
Nominal Value
of PkR 1,000 :
PkR 6,727
7,000
6,000
5,000
4,000
?
3,000
2,000
Today:
PkR 1,000
Inflation Adjusted
Value of PkR
1,000: PkR 122
1,000
Today Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
Yr 6
Yr 7
Yr 8
Yr 9 Yr 10 Yr 11 Yr 12 Yr 13 Yr 14 Yr 15 Yr 16 Yr 17 Yr 18 Yr 19 Yr 20
Un-invested
Average Prices
Investments provide protection from inflation
25,000
20yr CAGR: 17%
23,106
20,000
15,000
20yr CAGR: 13%
11,523
10,000
5,000
20yr CAGR: 10%
6,727
Pure Equity
Pure Fixed Income
Average Prices
Yr 20
Yr 19
Yr 18
Yr 17
Yr 16
Yr 15
Yr 14
Yr 13
Yr 12
Yr 11
Yr 10
Yr 9
Yr 8
Yr 7
Yr 6
Yr 5
Yr 4
Yr 3
Yr 2
Yr 1
Today
-
“The market will collapse!”
The crash of 2008
Index @ 18th Apr '08
Index @ 26th Jan ''09
Return
15,676
4,815
-69%
…and the recovery
Index @ 26th Jan ''09
Index @ 20th Apr '11
Return
4,815
11,745
144%
…zoomed-in view of the crash of 2005
Index @ Mar '04
Index @ Mar '06
Return
4,854
11,456
136.0%
It pays to stay invested
■
Riding out short-term depression in the market can pay off in the long-run
Gambling/ Trying to catch the momentum
“Investing in stocks is not like gambling.”
■
Investments are made using a systematic approach based on studies of business dynamics.
■
Scrips are selected on the basis of their potential for long-term earnings growth driven by
fundamentals.
■
Portfolio allocations are adjusted periodically to reflect a change in the underlying dynamics of the
company.
Do heavyweights manipulate the market?
■
Yes!
■
Speculators facilitate price discovery in any market – financial institutions look to
take advantage of any pricing opportunity created by the actions of the
speculators.
■
However, manipulation doesn’t last long
■
In the long-run, it’s earnings and cash flows that move stock prices – not the punters
“To begin investing, I need to accumulate
a lot of money first.”
■
No, A person can make investment with only PKR 500 in a mutual fund and gradually
build its investment through SIP.
“To begin investing, I need to accumulate
a lot of money first.”
Comparison with fixed-income returns and
inflation
In fact, equities have outperformed all
other asset classes in the past 15 years
Drawbacks of direct investment in equities
■
Un-informed decision-making
■
Monitoring costs
■
Diversified exposure not possible with small amounts
■
Brokerage fees
How A Mutual Fund Works
■
A large number of people with money to invest buy shares in a mutual fund.
■
They pool their money for buying power.
■
The fund manager invests the money in a collection of stocks, bonds or other
securities.
■
If the manager is successful in selecting good companies that generate value, the
fund will grow.
■
Investors receive periodic distributions and can book capital gains by redeeming
their investments.
Why Equity Funds?
The Reasons…
■ Diversification
■ Active management
■ Hedge against inflation
■ Professional Management
■ Benefits of automatic re-investment
■ Rupee-cost averaging
■ Investment Options: SIP, STP, SPT
Diversification
A stock fund reduces the overall risk faced by an investor through:
■
Diversification is the key to success with safety when investing in stocks.
■
A risk management technique that mixes a wide variety of investments within one
portfolio.
■
A well diversified portfolio is expected to yield higher average returns over the long
run while at the same time keeping your portfolio at a lower amount of risk.
■
There are a number of alternative methods for building stock investment portfolios
without holding stocks directly. One such method is to use mutual funds to gain
exposure to varied market segments.
