INDIAN INSTITUTE OF
BANKING & FINANCE
RISK MANAGEMENT
MODULE C & D
BY
M.Ravindran
ravindran@iibf.org.in
Syllabus
Module C: Treasury Management:
Treasury management; concepts and functions; instruments in the
treasury market; development of new financial products; control
and supervision of Treasury management; linkage of domestic
operations with foreign operations.
Asset-liability management; Interest rate risk; interest rate futures;
stock options; debt instruments; bond portfolio strategy; risk
control and hedging instruments.
Investments – Treasury bills – Money markets instruments such
as CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance and
rediscounting facilities.
Syllabus
Module D: Capital Management and Profit
Planning
 Prudential Norms- Capital Adequacy-Basel IIAsset Classification-provisioning
 Profit and Profitability-Historical Perspective of
the Approach of Banks to profitability-Effects of
NPA on profitability-A profitability Model-Share
holders value Maximization & EVA-Profit
Planning-Measures to improve profitability
RISK MANAGEMENT
Module C-Treasury
Management
Treasury Products
 Treasury Risk Management
 Derivative Products

Integrated Treasury

Integrated Treasury refers to integration of
money market, securities market and foreign
exchange operations.
-Meeting reserve requirements
-Efficient merchant services
-Global cash management
-Optimizing profit by exploiting market
opportunities in forex market, money market
and securities market
-Risk management
-Assisting bank management in ALM
Treasury
Function
Responsible for
Front
office
MidOffice
Dealing
Back
office
Risk
management,
accounting
and
management
information
Confirmations,
settlement
and
reconciliation
FRONT OFFICE
Dealing
MID OFFICE
BACK OFFICE
settlement
MIS
Treasury
Money Market
Certificate of Deposit (CD)
 Commercial Paper (C.P)
 Inter Bank Participation Certificates
 Inter Bank term Money
 Treasury Bills
 Call Money

Certificate of Deposit
CDs are short-term borrowings in the form of
Usance Promissory Notes having a maturity of
not less than 15 days up to a maximum of one
year.
 CD is subject to payment of Stamp Duty under
Indian Stamp Act, 1899 (Central Act)
 They are like bank term deposits accounts.
Unlike traditional time deposits these are freely
negotiable instruments and are often referred to
as Negotiable Certificate of Deposits

Features of CD

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CDs can be issued by all scheduled commercial
banks except RRBs
Minimum period 15 days
Maximum period 1 year
Minimum Amount Rs 1 lac and in multiples of
Rs. 1 lac
CDs are transferable by endorsement
CRR & SLR are to be maintained
CDs are to be stamped
Commercial Paper
Commercial Paper (CP) is an unsecured
money market instrument issued in the
form of a promissory note.
 Who can issue Commercial Paper (CP)
Highly rated corporate borrowers, primary
dealers (PDs) and satellite dealers (SDs)
and all-India financial institutions (FIs)

Eligibility for issue of CP
the tangible net worth of the company, as per the
latest audited balance sheet, is not less than Rs. 4
crore;
b) (b) the working capital (fund-based) limit of the
company from the banking system is not less than
Rs.4 crore
c) and the borrowal account of the company is
classified as a Standard Asset by the financing
bank/s.
a)
Rating Requirement

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All eligible participants should obtain the credit
rating for issuance of Commercial Paper
Credit Rating Information Services of India Ltd.
(CRISIL)
Investment Information and Credit Rating
Agency of India Ltd. (ICRA)
Credit Analysis and Research Ltd. (CARE)
Duff & Phelps Credit Rating India Pvt. Ltd. (DCR
India)
The minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by other
agencies
Maturity
CP can be issued for maturities between a
minimum of 15 days and a maximum upto
one year from the date of issue.
 If the maturity date is a holiday, the
company would be liable to make payment
on the immediate preceding working day.

