Download DIPLOMA TREASUR Y MGT 1 (IOBM

SECTION A
QUESTION 1 – Chapter 12 Policies and Limits
a) Explain your understanding of the term Trading Policy .
(3 marks)
b) Provide a brief description of the following concepts as they relate to the Trading
Policy as per your explanation in (a) above.
i)
Delegation of Duties and Limits
(4 marks)
ii)
Authorized currencies and Instruments (4 marks)
iii)
Position Management
(4 marks)
(Total 15 marks)
SOLUTION 1
a) Trading Policy is a document detailing how the activities of treasury are governed
in relation to the following aspects relating to trading other day to day operations
of Treasury. (From page 208)
 Delegation of duties and dealing limits
 Authorized currencies and instruments
 Position management
 Clients and counterparties
 Overall treasury operations.
bi)
Delegation of duties
 Activities, duties & limits delegated to Treasury by senior
management.
 Duties further delegated by Treasury management to the dealers
according to ability and market expertise.
 Dealers only trade according to the sanctioned limits
 Dealers not to be involved in any settlement or processing beyond
the initiation of the deals
 Overall limits approved vested in one individual although delegated
this person will be liable for the actions of all Treasury staff, usually
the Head of Treasury.
bii)
Authorized currencies and Instruments
 Dealers only trade in currencies that have the potential to be bought
and resold at a profit. Currencies must be authorized in dealers
mandates and as per exchange control regulations.
biii)
Position Management
 From buying and selling of currencies, positions build up and there
are laid down rules for the management of those positions.
 Unauthorized positions expose the bank to currency risk.
 Dealers must keep accurate record of positions.
 Transaction limits and daylight as well as overnight positions and
stop loss mechanisms must be carefully delegated and
communicated.
 Dealers are not allowed to keep speculative positions, eg keeping an
open position because they believe rates will go down or keeping
an overbought position because they believe rates will go up.
 Manipulation of exchange rates to suit the dealer’s positions is
strongly discouraged.
QUESTION 2 – Chapter 6 Instruments and Settlement
At Basic Banking Ltd (BBL), you are employed as the corporate dealer in the Treasury
department responsible for the money market desk. A ‘Premium deposit’ is one of the
products provided to clients on that desk and it has the following features:
 Interest Rate
15% p.a
 Tenor
30 Days
 Service Charge
MWK3,800
 Withholding tax
20%
a) A client places MWK2, 000,000 under Premium Deposit with you with all the
conditions stated above. Compute the final interest amount (after all deductions)
that the client pockets at the end of the investment period. (4 marks)
b) Another bank Chester Merchant Bank Ltd (CMB) offers the same product with the
following characteristics:
 Interest Rate
10.5% p.a
 Tenor
30 Days
 Service charge
MWK1,400
 Withholding tax for the first K20, 000 of interest absorbed by the bank.
Required
Comment on the attractiveness of the conditions as offered at your bank BBL and
conditions as offered by your competition CMB for the same amount of
investment, MWK2,000,000
(4 marks)
c) Contrast the risk rating of a bond issued by the Central Bank on behalf of the
government and a commercial paper issued by a reputable large institution. (4
marks)
d) Give a brief explanation of the process of marking to market
(3 marks)
SOLUTION 2
a)
Interest
Less Tax Charge @
20%
Less Service Charge
Final Interest
=
=
=
Deposit X Rate% X Days/365
2,000,000 X 0.15 X 30 / 365
24,657.53
=
=
=
=
0.8 x 24,657.53
19,726.02
19,726.02 - 3,800.00
15,926.02
b)
Interest
Less Tax Charge @
20%
Less Service Charge
Final Interest
=
=
=
Deposit X Rate% X Days/365
2,000,000 X 0.105 X 30 / 365
17,260.27
=
=
=
=
Absorbed by the bank since interest is less than K20,000
0
17,260.27 - 1,400
15,860.27
Despite the high service charge MWK3, 800 at BBL compared to MWK1, 400 at CMB,
the higher interest rate (15% at BBL compared to 10.5% CMB) is enough to cover both
the charge and the Tax charge. Conditions are better at BBL.
c) Securities issued by the central bank, Treasury bills, Local registered stocks,
Treasury Notes and Bonds have the full backing of the government of Malawi and
carry virtually no risk as the government never defaults on debt. However on the
international market these securities are subject to rating on the basis of country
risk and have some perceived level of default depending on country risk.
