1. Treasury Management
Policy Process and Performance
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2. Why Manage Risk?
Objective of the Organisation Maximise Shareholder Wealth How? Cash Flow = Value Discount Rate - Reduce Volatility - Reduce Risk - Reduce Cost of Capital
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3. Should We Manage Risk? Efficient Markets Parity Portfolio Theory
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4. 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
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5. Should We Manage Risk? Parity
Purchasing Power 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
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6. Should We Manage Risk? So maybe we should manage risk due to:
Even if the parity theories work long term we might, with large movements, be bankrupt short term
There is some value in certainty, e.g. planning liquidity even if hedging does not reduce volatility
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7. 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
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8. 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
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9. 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
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10. Foreign Exchange Policy Issues
Instruments
Define proportions in each
Options – write covered or uncovered, buy
Set Limits
Overall limits
Individual limits
Treasury Procedures
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11. 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
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12. VAR Correlation Approach
Example: Single Asset
Historic Data
Normal Distribution
68% of changes within one Standard Deviation (SD)
95% of changes within two SD’s
99% of changes within three SD’s
10 million (GBP equivalent) long position in USD SD .15% Want 95% confidence Max loss = 10,000,000 x x 2 = 30,000
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13. VAR Two Assets [(VAR1)2 + (VAR2)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 x 2)2 + (10,000,000 x x 2)2]
VAR = (30,000)2 + (40,000)2
VAR = ,000, ,600,000,000 = 2,500,000,000
= 50,000
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14. VAR Correlation (Related Movements)
VAR = [(VAR1)2 + (VAR2)2 + 2 x VAR1 x VAR2 x R] Example Same as above but Correlation Coefficient .6 VAR = (30,000)2 + (40,000)2 + 2 x 30,000 x 40,000 x .6] VAR = 62,769
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15. 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
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16. 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
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Month 1 2 3 4 5 6
Volatility
5.77
8.16
10.00
11.55
12.90
14.14
Position 3,198,976
Possible Loss
184,581
261,036
319,898
369,482
412,668
452,335
Maximum Loss 2,000,000

17. 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?
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18. 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.
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19. 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
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20. The Dealing Process Deal done Conversation recorded
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
Company back office
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Conversation recorded
Security/ controls on settlement
Internal audit, Physical access, Dual input, Pre formatted payment details, Passwords, Encryption, Authorisations, Answer back, Reconciliation

21. 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
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22. Electronic Banking Security
Different levels of authorisation/activity
Input
Second input
Verification
Authorisation and release
Free format
Pre-format/Templates in TMS
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23. 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
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24. Electronic Banking Security
Digital Signature
Uses the asymetric method to perform two functions
Authentication
Integrity
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25. Performance Measurement
Why have performance measurement?
To justify existence
To show value added
To motivate and reward
To control
What areas need benchmarks/objectives
What benchmarks may be used
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26. 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
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27. Performance Measurement
Some areas Cash management
Liquidity management
Risk management, FX and Interest Rate
Efficiency of Treasury
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28. Performance Measurement
Benchmarks should be
Agreed
Attainable
Measurable
Some might be
Cost per £1,000 of revenue
Time to process
Forward rate
Three month Libor
Overnight
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