copyright anbirts1 Treasury Management Policy Process and Performance

copyright anbirts2 Why Manage Risk? Objective of the Organisation Maximise Shareholder Wealth How? Cash Flow = Value Discount Rate - Reduce Volatility - Reduce Risk - Reduce Cost of Capital

copyright anbirts3 Should We Manage Risk? Efficient Markets Parity Portfolio Theory

copyright anbirts4 Should We Manage Risk? Efficient Markets Basically current prices reflect all known information and the next price will be a random walk What Does Random Walk Theory Mean? The theory that price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement. So we cannot beat the market over time and there are costs in hedging e.g. wider spreads on the forward, management time

copyright anbirts5 Should We Manage Risk? Parity Expected change in Movement in spot exchange rate expected inflation Expectations International Fisher effect Fisher Theory effect Difference between covered Interest rate parity Movement in spot and forward interest rates From Alpha Dhanani Purchasing Power Parity

copyright anbirts6 Should We Manage Risk? So maybe we should manage risk due to: 1.Even if the parity theories work long term we might, with large movements, be bankrupt short term 2.There is some value in certainty, e.g. planning liquidity even if hedging does not reduce volatility

copyright anbirts7 Should We Manage Risk? Portfolio Theory If hedging makes sense there is still the question as to whom should undertake the hedging, Managers or Shareholders? Portfolio theory Asymetric information Internal hedging Asymetric tax effect Access to markets

copyright anbirts8 Foreign Exchange Policy Issues Define Exposures to Be Managed –Economic –Translation –Transaction Objective: Minimise FX losses and Maximise FX Gains Commensurate with a defined level of Risk

copyright anbirts9 Foreign Exchange Policy Issues Which exposures are important Time Period –Start Date Price List, Forecast, Order Date –End Date Year end or beyond, invoiced or expected date Policy Alternatives Cover Everything Leave Open Selective Cover Hybrid

copyright anbirts10 Foreign Exchange Policy Issues Instruments –Define proportions in each –Options – write covered or uncovered, buy Set Limits –Overall limits –Individual limits Treasury Procedures

copyright anbirts11 Value at Risk (VAR) VAR estimates the potential pre-tax loss resulting from an adverse movement in market prices over a defined holding period. Equities Commodities FX Interest Rates

copyright anbirts12 VAR Correlation Approach Historic Data Normal Distribution 68% of changes within one Standard Deviation (SD) 95% of changes within two SDs 99% of changes within three SDs 10 million (GBP equivalent) long position in USD SD.15% Want 95% confidence Max loss = 10,000,000 x.0015 x 2 = 30,000 Example: Single Asset

copyright anbirts13 VAR Two Assets [(VAR 1 ) 2 + (VAR 2 ) 2 ] Example: Two Unrelated Assets 10,000,000 (GBP equivalent) long in USD SD.15% 10,000,000,Long (GBP equivalent) in Euro SD.20% 95% Confidence VAR = [(10,000,000 x.0015 x 2) 2 + (10,000,000 x.002 x 2) 2 ] VAR = (30,000) 2 + (40,000) 2 VAR = 900,000, ,600,000,000 = 2,500,000,000 =50,000

copyright anbirts14 VAR Correlation (Related Movements) VAR = [(VAR 1 ) 2 + (VAR 2 ) x VAR 1 x VAR 2 x R] Example Same as above but Correlation Coefficient.6 VAR = (30,000) 2 + (40,000) x 30,000 x 40,000 x.6] VAR = 62,769

copyright anbirts15 VAR Advantages –Reasonably simple concept to communicate –Used to aggregate risks –Can correlate Profits to Risk (Performance Measurement) Disadvantages –Based on major assumptions (normal distribution, history repeats itself) –Complex mathematics –Sudden shifts of volatility –Appears scientific

copyright anbirts16 Setting Limits: An Approach Co Net Worth GBP 10,000,000 Prepared to Lose 2,000,000 Currency Exposure USD Annual Volatility 20% and Monthly Volatility 20 x Maximum Exposure Period: 6 months Month Volatility Position 3,198,976 Possible Loss 184,581261,036319,898369,482412,668452,335 Maximum Loss 2,000,000

copyright anbirts17 Electronic Banking Why is Security important and in what areas should communications systems (telephone, , proprietary, internet) seek to give confidence? Authorisation Non repudiation Authentication Confidentiality Integrity What do these mean?

Electronic Banking Authorisation. Determines that the users or entities involved are authorised to perform the actions they have taken. Non repudiation. Evidence that the sender of the transaction intended to send the transaction (and that the receiver received it). Authentication. Guarantees that each party requesting access to the transaction are who they claim to be. copyright anbirts18

Electronic Banking Confidentiality. Ensures that access to the transaction is restricted to certain individuals. Integrity. Prevents data from being either maliciously or accidentally changed or corrupted. Internally, protection is also needed against Fraud and Error copyright anbirts19

copyright anbirts20 The Dealing Process Authorised deal by FD, treas etc Dealer Bank Deal done Dealer limits Confirmation Authorised/ Mandates Bank dealer logs details authorised Limits on Bank Limits on company Co dealer logs details on TMS + competitive quotes. Also logs in ERP system Both parties send confirmations and reconcile Segregation of duties Settlement to standard settlement instructions Segregation of duties Company back office Security/ controls on settlement Internal audit, Physical access, Dual input, Pre formatted payment details, Passwords, Encryption, Authorisations, Answer back, Reconciliation Conversation recorded

copyright anbirts21 Electronic Banking Security So how do we attain security and have a system that works? Authorisation for payments/deals Segregation of duties (back office/dealer) Physical security –Dedicated computers for payments –Separate room –Password protected

copyright anbirts22 Electronic Banking Security Different levels of authorisation/activity –Input –Second input –Verification –Authorisation and release Free format Pre-format/Templates in TMS

copyright anbirts23 Electronic Banking Security Encryption or cyphertext –Private key or symmetric –Public key or asymmetric (public key infrastructure, PKI) not only ensures confidentiality but also provides authentication of the sender thus preventing repudiation –SSL, Secure Sockets Layer –HTTPS, Hypertext Transfer Protocol, Secure

copyright anbirts24 Electronic Banking Security Digital Signature Uses the asymetric method to perform two functions –Authentication –Integrity

copyright anbirts25 Performance Measurement Why have performance measurement? 1.To justify existence 2.To show value added 3.To motivate and reward 4.To control What areas need benchmarks/objectives What benchmarks may be used

copyright anbirts26 Performance Measurement Measures used will depend on objectives/policy i.e. Cover everything then focus on expertise of dealing Selective cover then focus on performance against a benchmark versus risk taken

copyright anbirts27 Performance Measurement Some areas Cash management Liquidity management Risk management, FX and Interest Rate Efficiency of Treasury

copyright anbirts28 Performance Measurement Benchmarks should be 1.Agreed 2.Attainable 3.Measurable Some might be 1.Cost per £1,000 of revenue 2.Time to process 3.Forward rate 4.Three month Libor 5.Overnight