Treasury is a platform for generating bulk of banks non-interest income by way of dealing in different financial instruments. Besides this treasury plays a significant role in complying with various regulatory and statutory requirements, managing the liquidity, deploying the resources in different time horizons, maximizing the yields and realigning its assets structure in accordance with its ALM requirements.
The treasury operates in a fast changing and innovative market scenario, with frequent emergence of complex financial products and services. New products and services are generally followed by changes in the regulatory requirements.
Treasury operates in an integrated environment with simultaneous access to money market, debt market, capital market, forex market & derivatives market. The treasury policy of the bank lays down the scope and framework of various activities, which the treasury undertakes. The policy is updated and reviewed by the board every year.
OBJECTIVES
- Compliance of regulatory requirements
- Liquidity management
- Optimal deployment of funds both in short term and long term in line with the ALM requirements.
- Ensuring adequate liquidity.
- Profit maximization
- Risk Management
- To evolve a clearly defined risk management system across all the parameters of treasury operations.
- To ensure that the decisions taken are consistent with the assets and liabilities management policy of the bank.
SCOPE
- Forex Operations (both merchant and proprietary transactions – Front office and Back office)
- Domestic operations in money market, debt market and capital markets.
- Funding Operations
- Operations in derivative instruments both in foreign exchange and domestic treasury activities.
- Mid office functions
- System administration.
Functioning of the Treasury Department
The operations of the treasury are divided into three sub departments
- Front Office
- Mid Office
- Back Office
Front Office
The deals are concluded in the front office. All the Money market, Debt Market, Capital market, Forex operations and the Derivatives operations deals are struck in the front office. The front office manages the CRR and SLR requirements and also performs the operations of lending, borrowing, purchasing, selling using different instruments to maintain the minimum requirements and to earn profit.
Mid office and Back office
Input and completion-the core function of the back office is to recall the deal through the input system and decide what has to be done to complete the details of the deal
Verification by confirmation- To verify the deals through the external source as soon as possible after the deal is done. The verification can be done from the confirmation deal through NDS, Reuters etc.
Settlement- This is one of the important functions of back office and it deals with the payment and receipts of the securities/ cash etc
Reconciliation- Reconciliation of nostro accounts, position and books
Risk management—It provides the various risks details associated with the securities, the stop loss limits, the VaR etc. It also reports the same to the dealers and the higher authorities periodically
Operations of Treasury Department of Union Bank of India
The operations of the treasury department are divided into three parts:
Forex operations
Domestic operations
Derivatives
UBI has an integrated treasury department i.e. the domestic, forex and the derivative operations are done at the same head office.
For project purpose the Domestic department of the Treasury Department is explored along with some operations of the Mid Office i.e. the Risk Department of the Treasury Department.
The domestic market is further divided into:
- Money Market
- Debt Market
- Capital Market
Money Market
The money market is a market for short-term financial assets that are close substitutes of money. The most important feature of a money market instrument is that it is liquid and can be turned over quickly at low cost and provides an opportunity for balancing the short-term surplus funds of lenders and the requirements of borrowers. By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year. The most active part of the money market is the market for overnight call and term money between banks and institutions and repo transactions. Call Money / Repo are short-term Money Market products. There are a wide range of participants (banks, primary dealers, financial institutions, mutual funds, trusts, provident funds etc.) dealing in money market instruments. Money Market Instruments and the participants of money market are regulated by RBI and SEBI.
Money market Instruments:
- Call/ Notice/ Term Money
- Repo/ Reverse Repo
- Inter Corporate Deposit
- Commercial Paper
- Certificate of Deposit
- T-bills
- Inter Bank Participation Certificate
Functioning at UBI
Besides maintaining required balances with RBI for the purpose of CRR compliance, and maintenance of Intra Day Liquidity under RTGS, Money Market Operations are undertaken keeping in mind the need to ensure comfortable level of short-term liquidity and earn decent returns.