Active management
■
The manager of an equity fund can periodically adjust the fund’s allocation in
order to maximize the potential returns from the portfolio
■
Selection of Scrips is done on the basis of a rigorous screening criteria that will
ensure returns over the next year
■
Active management of a portfolio requires substantial time and energy – which the
average retail investor cannot afford
■
The investor gets the benefit of active management of an equity portfolio at a very
low cost
Hedging against inflation
■
Historically, equities have generally outpaced inflation, thus ensuring that the realvalue of the investment is protected.
Professional Management
■
Alpha indicates the additional return that is generated through professional
management of the portfolio.
■
This superior performance is due to extensive research and the professional
experience of the fund manager.
Rupee-cost averaging
Average KSE100 Idx
July KSE100 Idx
June KSE100 Idx
Lump Sum Return
Avg. Cost Return
FY06
FY07
9,518 11,168
7,465
9,604
9,989 13,772
33.8% 43.4%
4.9% 23.3%
FY08
FY09
13,899
8,013
13,930 12,222
12,289
7,162
-11.8% -41.4%
-11.6% -10.6%
FY10
9,348
7,271
9,722
33.7%
4.0%
■
The Markets are volatile: they move up and down in an unpredictable manner
■
By using a systematic investment process such rupee-cost averaging, the investor
can purchase more units when the prices are relatively low and fewer units when
prices are relatively high.
■
This method can provide the investor with an effective cushion against a sharp
downturn in the equity market and protect investor’s capital to some extent.
Rupee-cost averaging: USF
40%
USF Cost Averaging
Beginning NAV**
Ending NAV
Avg/NAV
Lump Sum Return
Avg. Cost Return
*Since inception
**Div Adjusted NAVs
30%
20%
10%
0%
-10%
FY07*
FY08
FY09
FY07*
100.00
129.73
106.48
30%
22%
FY08
129.73
124.39
134.24
-4%
-7%
FY09
123.91
80.54
102.23
-35%
-21%
FY10
81.79
99.96
103.85
22%
-4%
FY10
-20%
-30%
-40%
* Since inception
Lump Sum Return
■
Avg. Cost Return
This is especially true for investments in equities. When you invest the same amount in
a fund at regular intervals over time, you buy more units when the price is lower. Thus,
you would reduce your average cost per share (or per unit) over time. This strategy is
called 'rupee cost averaging'. With a sensible and long-term investment approach,
rupee cost averaging can smoothen out the market's ups and downs and reduce
the risks of investing in volatile markets.
Investment Options: SIP
■ SIP works on the principle of regular investments. It is like your recurring deposit
where you put in a small amount every month. It allows you to invest in a MF by
making smaller periodic investments (monthly or quarterly) in place of a heavy onetime investment.
■ SIP has brought mutual funds within the reach of an average person as it enables
even those with tight budgets to invest with minimum amount on a regular basis in
place of making a heavy, one-time investment.
■ While making small investments through SIP may not seem appealing at first, it
enables investors to get into the habit of saving. And over the years, it can really
add up and give you handsome returns
Investment Options: SIP
Investment Options: SPT and STP
■ STP refers to Systematic Transfer Plan where in an investor invests a lump sum
amount in one scheme and regularly transfers (i.e. switches) a pre-defined mount
into another scheme. Every month on a specified date an amount you choose is
transferred from one mutual fund scheme to another of your choice.
■ SPT refers to Systematic Profit Transfer where in an investor invests a lump sum
amount in one scheme and regularly transfers profit amount into another scheme.
Every month on a specified date profit amount is transferred from one mutual fund
scheme to another of your choice.
Investment Options: SPT and STP
Final Verdict
■
It finally proves that equity investment through mutual fund provides best hedge
against inflation in the long term. Diversified portfolio allows superior yields in
comparison to other alternate investment opportunities. It also offer variety of plans,
such as regular investment, regular withdrawal and dividend reinvestment plans,
systematic plans like (SIP, SPT & STP) which enhance the overall return in the longer
period. These plan’s depending upon one’s preferences and convenience, one
can invest or withdraw funds, accordingly.
JAZAK ALLAH