Commercial paper on the other hand although issued by reputable large
institutions will have more risk than Central bank issued securities as companies
can go into liquidation no matter how sound they may be.
d) Marking to market – is the process of restating the carrying value of an asset or
liability to equal its current value. Under FAS 115, financial instruments held in
trading accounts must be marked to market by increasing income to reflect
unrealized losses.
QUESTION 3 – Chapter 3 Treasury Operations – Front office
a) Provide any three drivers that explain volatility of exchange rates in the foreign
exchange markets.
(3 marks)
b) The following is an extract from the exchange rate sheet of a local bank.
PAIR
QUOTE
GBP/USD
##
EUR/USD
##
USD/ZAR
**
USD/CAD
**
AUD/USD
##
USD/CNY
**
RATE
1.5089
1.2035
10.256
1.1826
0.8678
6.2352
Key: ## - So much of USD is equal to a unit of the other currency in the currency pair.
** - A unit of USD is equal to so much of the other currency in the currency pair.
i)
Comment on which currency is stronger between the Canadian Dollar
(CAD) and the Australian Dollar (AUD) (2 marks)
ii)
How much South African Rand (ZAR) is needed to buy CNY100,000 (2
marks)
iii)
Compute the currency quotes for the following currency pairs.
 EUR/ZAR
(2 marks)
 GBP/AUD
(2 marks)
c) From the same local bank an extract of the dealer’s currency position was taken as
follows;
Currency
USD
GBP
EUR
ZAR
CAD
AUD
CNY
Required
Opening Position
680,000.00
(200,000.00)
50,000.00
(350,000.00)
(15,000.00)
30,000.00
270,000.00
Revaluation Rate
490.00
650.00
580.00
38.00
460.00
480.00
65.00
Compute the dealer’s overall currency position in EUR terms before any trading for the
day.
(4 marks)
(Total 15 marks)
SOLUTION 3
a) Drivers of exchange rate volatility
 Supply and Demand
 Market Sentiment
 Market Triggers
 Movement of other closely linked currencies.
 International Trade
 Policy shifts, Monetary and Fiscal Policies.
b) i) Convert one of the two given quotes to reflect the other form of quote i.e both
quotes have to be in the same quote format against the USD.
e.g Convert the AUD/USD quote to reflect the same as the USD/CAD
AUD/USD =
USD/AUD =
=
USD/AUD =
0.8678
1 / 0.8678
1.15233925
1.1515
Compared to the USD/CAD quote 1.1826 the AUD appears stronger than the CAD as less
AUD is needed to purchase a unit of USD.
The same conclusion should be reached converting the USD/CAD quote as follows
USD/CAD =
USD/CAD =
=
USD/CAD =
1.1826
1 / 1.1826
0.84559445
0.8452
Compared to the AUD/CAD quote 0.8678 AUD still appears stronger as more units of
USD is needed to buy a single unit of AUD than is needed to buy a unit of CAD.
ii)
To buy CNY100,000 first convert CNY100,000 to USD and then convert USD to
ZAR.
CNY100,000
USD
ZAR
=
=
=
USD (CNY100,000/6.2352)
16,037.98
16,037.98 X 10.2560
=
164,485.52
iii) Currency Quotes
EUR/ZAR
=
=
=
EUR/USD X USD/ZAR
1.2035 X 10.2560
12.3431
GBP/AUD
=
=
GBP/USD ÷ AUD/USD
1.5089 / 0.8678
1.7388
c) Overall Position in EUR terms
Opening
Revaluation
Position
Rate
680,000.00
490.00
(200,000.00)
650.00
50,000.00
580.00
(350,000.00)
38.00
(15,000.00)
460.00
30,000.00
480.00
270,000.00
65.00
Total Position MWK
Divide by EUR Rate
Equivalent EUR Overall Position
Currency
USD
GBP
EUR
ZAR
CAD
AUD
CNY
MWK
333,200,000.00
(130,000,000.00)
29,000,000.00
(13,300,000.00)
(6,900,000.00)
14,400,000.00
17,550,000.00
243,950,000.00
580.00
420,603.45
QUESTION 4 – Chapter 8 Asset & Liability Management
a) Evaluate the need for an Asset & Liability Management (ALM) program within a
financial institution b providing four well explained objectives of the program. (8
marks)
b) Refer to the table of currency exchange rates to the local unit (MWK) below on
two randomly selected trading days.