With the objective of prudent funds and liquidity management, rediscounting of eligible bills etc. are undertaken without losing sight of the profitability aspect at the same time.
Short-term liquidity is deployed in the call money market and/or in the money market instruments taking into account yield and maintaining proper maturity-wise composition within the exposure limits.
Union Bank Deals with the following instruments:
- Call Money/ Notice Money/ Term Money
- CBLO
- Inter Bank Repo/ Reverse Repo
- LAF Repo/ Reverse Repo
- CD
- CP
Call Money/ Notice Money/ Term Money
Call Money is the money lent by banks on a short term basis which the bank, as lender, can "call" (demand payment at any time, usually on 24 hours notice.)
Call markets represent the most active segment of the debt markets. Though the demand for funds in the call market is mainly governed by the banks' need for resources to meet their statutory reserve requirements, it also offers to some participants a regular funding source for building up short-term assets. However, the demand for funds for reserve requirements dominates any other demand in the market.
Call Money - Overnight
Notice Money - 2 to 14 days
Term Money - above 14 days
Participants in call/notice money market include banks (excluding RRBs) and Primary Dealers (PDs), both as borrowers and lenders. Non-bank institutions are not permitted in the call/notice money market.
In case of call/ notice money the eligible participants are free to decide on interest rates of the borrowing/ lending.
The reporting of call/ notice is done through NDS- CALL. The institution participating in the CALL/ NOTICE has the freedom to choose the counter party. The further negotiation can be done on the NDS system.
In case of TERM Money the deal is entered in the NDS system after telephonic negotiation.
As the call/ notice/ term money instrument is not backed by any securities the yields associated with them are higher than the higher secure instruments like CBOL.
As the liquidity in the system is higher due to the market conditions the Call/ Notice rate have come down to around 3.00 to 4.00 compared to 7.00 before the recession.
CBLO
Collateralized Borrowing and Lending Obligation (CBLO) is a money market instrument approved by RBI, and developed by CCIL for the benefit of the entities who have either been phased out from interbank call money market or have been given restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market. CBLO is a discounted instrument for the maturity period ranging from one day to ninety Days (can be made available up to one year as per RBI guidelines). In order to enable the market participants to borrow and lend funds, CCIL provides the Dealing System through: NDS platform
Membership to CBLO segment is extended to entities who are RBI- NDS members viz. Nationalized Banks, Private Banks, Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual Funds, Primary Dealers etc.
Associate Membership to CBLO segment is extended to entities who are not members of RBI- NDS viz. Co-operative Banks, Mutual Funds, Insurance companies, NBFC's, Corporate, Provident/ Pension Funds etc.
Borrowing Limit and Initial Margin
Borrowing limit for the members is fixed everyday after marking to market and applying appropriate hair-cuts on the securities deposited in the CSGL account. The post hair-cut Mark-to-Market value after adjusting for the amounts already borrowed by the members is the borrowing limit, which, in effect, denotes the drawing power up to which the members can borrow funds. Members are required to deposit initial margin generally in the form of Cash (minimum Rs.1 lac) and Government Securities. Initial margin is computed at the rate of 0.50% on the total amount borrowed/lent by the members
Eg. if a participant wants to borrow 10crores through CBLO then:
For 10crores he must have securities worth 10.5 cores (0.50% is the MTM haircut) and 5% extra as an security in case the party defaults.
Hence for borrowing 10crores the participating party have to keep securities in the form of approved securities and cash with CCIL worth 12.5crores out of which 2crores are kept as security with CCIL and 0.5crores is the MTM associated with the securities kept as collateral .
Eligible securities are Central Government securities including Treasury Bills, as specified by CCIL from time to time.
Other features of CBLO
- The total lending/ borrowing amount can be specified by the participant i.e. if a participant is eligible for borrowing/lending 50crores then if he wants he can specify the limits: borrow 20crores , lend 30crores
- In case the participants breaches the limits he has to pay penalty on the amount breached
- The participants can manually hit the transaction instead waiting for the NDS platform waiting for the match.
