Treasury Management Exam 2004
Guideline Answers
Q1)
i)
ii)
Companies need written policies so that there are benchmarks, agreed procedures (by
the board), performance evaluation and continuity for new personnel. Companies need
to protect against fraud, theft, data leakage, data contamination and
human
error. (Each would need to be fleshed out e.g. what is contamination etc etc)
The process would be as follows
Segregation of
duties
Co dealer logs details on
TMS
+ competitive quotes.
Also logs in ERP system
Company
back
office
authorised
Authorised deal
by FD, treas etc
Both parties send
confirmations and
reconcile
Limits on Bank
Limits on company
Deal done
done
Dealer
Dealer
limits
Bank
Authorised/
Mandates
Confirmation
Bank dealer
logs details
Settlement to
standard
settlement
instructions
Segregation of
duties
Conversation recorded
Security/ controls on settlement
Internal audit, Physical access, Dual input, Pre formatted
payment details, Passwords, Encryption, Authorisations,
Answer back, Reconciliation
iii)
Physical security issues may be difficult to maintain e.g. for restricting access to
computers if there is a space problem or hardware rationing. Dual entry may be a
problem with limited staff and also when staff are on holiday, also maybe keeping
passwords and access codes a secret. Same for dual authorisation. Segregation of duties
may be impossible in a small department.
Treasury Management Exam 2004
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Q2)
i) Translation Exposure. This arises through the need to translate overseas assets and
liabilities into the base currency for reporting purpose. Affects the P&L and the Balance Sheet.
A few areas may give problems. The first would be any fixed assets overseas e.g. are overseas
offices rented or owned, as for the second, any currency loans taken on to fund these assets, or
assets elsewhere. The third area might be the aircraft, depending on how they are carried on
the books and whether they are bought or leased.
Economic Exposure. This arises through the appreciation of a company’s cost base
relative to that of its competition through the movement of exchange rates. Depending where
the airline flies and where the customer base is, then there are two areas of economic risk. The
first is the overall economic environment that will effect the whole of the airline industry, i.e.
ticket sales. The second is the relative strength or weakness of the various currencies of the
countries the airline flies to or from and how this affects the direction and volume of tourist
traffic and business traffic. Many costs in the airline industry will be dollar based, e.g. aircraft
but there will still be differences in local costs such as aircrew, head office etc
Transaction. Transaction exposure arises through the effects of exchange rate movement
on transactions that have to be done. This will arise from a number of areas; ticket sales, fuel
costs, aeroplane purchase/ loan repayments, operations in other countries, on-flight sales, other
purchases (e.g. meals).
ii) Translation – depends on the size of the problem but probably not a big issue. Maybe
some currency loans to match assets but would not spend shareholders money on
forwards, options etc to ‘cosmeticise’ the balance sheet. There may be issues with covenants or
earnings/performance and this might influence me. Would not use too much debt as excess
borrowings could lead to
- Thin cap issues – performance issues (measurement) – increased interest cost- local
management problems ref the balance sheet if borrowing done in country Economic – little that can be done in the treasury area. Would not undertake any FX
deals of a ‘speculative nature’. Would advise on issues of sourcing into other currencies
for supplies but there may be restricted availability etc. At strategic level, would look to
arrange destinations to pick up traffic both ways. Treasury to advise on this and strategic
alliances.
1)
2)
3)
4)
5)
6)
Transaction. Would use a mixture of techniques:
As much internal hedging as possible i.e. local costs matched by local ticket sales with
mismatches in time managed via currency accounts and borrowing.
Forwards where there are large known exposures, i.e. purchase and financing of
aeroplanes and fuel.
Options – might use options, especially to ‘mop up’ fluctuations in fuel usage/spot price
fluctuations or for covering uncertain purchases e.g. aircraft purchases
Borrowing
Swaps to cover mismatches in time
Look at leading and lagging supplier payments
Treasury Management Exam 2004
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Q3)
i)
Cash Management is important to;







ensure liquidity/cash is available
maximise interest earnings/minimum interest costs
control cost of working capital (float)
ensure balance sheet looks well managed for creditors, analysts and rating agencies,
customers
good ratios (current, acid for creditor comfort)
Fx risk management
Minimise transaction costs/charges
Cash cycle illustrates the importance of generating cash as well as making profit.
Inventory
£40
Labour etc £20
Purchases
£20
Sales
£80
Cash ??
-40 to
+80
ii)
Float is the time lost between a payer making a payment and it being recognised
as good value funds on your account. This is a narrow definition of bank float.
The concept can be extended to include any delay in the order to good value
process. Float has a cost.