To whom issued
CP is issued to and held by individuals,
banking companies, other corporate
bodies registered or incorporated in India
and unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional
Investors (FIIs).
Repo

Uses of Repo
It helps banks to invest surplus cash
It helps investor achieve money market returns
with sovereign risk.
It helps borrower to raise funds at better rates
An SLR surplus and CRR deficit bank can use the
Repo deals as a convenient way of adjusting
SLR/CRR positions simultaneously.
RBI uses Repo and Reverse repo as instruments
for liquidity adjustment in the system
Meaning of Repo
It is a transaction in which two parties agree to
sell and repurchase the same security. Under
such an agreement the seller sells specified
securities with an agreement to repurchase the
same at a mutually decided future date and a
price
 The Repo/Reverse Repo transaction can only be
done at Mumbai between parties approved by
RBI and in securities as approved by RBI
(Treasury Bills, Central/State Govt securities).

Coupon rate and Yield
The difference between coupon rate and
yield arises because the market price of a
security might be different from the face
value of the security. Since coupon
payments are calculated on the face value,
the coupon rate is different from the
implied yield.
Example
10% Aug 2015 10 year Govt Bond
 Face Value RS.1000
 Market Value Rs.1200
 In this case Coupon rate is 10%
 Yield is 8.33%

Call Money Market
The call money market is an integral part of
the Indian Money Market, where the dayto-day surplus funds (mostly of banks) are
traded. The loans are of short-term
duration varying from 1 to 14 days.
The money that is lent for one day in this
market is known as "Call Money", and if it
exceeds one day (but less than 15 days) it
is referred to as "Notice Money".
Call Money Market
Banks borrow in this market for the
following purpose
 To fill the gaps or temporary mismatches
in funds
 To meet the CRR & SLR mandatory
requirements as stipulated by the Central
bank
 To meet sudden demand for funds arising
out of large outflows.
Factors influencing interest rates
The factors which govern the interest rates are
mostly economy related and are commonly
referred to as macroeconomic factors. Some of
these factors are:
1) Demand for money
2) Government borrowings
3) Supply of money
4) Inflation rate
5) The Reserve Bank of India and the Government
policies which determine some of the variables
mentioned above.
Gilt edged securities
The term government securities encompass all
Bonds & T-bills issued by the Central
Government, and state governments. These
securities are normally referred to, as "giltedged" as repayments of principal as well as
interest are totally secured by sovereign
guarantee.
Treasury Bills
Treasury bills, commonly referred to as T-Bills
are issued by Government of India against their
short term borrowing requirements with
maturities ranging between 14 to 364 days.
All these are issued at a discount-to-face value.
For example a Treasury bill of Rs. 100.00 face
value issued for Rs. 91.50 gets redeemed at the
end of it's tenure at Rs. 100.00.
Who can invest in T-Bill
Banks, Primary Dealers, State
Governments, Provident Funds, Financial
Institutions, Insurance Companies, NBFCs,
FIIs (as per prescribed norms), NRIs &
OCBs can invest in T-Bills.
What is auction of Securities
Auction is a process of calling of bids with
an objective of arriving at the market price.
It is basically a price discovery mechanism
Debenture
A Debenture is a debt security issued by a
company (called the Issuer), which offers
to pay interest in lieu of the money
borrowed for a certain period.
 These are long-term debt instruments
issued by private sector companies. These
are issued in denominations as low as Rs
1000 and have maturities ranging
between one and ten years.

Difference between debenture and
bond
Long-term debt securities issued by the
Government of India or any of the State
Government’s or undertakings owned by
them or by development financial
institutions are called as bonds.
Instruments issued by other entities are
called debentures.
Current yield
This is the yield or return derived by the investor
on purchase of the instrument (yield related to
purchase price)
It is calculated by dividing the coupon rate by
the purchase price of the debenture. For e. g: If
an investor buys a 10% Rs 100 debenture of
ABC company at Rs 90, his current Yield on the
instrument would be computed as:
Current Yield = (10%*100)/90 X 100 , That is
11.11% p.a.
Primary Dealers & Satellite
Dealers
Primary Dealers can be referred to as Merchant
Bankers to Government of India, comprising the
first tier of the government securities market.
Satellite Dealers work in tandem with the
Primary Dealers forming the second tier of the
market to cater to the retail requirements of the
market.
 These were formed during the year 1994-96 to
strengthen the market infrastructure