- The counter party is not disclosed as its electronic screen based.
In case of CBLO the borrowing and lending is backed with the securities specified by CCIL i.e. the operations are secured by the Government securities which has low risk attached to it. Hence the yield returns are also less compared to call money or other unsecured borrowing/lending instruments. Hence major borrowings are from CBLO
Commercial Paper
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. CP is a privately placed instrument with a view to enable highly rated corporate to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Primary dealers, satellite dealers and India financial institutions are permitted to issue CP to enable them to meet their short-term funding requirements for their operations.
A corporate is eligible to issue CP provided
- The tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs.4crore
- Company has been sanctioned working capital limit by bank/s or all-India financial institution/s
- The borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.
Commercial Paper must be rated from either the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agencies as may be specified by the Reserve Bank of India from time to time, for the credit rating purpose.
CP is issued for maturities between a minimum of 7 days and a maximum up to one year from the date of issue. The maturity date of the CP should not go beyond the date up to which the credit rating of the issuer of the CP is valid.
CP can be issued in denominations of Rs.5lakh or multiples thereof. Amount invested by a single investor should not be less than Rs.5lakh (face value). CP can be issued as a "stand alone" product. The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors or the quantum indicated by the Credit Rating Agency for the specified rating, whichever is lower.
CP can be issued either in the form of a promissory note (Schedule I) or in a dematerialized form through any of the depositories approved by and registered with SEBI. CP’s are issued at a discount to face value as may be determined by the issuer.
In case of CP’s higher the maturity period, higher is the yield. Also in case of CP’s as they are unsecured loans the yields are high. UBI invests in short term n long term (1year maturity) CP’s. It also invests in those CP’s which can be absorbed quickly in the secondary market. The deals are telephonically negotiated.
Certificate of Deposits
Certificates of Deposits (CDs) are short-term borrowings by banks. CDs differ from term deposit because they involve the creation of paper, and hence have the facility for transfer and multiple ownerships before maturity. CD rates are usually higher than the term deposit rates, due to the low transactions costs. Banks use the CDs for borrowing during a credit pick-up, to the extent of shortage in incremental deposits.
Certificates of Deposit (CDs) is an instrument issued in dematerialized form or as a Issuance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are governed by various directives issued by the Reserve Bank of India from time to time.
CD’s can be issued by Scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs) and selected India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements.
Minimum amount of a CD should be Rs.1lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs. 1lakh and in the multiples of Rs. 1lakh thereafter. CDs can be issued to individuals, corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs,
The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue.
Banks have to maintain the appropriate reserve requirements, i.e., cash reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs. Banks/FIs should issue CDs only in the dematerialised form
CD’s are transferable and unsecured securities. As this instrument is unsecured the yields are high. As they are issued by FI’s and banks they are more secured compared to CP’s and hence their yields are less compared to CP’s. UBI is active in both the primary and secondary market of CD’s
Repo/ Reverse Repo
Repo enables collateralized short term borrowing and lending through sale/purchase operations in. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate.
The transaction is nothing but collateralized lending as the terms of the transaction are structured to compensate for the funds lent and the cost of the transaction is the repo rate. In other words, the inflow of cash from the transaction can be used to meet temporary liquidity requirement in the short-term money market at comparable cost.
To the lender of cash, the securities lent by the borrower serves as the collateral; to the lender of securities, the cash borrowed by the lender serves as the collateral.