Principal x days lost x int = float cost/gain
365/360
Treasury Management Exam 2004
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250,000,000 x .06 x 39/365 = 1,602,740 assuming 30 days credit have been
costed in and based on a receivables days of
47,260,270/250,000,000 x 365 = 69
Float may be occurring, in no particular order, in the following areas:
Invoicing – why batch? Average payment is £700,000 so invoicing once a month will give
average number of days of 45, i.e. 15 more, cost =
£ 700,000 x .06 x 15 = £1,726 (note: the extra 15 days will not be picked up in receivables
figures).
So, invoice as delivered saving £1,726
Delivery. Customers will probably, at the least take 30 days from delivery, no matter what the
invoice date. With high value, low weight/volume products, why not send by courier?
Say, saves 4 or 5 days
Then 700,000 x .06 x 5/365 = £575.
It is unlikely to cost this much.
Internal order to delivery process, cannot comment.
Can encourage to change by;
 Offering discount to pay early but ensure it is reasonable
 Method of payment. Instructions on invoice to pay by eft – may not work but costs
‘nothing’.
 Offer to absorb extra cost of eft etc.
 Know your customers paying habits
 Refuse supply but effect on relationship
 Payment in advance or use post dated cheque where allowed, illegal in some countries
 Take legal action but costly potentially and may ruin relationship
 Apply penalties but may not be able to collect them
Savings will depend on what costs are involved versus float saved, but could save;
75% by cheque. Assuming 2-3 days in post and 2 days clearing (in UK), longer for cheques
drawn
on Europe, say, 75% of payments taking 10 days longer than eft then:
250,000,000 x .06 x .75 x 10/365 = £308,219
or for those paying by cheque 700,000 x .06 x
10
/365 = 1,151 per invoice.
Float loss through clearing cheques back to Europe. For those who will stick with cheques then
Open a/cs in Europe to cut down on post and clearing times.
Treasury Management Exam 2004
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Q4)
.040625
i)
Total at T91
a)
UK on own 950,000 x 4 1/16 x 91/365 = 9,622 = 959,622
b)
Dkr on own 970,000 x 1 27/32 x 91/360 = 4,521 = 974,521
.0184375
Swap into GBP
Sell Dkr
970,000
@11.1880
Buy GBP
86,700
Buy Dkr
Sell GBP
974,521
@ 11.1240
87,605
43
/16
Total to invest 1,036,700 x .041875 x 91/365 = 10,823 = 1,047,523.22
Sell GBP 87,605 to leave GBP 959,918.22
Net overall again in GBP: 296.20
Swap into Dkr.
950,000 sell GBP
@11.1895
10,630,025 Buy Dkr
Buy GBP 960,032
@ 11.1280
Sell Dkr 10,683,232
1 31/32
Total Dkr to invest 11,600,025 x .0196875 x 91/360 = 57,728 = 11,657,753.4
Leave Dkr 974,521 in Denmark, sell balance of 10,683,232 @ 11.1280
to give £ 960,032
959,622.
Surplus over GBP on individual basis
410.00 which is GBP 113.8 better than
swapping into GBP so Swap to Dkr.
b)
Opportunities elsewhere – transaction costs – tax/inter-company loan implications
time vs return – certainty of funds for 91 days – other investment types – policyaccess to markets – view of rates etc.
ii)
Certainty of exposure as to timing, actuality and amount. If uncertain may go ahead for
flexibility of option. View of the future both expected spot vs current forward and view
on volatility.
iii)
Discussion as to –
Buy Puts or Calls – dictated by exposure.
How many contracts- dictated by amount tempered by desire to over/under hedge via
options.
Treasury Management Exam 2004
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Strike price – tempered by view on expected spot, current underlying and premiums. In,
at or out of the market.
Expiry Date – tempered by view on movement in volatility and decay of time value vs
exposure date and increased premiums for longer period.
European or American, OTC or traded
iv)
a)
Calls
b)
1,365,000 = 21.84 so, 21 or 22
62,500
c)
either 21 x 62,500 x 1.84/100 = $24,150
or
22 x
= $25,300
1.5800 a call, therefore add premium.
184
1.5984
Call, GBP at discount, therefore spot of 1.5911
Sell. Buy GBP at 1.5875
less 1 cent gained 100
Effective rate
1.5775
d)
e)
f)
Q5)
i)
Benefits of netting are;









Reduced funds movement, therefore float savings and reduced system risk.