What role do Primary Dealers
play?
The role of Primary Dealers is to;
(i) commit participation as Principals in
Government of India issues through
bidding in auctions
(ii) provide underwriting services
(iii) offer firm buy - sell / bid ask quotes
for T-Bills & dated securities
(v) Development of Secondary Debt
Market
OMO

OMO or Open Market Operations is a
market regulating mechanism often
resorted to by Reserve Bank of India.
Under OMO Operations Reserve Bank of
India as a market regulator keeps buying
or/and selling securities through it's open
market window. It's decision to sell or/and
buy securities is influenced by factors such
as overall liquidity in the system,
YIELD CURVE

The relationship between time and yield
on a homogenous risk class of securities is
called the Yield Curve. The relationship
represents the time value of money showing that people would demand a
positive rate of return on the money they
are willing to part today for a payback into
the future
SHAPE OF YIELD CURVE
A yield curve can be positive, neutral or flat. A
positive yield curve, which is most natural, is when
the slope of the curve is positive, i.e. the yield at the
longer end is higher than that at the shorter end of the
time axis. This results, as people demand higher
compensation for parting their money for a longer
time into the future. A neutral yield curve is that
which has a zero slope, i.e. is flat across time. T his
occurs when people are willing to accept more or less
the same returns across maturities. The negative yield
curve (also called an inverted yield curve) is one of
which the slope is negative, i.e. the long term yield is
lower than the short term yield
LIBOR
LIBOR stands for the London Interbank Offered
Rate and is the rate of interest at which banks
borrow funds from other banks, in marketable
size, in the London interbank market.
 LIBOR is the most widely used "benchmark" or
reference rate for short term interest rates. It is
compiled by the British Bankers Association as a
free service and released to the market at about
11.00[London time] each day.

CRR & SLR
The minimum and maximum levels of CRR are
prescribed at 3% and 20% of demand and term
liabilities (DTL) of the bank, respectively, under
Reserve Bank of India Act of 1934. The
minimum and maximum SLR are prescribed at
25% and 40% of DTL respectively, under
Banking Regulation Act of 1949. The CRR and
SLR are to be maintained on fortnightly basis.
The RBI is authorized to increase or decrease
the CRR and SLR at its discretion.
Demand and Time Liabilities
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Main components of DTL are:
Demand deposits (held in current and savings
accounts, margin money for LCs, overdue fixed
deposits etc.)
Time deposits (in fixed deposits, recurring deposits,
reinvestment deposits etc.)
Overseas borrowings
Foreign outward remittances in transit (FC liabilities
net of FC assets)
Other demand and time liabilities (accrued interest,
credit balances in suspense account etc. )
SLR
SLR is to be maintained in the form of the
following assets:
 Cash balances (excluding balances
maintained for CRR)
 Gold (valued at price not exceeding
current market price)
 Approved securities valued as per norms
prescribed by RBI.
VaR
Value at Risk (VaR) is the most probable loss
that we may incur in normal market conditions
over a given period due to the volatility of a
factor, exchange rates, interest rates or
commodity prices. The probability of loss is
expressed as a percentage – VaR at 95%
confidence level, implies a 5% probability of
incurring the loss; at 99% confidence level the
VaR implies 1% probability of the stated loss.
The loss is generally stated in absolute amounts
for a given transaction value (or value of a
investment portfolio).
VaR
The VaR is an estimate of potential loss, always for a given
period, at a given confidence level.. A VaR of 5p in USD /
INR rate for a 30- day period at 95% confidence level
means that Rupee is likely to lose 5p in exchange value
with 5% probability, or in other words, Rupee is likely to
depreciate by maximum 5p on 1.5 days of the period
(30*5% ) . A VaR of Rs. 100,000 at 99% confidence level
for one week for a investment portfolio of Rs. 10,000,000
similarly means that the market value of the portfolio is
most likely to drop by maximum Rs. 100,000 with 1%
probability over one week, or , 99% of the time the
portfolio will stand at or above its current value.
Exchange Rate Quotation
Exchange Quotations :
There are two methods
 Exchange rate is expressed as the price per unit of
foreign currency in terms of the home currency is known
as the “Home currency quotation” or “Direct Quotation”
 Exchange rate is expressed as the price per unit of home
currency in terms of the foreign currency is known as
the “Foreign Currency Quotation” or “Indirect Quotation”
 Direct Quotation is used in New York and other foreign
exchange markets and Indirect Quotation is used in
London foreign exchange market.