In a repo transaction, there are two legs of transactions viz. selling of the security and repurchasing of the same. In the first leg of the transaction which is for a nearer date, sale price is usually based on the prevailing market price for outright deals. In the second leg, which is for a future date, the price is structured based on the funds flow of interest and tax elements of funds exchanged. This is on account of two factors. First, as the ownership of securities passes on from seller to buyer for the repo period, legally the coupon interest accrued for the period has to be passed on to the buyer. Thus, at the sale leg, while the buyer of security is required to pay the accrued coupon interest for the broken period, at the repurchase leg, the initial seller is required to pay the accrued interest for the broken period to the initial buyer.
A reverse repo is the mirror image of a repo. For, in a reverse repo, securities are acquired with a simultaneous commitment to repurchase. Hence whether a transaction is a repo or a reverse repo is determined only in terms of who initiated the first leg of the transaction.
Repo/ Reverse Repo takes place at Repo/ Reverse Repo rate and the rate is annualised interest rate i.e. the rate is for 1year hence the corresponding rate for which the repo transaction has taken place is calculated.
For eg. If the Repo is for 4days at repo rate 3.85% for amount 100crores then the interest earned will be
Interest= (100 x 0.0385 x 4)/ 365
= 0.04219crores
Hence the total Maturity amount will be 100.04219crores
In case the repo transaction is with a bank or a Financial Institution then the transaction is called as Inter Bank Repo. But in case the Repo transaction is with RBI its called LAF- Liquidity Adjustment Facility
LAF Repo/ Reverse Repo
In case of LAF the bank or financial institution has to keep 5% more securities on the loan amount i.e. if the loan amount is 100crores then securities must be worth 105crores.
The LAF operations the bank needs RCSGL Account and RRCSGL Account along with the banks current account with RBI. The working is explained as follows:
LAF Repo
The banks current account with RBI is credited with the loan amount as per Repo operations and the securities will be debited from the banks RCSGL account simultaneously. On the date of maturity of the transaction the banks RCSGL account will be credited with the securities kept for collateral and the banks current account with RBI will be debited with the maturity amount i.e. the loan amount and the interest on the loan amount. The second leg operation takes place automatically on the maturity date hence the bank must keep sufficient funds in the current account.
For a loan of Rs.500crore at rate of 6% for 1day under LAF the operations under both the legs are as follows:
LEG1-
Banks Current Account: Cr. Rs500crore
Banks RCSGL Account: Dr. Rs525crores (5% more securities on the loan amount)
LEG2-
Banks RCSGL Account: Cr. Rs525
Banks Current Account: Dr. Rs550.0821918crores (Loan amount + 1day interest @ 6%)
LAF Reverse Repo
The banks current account with RBI is debited with the loan amount as per Reverse Repo operations and the securities will be credited into banks RCSGL account simultaneously. On the date of maturity of the transaction the banks RCSGL account will be debited with the securities kept for collateral and the banks current account with RBI will be credited with the maturity amount i.e. the loan amount and the interest on the loan amount.
For a loan of Rs.500crore at rate of 6% for 1day under LAF the operations under both the legs are as follows:
LEG1-
Banks Current Account: Dr. Rs500crore
Banks RCSGL Account: Cr. Rs525crores (5% more securities on the loan amount)
LEG2-
Banks RCSGL Account: Dr. Rs525
Banks Current Account: Cr. Rs550.0821918crores (Loan amount + 1day interest @ 6%)
LAF is used by RBI to inject/ absorb liquidity in/ from the system. LAF transaction calendar is given by RBI in advance. In case it wants to introduce LAF again apart from the mentioned dates in the LAF calendar then it comes up with SLAF i.e. Second LAF. SLAF is introduced depending upon the market conditions.
Debt Market/ Capital Market
The Bank’s Investment portfolio can be broadly categorized into approved securities (SLR) and other (Non-SLR) securities.
SLR securities are those approved securities which are required for `Statutory Liquidity Reserve’ purpose. They consist of:
- Central and State Government Securities (G. Secs and SDLs)
- Treasury Bills
- Securities issued by Public Sector Undertakings and other statutory bodies under Central Government Guarantee (Notified as approved securities)
- Securities issued by State level Public Sector Undertakings and other Statutory Bodies under State Government Guarantee (Notified as approved securities.)