Required
Trading Day
GBP/MWK
EUR/MWK
Dealer Position
-278,000
-323,000
Wed. 12 Mar 2014
708.5241
687.9512
Thur. 13 Mar 2014
701.8564
692.5473
Comment on the currency risk of the currencies indicated in relation to the open
positions and the direction of exchange rates as per the currency table for the two
trading days.
(7 marks)
(Total 15 marks)
SOLUTION 4
a) ALM is the management of the pricing and mix of assets and liabilities with a view
to minimizing exposure. The objectives of ALM are as follows
 Controlling interest rate risk within predetermined limits
 Maintaining adequate levels of liquidity
 Setting and achieving profitable spreads
 Achieving adequate returns on capital and assets
 Holding and maintaining adequate levels of capitalization.
b) Both currencies have overbought positions and the exposure to currency risk is
that left overnight as in the case given the bank’s margins would be compromised
if the rates were to go up as this would mean that the open positions are being
covered by more expensive money than the sales that led to the open positions.
Specifically the losses on each currency are as follows.
Trading Day
GBP/MWK
EUR/MWK
Dealer Positions
Wed. 12 Mar 2014
Thur. 13 Mar 2014
Rate change
(278,000.00)
708.5241
701.8564
-6.6677
(323,000.00)
687.9512
692.5473
4.5961
Loss/Profit
1,853,620.60
(1,484,540.30)
The open position on GBP will be covered at a lower rate (specifically K6.67
cheaper) and resulting into an effective profit of MWK1.85million. The open
position on EUR will be covered at an expensive rate (specifically K4.60
expensive) and resulting in a MWK1.48million loss.
SECTION B
QUESTION 5 – a) Chapter 1 – The General Financial System b) & c) – Chapter 7 Roles of
the Central Bank
a) Provide four arguments for the need of financial intermediaries within the
financial system. (4 marks)
b) Explain the following roles of the Central Bank as they relate to stabilizing the
financial system:
i)
Provision of accommodation and lender of last resort (3 marks)
ii)
Open Market Operations
(3 marks)
iii)
Monetary Policy
(3 marks)
iv)
Exchange Rate Policy
(3 marks)
c) A REPO is both an Asset and a Liability. Explain the assertion (4 marks)
(Total 20 marks)
SOLUTION 5
a) Need for financial intermediaries
 Matching the needs of surplus and deficit units
 Maturity Transformation
 Funds management for surplus units eg fund managers, pension managers
asset managers.
 Funding, for deficit units. Funding of operations e.g international trade
 International settlements, especially where it woul be costly for
counterparties to trade directly with one another. Financial intermediaries
bridge the gap.
b) Roles of the Central Bank
i)
Provision of accommodation and lender of last resort
The central bank accommodates banks that are running short liquidity
positions if they are unable to secure funds on the interbank. The bank
comes in as lender of last resort to help the banks comply with regulatory
requirements and stabilizing the markets to avoid panic and bank runs.
ii)
Open Market Operation (OMOs) – The Central Bank conducts OMOs to
control the money supply and achieve the desired level of interest rates.
When there is a lot of liquidity the reserve bank sells securities and thereby
reducing the excess. When there a liquidity squeeze the Central bank would
buy securities and as a result injecting liquidity. In the process stabilizing
both the flow of money and the level of interest rates.
iii)
Monetary policy is a tool used to direct the economy by means of either
interest rates or the money supply. Monetary authorities use monetary
policy to influence the level of aggregate demand by lowering interest rates
to boost aggregate demand or raise interest rates to slow demand. Policy
choice depends on what the authorities seek to achieve in terms of
inflation, employment, GDP growth.
iv)
Exchange rate Policy is another addition to the monetary policy tools that
is used to achieve the same goals. The authorities can choose from various
exchange rate policies depending on their overall objectives, either fixed
exchange rate, freely floating, managed float. Authorities sell/buy currency
to the market to affect local currency liquidity positions and the level of
interest rates and inflation.
c) A REPO is a tool used by interbank counterparties to manage liquidity, under the
REPO arrangement a counterparty running a short liquidity position enters into an
agreement to sell off securities for cash to satisfy immediate liquidity gap with an
undertaking to buy back the securities at the end of the agreed period. When the
counterparty receives cash it is recorded as a loan in its books (a liability) and the
securities surrendered will be received at the end of the REPO period and
therefore recorded as an asset in the books. The same transaction will be
interpreted in reverse for the other counterparty with both an asset and a liability.