Principles
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Direct Quotation: Buy Low, Sell High:
The prime motive of any trader is to make profit. By
purchasing the commodity at lower price and selling it at
a higher price a trader earns the profit. In foreign
exchange, the banker buys the foreign currency at a
lesser price and sells it at a higher price.
Indirect Quotation: Buy High, Sell Low:
A trader for a fixed amount of investment would acquire
more units of the commodity when he purchases and for
the same amount he would part with lesser units of the
commodity when he sells.
Spot and Forward Transactions
‘A’ Bank agrees to buy from ‘B’ Bank USD
100000. The actual exchange of
currencies i.e. payment of rupees and
receipt of US Dollars, under the contract
may take place :
 on the same day or
 two days later or
 some day later, say after a month.

Interpretation of Quotation
The market quotation for a currency consists of
the spot rate and the forward margin. The
outright forward rate has to be calculated by
loading the forward margin into the spot rate.
For example US Dollar is quoted as under in the
inter-bank market on a given day as under :
 Spot
1 USD = Rs.44.1000/1300
 Spot/November
0200/0500
 Spot/December
1500/1800

TT Buying Rate
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TT Buying Rate (TT stands for Telegraphic
Transfer)
This is the rate applied when the transaction
does not involve any delay in realization of the
foreign exchange by the bank. In other
words, the nostro account of the bank would
already have been credited. The rate is
calculated by deducting from the inter-bank
buying rate the exchange margin as
determined by the Bank.
Bills Buying Rate

This is the rate to be applied when a
foreign bill is purchased. When a bill is
purchased, the proceeds will be realized
by the Bank after the bill is presented to
the drawee at the overseas center. In the
case of a usance bill the proceeds will be
realized on the due date of the bill which
includes the transit period and the usance
period of the bill.
Problem
You would like to import machinery from USA
worth USD 100000
to be payable to the overseas supplier on 31st Oct
[a] Spot Rate
USD = Rs.45.8500/8600
Forward Premium
September 0.2950/3000
October 0.5400/5450
November 0.7600/7650
[b] exchange margin 0.125%
[c] Last two digits in multiples of nearest 25 paise
 Calculate the rate to be quoted by the bank ?
Solution
This is an example Forward Sale Contract .
Inter Bank Spot Selling Rate Rs. 45.8600
Add Forward Margin
.5450
-------------46.4050
Add Exchange Margin
.0580
--------------Forward Rate
46.4630
Rounded Off to multiple of 25 paise
Rs.46.4625
Amount Payable to the bank
Rs.46,46,250
Swap
A swap agreement between two parties
commits each counterparty to exchange
an amount of funds, determined by a
formula, at regular intervals, until the
swap expires.
 In the case of a currency swap, there is an
initial exchange of currency and a reverse
exchange at maturity.

Mechanics
Firm A needs fixed rate loan –AAA rated
 Firm B needs floating rate
-A rated
 Firm A enjoys an absolute advantage in
both credit markets.

Fixedrate
finance
Firm A
Firm B
9%
11%
Floating- LIBOR LIBOR
rate
finance +0.0% +1%
Mechanics
STEP !
Firm A will borrow at Fixed rate 9%
Firm B will borrow at floating rate (LIBOR +1)%
STEP 2
Firm A will pay Floating rate [LIBOR] to Firm B
Firm B will Pay Fixed rate [9.5%] only
Gain
Net interest cost LIBOR- .5%
Net Interest cost 9+[ 1%+0.5%]=10.5%
Mechanics
Interest payments to each
other in years t 1 to t 7.
Gain
A
B
9.5%
Borrows at
9.0%
fixed
for 7 years
LIBOR
Borrows at
LIBOR + 1%
floating
for 7 years