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Treasury and Fund Management Commercial Banks & Asset Management.

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Presentation on theme: "Treasury and Fund Management Commercial Banks & Asset Management."— Presentation transcript:

1 Treasury and Fund Management Commercial Banks & Asset Management

2 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.

3 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.

4 Inter-Dept Chart….

5 TREASURY Front Office Lending to Branches Borrower Investment Reserve Requirement Depositor Branch Excess Liquidity Borrowing Funding Spread 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 Treasury Back Office FunctionsFunctionality….

6 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.

7 ■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….

8 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”. ■The shape of the yield curve is closely monitored because it helps to give an idea of future interest rate change and economic activity.

9 ■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. ■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.

10 ■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.

11 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.

12 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.

13 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%.

14 M.M Instruments & Transactions…. ■Pakistan Investment Bonds ■Treasury Bills ■Repo / Rev. Repo Transactions ■Call / Clean Money ■Term Finance Certificate ■Certificate of Investments ■Commercial Papers

15 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.

16 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.

17 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

18 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.

19 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.

20 Net Open Position ■Currency-wise NOP in equivalent PKR ■NOP calculating in the following manner. TOTAL -549/84 NOP USD POUND YEN

21 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

22 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.

23 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.

24 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.

25 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.

26 KSE Clearing House BrokerBuyerBrokerSeller T+2 Settlement PaymentShares Equity Trading Mechanism

27 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

28 SIMPLE ARBITRAGE Price differential between two exchanges or market of the same instrument. PTC Rs. 30 PTC Rs. 32 K.S.EL.S.E T+2 Settlement BuySell

29 READY FUTURE ARBITRAGE Price differential between ready and future contracts of the same instrument in the same exchange or market. PTC (ready) Rs. 30PTC (future) Rs. 34 K.S.E T+15 Settlement T+2 Settlement

30 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. EQUITY PORTFOLIO MANAGEMENT

31 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. Portfolio Management Guidelines

32 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.

33 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.

34 ■“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.” Myths about the stock market

35 Today: PkR 1,000 Inflation Adjusted Value of PkR 1,000: PkR 122 Nominal Value of PkR 1,000 : PkR 6,727 Inflation gradually erodes the value the Rupee

36 Investments provide protection from inflation

37 “The market will collapse!”

38 …zoomed-in view of the crash of 2005

39 ■Riding out short-term depression in the market can pay off in the long-run It pays to stay invested

40 Gambling/ Trying to catch the momentum

41 ■ 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. “Investing in stocks is not like gambling.”

42 ■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 Do heavyweights manipulate the market?

43 “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.

44 “To begin investing, I need to accumulate a lot of money first.”

45 Comparison with fixed-income returns and inflation

46 In fact, equities have outperformed all other asset classes in the past 15 years

47 ■Un-informed decision-making ■Monitoring costs ■Diversified exposure not possible with small amounts ■Brokerage fees Drawbacks of direct investment in equities

48 ■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. How A Mutual Fund Works

49 Why Equity Funds?

50 ■ Diversification ■ Active management ■ Hedge against inflation ■ Professional Management ■ Benefits of automatic re-investment ■ Rupee-cost averaging ■ Investment Options: SIP, STP, SPT The Reasons…

51 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. Diversification

52 ■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 Active management

53 ■Historically, equities have generally outpaced inflation, thus ensuring that the real- value of the investment is protected. Hedging against inflation

54 ■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. Professional Management

55 ■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

56 Rupee-cost averaging: USF * Since inception ■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.

57 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 one- time 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

58 Investment Options: SIP

59 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.

60 Investment Options: SPT and STP

61 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.

62 JAZAK ALLAH


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