QUESTION 6 – Chapter 9 Bank Supervision and Returns
a) Provide two justifications of the need for exchange control. (2 marks)
b) Describe the exchange rate regime that is currently being used by the Central Bank
of Malawi and clarify the role of the Central Bank in that identified regime. (8
marks)
c) Identify five returns that commercial banks report to the Central Bank with an
explanation of why it is necessary for banks to comply with the reporting
requirements for your identified returns.
(10 marks)
SOLUTION 6
a) Exchange control is necessary for the following reasons
 To ensure harmony of the foreign exchange market.
 To avoid the flight of foreign reserves and preserve the country’s
sustainable foreign exchange reserves (as measured by the import cover).
 To advance major economic objectives eg attraction of Foreign Direct
Investment (FDI) for growth, inflation control, employment, protection of
a strategic sector against foreign competition etc.
 To protect the interest of the masses/the general public so that authorized
dealer banks do not take undue advantage of their position in the
financial markets.
Exchange control regulations currently in use in Malawi
 Restrictions on capital account - Prior approval for inward and outward
portfolio investments is to be sought from Reserve Bank beforehand.
 Retention rules for foreign exchange earned or owned by residents – 20%
of all export proceeds must be immediately sold to ADBs upon receipt and
the exporters only retain 80% in their FCDA accounts.
 Exchange control restrictions on current account – the current exchange
control regulations do NOT impose any controls/restrictions on current
accounts.
 Externalization of foreign currency - any payment for goods and services
brought to Malawi must have the prior approval of the Central Bank and
follows a strict authorization process that includes the confirmation of
whether the same goods or services cannot be obtained from the local
market.
b) The current exchange rate regime is a freely floating regime. The price of the local
unit, the Malawi Kwacha is determined on the foreign exchange market purely by
the forces of demand and supply. The Reserve Bank allows the markets to work
freely to determine the MWK exchange rate against all trading currencies. The role
of the Central Banl is thus limited to only Supervision of the ADBs to ensure other
exchange control regulations are being adhered to to maintain the harmony of
the foreign exchange markets. No influence is put on the determination of the
exchange rate in terms regulation.
c) Returns submitted to the Central Bank
 Balance Sheet – Important so that the Central Bank knows the structure of
the Assets and Liabilities of the reporting commercial bank and on a
consolidated basis for the whole banking industry. The same information is
further reported to the International Monetary Fund (IMF) and World
Bank for the compilation of global/world data.
 Income statement – to show bank’s profitability
 Liquidity Risk return – Shows the assets and liabilities of the bank as they
relate to liquidity risk especially in maturity bands. The Central Bank can
thus have a view of the overall liquidity risk for the bank and determine
whether the bank is properly safeguarding depositors funds, again it allows
the bank to know the liquidity position on a global basis for the whole
market.
 Capital Adequacy – banks that fail to meet capital requirements are not fit
to continue in operations as going concerns as they pose a risk to the
proper function of the financial market. Risk is in failure to safeguard
depositors’ funds and a potential for systemic risk that would bring the
whole financial system down.
 Large exposures – that is exposure that may have a bearing on the liquidity
position of the reporting institution and thus its balance sheet structure.
 Minimum reserve balance and Liquiditry assets
 Risk exposures – Market risk, Liquidity risk, credit risk, counterparty risk,
operational risk. All covered currently under Basel II reporting to the
Central Bank and enables the Bank to determine the commercial banks’
ability to absorb shocks and thus hold capital levels adequate for the kind
of risks they face.
QUESTION 7 – Chapter 10 RISKS
a) Explain how a gap/mismatch in assets and liabilities for a bank may arise and how
this would affect the balance sheet of the bank
(5 marks)
b) Refer to the table of the asset & liability profiles for a given foreign bank.
Maturity Band
Up to 1 Month
2-3
Months
3-6
Months
6-9
Months
9 - 12
Months
Over12 Months
Assets (US$)
18,620.00
6,524.00
7,481.00
7,582.00
8,547.00
10,524.00
Liabilities (US$)
14,250.00
5,241.00
8,423.00
4,512.00
9,527.00
11,542.00
The bank earns 7.5% on all its assets across all the maturity bands and pays 7.8%
in the up to 1 month band and 6.5% for all the other bands for all Liabilities.
Required
i)
ii)
Calculate the bank’s Asset/Liability re-pricing gap for each maturity band
and indicate whether the gap is an asset or liability.