The SLR securities mainly consist of the Government Securities and the Treasury Bills.
Government Bonds
The central or state government on India issues these bonds. As the bonds issued are backed by the government of India they are highly secure and considered as risk free. Hence the coupon rates attached to them are low compared to other securities.
Instrument features are:
- Maturity
- Coupon
- Principal
In the bond markets, the terms maturity and term-to-maturity, are used frequently. Maturity of a bond refers to the date on which the bond matures, or the date on which the borrower i.e. the state or central government has agreed to repay (redeem) the principal amount to the lender. The borrowing is extinguished with redemption, and the bond ceases to exist after that date. Term to maturity, on the other hand, refers to the number of years remaining for the bond to mature. Term to maturity of a bond changes every day, from the date of issue of the bond until its maturity.
Coupon Rate refers to the periodic interest payments that are made by the borrower (the issuer of the bond) to the lender (the subscriber of the bond) and the coupons are stated upfront either directly specifying the number (e.g.8%) Coupon rate is the rate at which interest is paid, and is usually represented as a percentage of the par value of a bond.
Principal is the amount that has been borrowed, and is also called the par value or face value of the bond. The coupon is the product of the principal and the coupon rate. Typical face values in the bond market are Rs. 100.
The bonds can be purchased at premium (at price higher than the par value) or at discount (at price lower the par value)
In case of G.Sec the coupon is paid semi-annually.
For eg. 6% GS2019Feb
This means the coupon rate is 6% and the security will redeem in February 2019. And as the coupons are paid semi-annually the 1st payment of the coupon i.e. 3% will be in February and the next 3% will be paid in August.
The Ratings of different Government Security on different parameters.
Treasury Bills
Treasury Bills are Zero Coupon Bonds issued by RBI, maturing in less than a year. Treasury Bills are issued in the form of Promissory notes or Finance Bills by the government. Treasury Bills are risk free and issued by RBI on behalf of Government.
Treasury Bills are money market instruments to finance the short-term requirements of the Government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price.
There are different types of Treasury bills based on the maturity period at present; the Treasury Bills are the 91-days, 182-days and 364-days Treasury bills.
They can also form the part of the compliance of the SLR requirement by the banks. As their maturity period is less they are used for short term investment. TB’s are issued on Wednesdays by RBI and the trading of TB takes place on the NDS platform.
The bidding for TB’s is done mainly depending upon the secondary market. TB’s are not very liquid as the secondary market for TB’s is not very active but as their maturity period is small they are considered as a liquid instrument.
Non-SLR Securities
Non SLR Securities are the securities which are not required for Statutory Liquidity Purpose. Non SLR investments shall include following instruments:
- Non SLR Central and State Government Securities.
- Debentures and Bonds of PSUs.
- Corporate Debentures and Bonds issued through public issue / Private Placement route.
- Floating rate Bonds issued by PSUs, Corporates, Banks and FIs.
- Equity & Preference Shares
- Units of UTI and other Mutual Funds
- Indira Vikas Patra
- Pass-through certificates (PTC)/ Collateralized Bond Obligations(CBO)Asset Backed Securities/ Mortgage Backed Securities.
- Venture Capital Funds.
- Any other new instrument not specifically mentioned above and which is not in the nature of a credit proposal.
The Banks are required to value their investment portfolio at market prices and if required, provide for depreciation on an ongoing basis and ignore the appreciation if any in case of SLR, Non SLR securities
Categorization of Securities
The securities held in SLR and Non-SLR category are further subdivided into three categories depending upon the
- Yield
- demand in the secondary market
- maturity period
- liquidity of the security
The securities are categorised in:
- HTM- Held to Maturity
- HFT- Held for Trading
- AFS- Available for Sale
The categorization of the security is done before they are purchased i.e. before they enter the account books.