Reduced number of fx sales and purchases
Reduced fx margins due to expertise and market amounts
Guaranteed payment dates, therefore better cashflow forecasting for subs
Some fx management available
Eliminates need for subs to hold currency accounts
Better and more timely management information
Reduced administration in the group
Increased control and sorting of inter-company disputes.
ii)
Payer
Sub A GBP
Sub A GBP
Sub B SGD
Sub C CHF
Sub B SGD
2,581.5
Treasury Management Exam 2004
2,359.3
Sub C CHF
3,000
Sub D EUR
1,500
322.6
Total
4,500
2,904.1
2,359.3
6
Sub D EUR
Total
UNIT
Sub A GBP
Sub B SGD
Sub C CHF
Sub D EUR
3,993.6
6,575.1
PAYMENTS
6,575.1
2,359.3
3,000
1,822.6
13,757
2,359.3
Q5)
iii)

















1,822.6
RECEIPTS
NET FLOW
4,500
2,904.1
2,359.3
3,993.6
13,757
(2,075.1)
544.8
(640.7)
2,171.0
- 2,715.8
+ 2,715.8
Savings.
Transfers: from six to four, therefore, 2 @ GBP 20
Float, from 13,757 to zero
13,757,000 x .055 x 2/365
FX saving at 1%
11,041,200 x .01
Therefore, annual
3,000
=
40
=
4,146
3,993.6
13,757.0
FLOWS
ELIMINATED
4,500.0
2,359.3
2,359.3
1,822.6
11,041.2
=
110,412
114,598
= 1,375,176
Which companies are involved?
Payables or receivables driven?
Who does central bank reporting?
Third party flows included?
Other financial flows included?
Who operates netting (in house, bank, managed)
Netting centre location
What FX rates? Spots – forwards – budget.
Country level netting?
Currencies? – To be used for billing and in netting
Credit Period
Settlement dates
Rules, Regs and Permissions. Which countries allow netting
Schedule e.g. invoice submission- pre net run- dispute resolution etc
Interco loans/tax issues
Motivational issues
Frequency of netting
Treasury Management Exam 2004
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Q6)
i)
Riding the yield curve means trading one time period against another. E.g.
assuming upward sloping yield curve.
5 3/4
5 5/8
Interest
Rate
5½
5¼
3 Mo
6 Mo
Time
Bank could lend for 6 months 5 ¾ and fund itself 3 months at 5 ½ and hopefully, rollover
funding after 3 months for further 3 months at 5 ½ thus making ¼ %.
Risks are twofold.
1) Liquidity risk. Can the bank re-finance after 3 months and 2) Interest rate risk. i.e. will
rates have moved up (as indicated by yield curve) in 3 month period say to 6.00?
ii)
a)
Forward forward
To
T3
T6
4 5/16
Dept 6 Mo
Borrow 3 Mnth
Therefore, fwd fwd =
4 3/8
4.3125 x 6 = 25.875
4.375 x 3 = 13.125
12.75 divide by 3 = 4.25
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b)
FRA rate would be 3-6 and therefore 4 ¾
1,000,000 x 0.475 x 90/365 = 11,712.33 interest. =
1,011,712.33 total
Actual 1,000,000 x .05 x 90/365 = 12,328.77
Difference
616.44
Therefore, compensation paid by ‘You’ to the bank.
616.44
=
90
1+ (.05 x /365)
616.44
= 608.94
1.0123286
Proof. (not asked for)
Deposit: 999,391.1 x .05 x 90/365 = 12,321.26 =
1,011,712.33 total
iii)
a)
implied rate is 100-95.49 = 4.51%
b)
worried rates may fall; buy today, to sell in future, therefore buy a contract today at:
sell at
95.49
95___
49 basis point loss
49 x 25 = $1,225 loss
but 1,000,000 at 4.00% = 1,000,000 x .04 x 90/360 = 10,000
1,000,000 at 4.5 = 1,000,000 x .045 x 90/360 =
Gain =
Net gain =
iv)
11,250
1,250
25
They are different instruments. The future is to a specific expiry date and
therefore is likely to be different to an FRA and Fwd Fwd to the exact date the
treasurer wants. The FRA and Fwd Fwd, at any one time, in theory should be the
same but the FRA is a better instrument for the bank as it does not take up the
balance sheet and so may quote a finer rate while for a ‘home made’ fwd fwd
other costs will affect the comparability. E.g. spread on borrowing while FRA is
based on Libor.
Treasury Management Exam 2004
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v)
These are short term exposures so interest rate swaps are not really relevant. Other
relevant ones would be options related either a floor?!!
or a cylinder etc.
Floor: higher premium but gives all topside potential, as period short premium may not
be too large.
Collar: Low premium, even zero depending on where buy and sell margins are set.
Would use if do not want premium cost and prepared to give away partial topside
potential or do not think rate will reach the top level anyway. Maybe critical to reach a
certain level of return to meet availability but additional return not so important.
Treasury Management Exam 2004
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