(5 marks)
The bank has just been downgraded by the credit rating agencies and
interest rates earned on the assets fall by a percentage point while interest
rates paid on liabilities go up by the same margin across all the maturity
bands. Compute the net interest paid/earned before and after the
downgrade and comment on the effect of the downgrade on the bank’s
asset liability gap.
(10 marks)
(Total 20 marks)
SOLUTION 7
a) A gap exposure arises from the differences in maturities and or re-pricing of assets
and liabilities that are interest rate sensitive. It all stems from the structure of the
assets and liabilities on the balance sheet for a bank. Assets i.e the loans extended
to clients are on a long term basis and the liabilities I.e the deposits that support
those loans are ususally on a short term basis. This results in a mismatch in the
maturity structure of these assets and liabilities and hence the gap. This is managed
through a bank’s Asset & Liability Management (ALM) activities.
b) i)
Maturity Band
Assets
Liabilities
Re-pricing Gap
Sensitivity
Income Decrease if
Rates
Up to 1
Month
18,620.00
14,250.00
4,370.00
Asset
2-3
Months
6,524.00
5,241.00
1,283.00
Asset
3-6
Months
7,481.00
8,423.00
(942.00)
Liability
6-9
Months
7,582.00
4,512.00
3,070.00
Asset
9 - 12
Months
8,547.00
9,527.00
(980.00)
Liability
>12
Months
10,524.00
11,542.00
(1,018.00)
Liability
Fall
Fall
Rise
Fall
Rise
Rise
3-6
Months
7,481.00
8,423.00
(942.00)
7.50%
6.50%
1.00%
-9.42
6-9
Months
7,582.00
4,512.00
3,070.00
7.50%
6.50%
1.00%
30.7
9 - 12
Months
8,547.00
9,527.00
(980.00)
7.50%
6.50%
1.00%
-9.8
>12
Months
10,524.00
11,542.00
(1,018.00)
7.50%
6.50%
1.00%
-10.18
3-6
Months
7,481.00
8,423.00
(942.00)
6.50%
7.50%
-1.00%
9.42
6-9
Months
7,582.00
4,512.00
3,070.00
6.50%
7.50%
-1.00%
-30.7
9 - 12
Months
8,547.00
9,527.00
(980.00)
6.50%
7.50%
-1.00%
9.8
>12
Months
10,524.00
11,542.00
(1,018.00)
6.50%
7.50%
-1.00%
10.18
b ii) Net Interest Earned Before the Downgrade
Maturity Band
Assets
Liabilities
Re-25pricing Gap
Interest Earned
Interest Paid
Margin
Net Interest Earned
Up to 1
Month
18,620.00
14,250.00
4,370.00
7.50%
7.80%
-0.30%
-13.11
2-3
Months
6,524.00
5,241.00
1,283.00
7.50%
6.50%
1.00%
12.83
Net Interest Earned After the Downgrade
Maturity Band
Assets
Liabilities
Re-pricing Gap
Interest Earned
Interest Paid
Margin
Net Interest Earned
Up to 1
Month
18,620.00
14,250.00
4,370.00
6.50%
8.80%
-2.30%
-100.51
2-3
Months
6,524.00
5,241.00
1,283.00
6.50%
7.50%
-1.00%
-12.83
Comment
The downgrade affected the bank’s net interest especially in the up to 1 month band as
the interest expense margin increased by 2 percentage points from just -0.3% to -2.3%
and thereby increasing the expense to 100.51 from 13.11 before the downgrade. The
other bands however resulted in the same absolute number in terms of interest but with
a change in the sign i.e all interest earned turned to expense and all interest expense
turned to income after the downgrade. The up to 1 month band was mostly affected
because the bank was paying more to its liabilities than what they were getting on the
assets, after the downgrade the gap widened.
QUESTION 8 – Chapter 5 Various Markets in which Treasury Operates
Write a report to be considered for publication in a newly introduced financial magazine
on the various markets that make up the financial system. Your report must have the
following structure:



Introduction
A discussion of at least six different markets under a separate heading with
examples of products traded in that market.
Conclusion.
(Total 20 marks)
SOLUTION 8
Report Format
Introduction
Body – With sub-topics discussed as follows:







Primary Markets
Secondary Markets
Money Markets
Capital Markets
Spot & Forward Markets
Derivatives Markets
Financial Exchanges
Conclusion
Candidates should be marked according to the clear articulation of points that shows
understanding of the markets that they choose.
End of Examination Paper.