HTM- Held to Maturity
As the name suggests the main purpose is to keep the securities till the maturity period.
The Bank has intent and the ability to hold the security till maturity.
Features of the securities in this category are:
- SLR securities in HTM category should not exceed 25% of the bank’s Demand and Time Liabilities.
- The securities classified in HTM become illiquid as these securities are normally not available for trading. Generally illiquid securities which are prone to mark to market depreciation are held in this category as the securities demand in the secondary market is less.
- In case the securities are sold before maturity, the profit earned will be first taken to profit and loss account and then transferred to the reserves and surplus in the bank’s balance sheet. The loss on sale of securities from HTM category is recognized in profit and loss account.
- HTM securities are not required to be marked to market. However, permanent diminution if any in the value of security is required to be provided individually. The premium if any paid on acquisition of securities under HTM category is required to be amortized over their residual maturity. The amortization expense is a charge on profit and loss account and is deducted from interest / dividend income on investments.
- HTM securities are generally long term investment
- Banks can acquire fresh SLR securities in HTM category. Acquisition of fresh non-SLR securities in HTM is restricted only to specific securities prescribed by RBI.
HFT- Held for Trading
The main purpose of the securities in this category is trading i.e. short term profit from the sale of these securities.
Features of the securities held in this category.
- There is no restriction for investment in this category like that in HTM
- The securities held in this category must be sold within 90 days from the day the securities are acquired.
- Securities which have high demand in the secondary market are kept in this category.
- The profits earned are transferred to the P&L account.
- HFT securities are for short term investment.
- The securities held in this category are marked to market on daily basis and necessary provision is made for depreciation.
- SLR and Non-SLR securities can be part of this category.
- In case the securities in HFT category are not sold then they are shifted to AFS category.
AFS- Available for Sale
Securities which are neither classified into HTM or HFT categories are classified AFS is the residual category in which securities other than HTM and HFT securities are classified.
Features of securities held in this category.
- There is no restriction for investment in the securities like that in HTM
- Securities which are neither very liquid or very illiquid are kept in this category
- The profits earned are transferred to the P&L account
- AFS securities are for midterm investment
- The securities held in this category are valued on daily basis and necessary provision is made for depreciation
- SLR and Non-SLR securities can be part of this category.
The securities can be shifted from one category to other once in a year as per RBI guidelines. Generally the transfer is done at the beginning of the financial year. Provision is made for the necessary depreciation when transfer is made from one category to other. The depreciation calculation will be explained later in the report.
Subject to fulfillment of the SLR requirement, management of Investment portfolio involves, inter-alia, purchases, sales and switches of securities with a view to having a balanced mix with respect to maturity, yield and composition so that interest risk is minimized and yield on the securities is maximized.
Yield
The price of a bond is the present value of the bond’s cash flows. The bond’s cash flows consist of coupons paid periodically and principal repaid at maturity. The present value of each cash flow is calculated using the yield of the bond. Yield is an internal rate of return (IRR). That is, yield is an interest rate that, when used to calculate the present value of each cash flow of the bond gives the price of the bond.
The yield plays a very important role in deciding the investment portfolio and in categorization of the securities in different categories. Yield calculation plays a very important role in the treasury operation and in deciding which securities to buy and for which category.
The yield depends upon the following:
- The coupon rate
- The redemption period
- Date of purchase of security
- Cost of security i.e. weather security is purchased at discount or premium
- Frequency of receiving the coupon
The yield and price of a security are inversely related.
Price α 1/ Yield
Hence in case of SLR securities the securities are purchased at higher yields i.e. at lower price and sold at lower yields i.e. at higher price to earn profit.
And in case of Non-SLR securities like equity the security is purchased at lower yields i.e. at lower prices and sold at higher yields i.e. at higher prices.
Yield formulae for TB:
yield = ((100-Price) x 365 x 100)/(Price x Number of days)
Price i.e. the holding price of the TB= Rs. 98.89
Number of Days= 91 days
Hence the yield of the TB is:
Yield= ((100-98.89) x 365 x 100)/( 98.89 x 91)
Yield= 4.502%
Yield formulae for Bond:
P = Price of the bond
Ct = Coupon payment for period t
FV= Face value of the bond
Y =Yield to maturity of the bond (YTM)
k =Frequency of coupon payment
n =Maturity of the bond in years
The above formulae can also be written as:
Price= (Coupon/k) x PVIFA (yield/k, n x k) + Par Value of Bond PVIF (yield, n )
For eg.
Coupon rate: 10% semi annually
Face value of the bond: Rs.100
Yield: 12 %
Period: 8years
Hence the bond price will be:
Price= (10/2) x PVIFA (12/2,8x 2) + 100 PVIF (12, 8)
= 5 (10.106) + 100(0.404)
= 90.93
Comparison of different securities and instruments in the domestic market
Initial issue and Re-Issue of Government Bonds
The yields of the Government Securities depends upon its issue i.e. whether it is being issued for the first time in the market or whether it is being re-issue.
Initial Issue of Government Bond
The parties participating in the auction decide when RBI the coupon rate of the security is issuing a security for the first time. The interested parties submit their expected yields for the newly issued security along with the volume of security they want to buy. RBI then decides the cut-off depending upon various bids it receives.
The bids for the security depends upon the urgency of the security by the bidding party, the maturity period of the bond, the yields of other bonds having similar maturity period etc.
RBI decides the yield of the bond by taking weighted average of all the bid offers. Parties whose yields are lower than the cut-off yield get the security. The cut-off yield becomes the coupon rate for the bond. When the bond is issued again this cut-off yield is the coupon rate of the bond.
Re- Issue of Government Bond
In case of re-issue of a government bond the coupon rate associated with the bond is already decided in the initial issue. Hence in re-issue the bidders get the bond at same price irrespective of the price at which they bid. The bids received and the volume of the bid decide the price. The weighted average of all the offers is considered to decide the price.
The bid price depends on the volume the bidder wants to buy as in re-issue all the parties have to buy the bond at the same rate the volume of the bid plays a significant role.
Hence for the initial issue of the bond the bidding is done in terms of yield and in case of re-issue of the government bond the bidding is done in terms of price of the bond.
Valuation of SecuritiesThe SLR and Non-SLR securities are valued frequently on MTM (mark to market) basis to make provision for depreciation. The relevant data for valuation is gathered from different software. Securities in HTM category are not valued as their main motive is to hold them till maturity.
In case of Government Securities the data is available from FIMMDA (Fixed Income Money Market & Derivatives Association of India). And for Equity the data is available from BSE and NSE.
In case of HFT and AFS the valuation is done on daily basis at the Risk Department and provision is made in case the MTM value of the security is less than the holding price i.e. the cost of the security. The provision made is called as the depreciation and it can be calculate don Gross or Net basis. Any kind of appreciation is ignored.
The provision is made on Net basis within the categories. The provision is calculated as follows: Suppose there are 10 securities in HFT category. The details are as follows:
In case of Net basis depreciation, the depreciation of the entire category is taken i.e. the individual depreciation on securities is not provided. Hence in the above example the overall depreciation of the HFT category will 4.
In case there is overall appreciation then it is ignored.
Gross depreciation is calculated in case securities are transferred from one category to other. Hence gross depreciation takes place when securities are transferred from HTM to HFT or AFS. In this case the individual depreciation is considered instead of net depreciation of the entire category.
For example:
When security 1 and 2 are transferred from HTM to HFT category then net depreciation is considered i.e. the appreciation of security1 is ignored and provision is made for the depreciation on security2.
Similarly when HTM security3 and 4 are transferred to AFS the net depreciation (1 + (1) = 0) is not considered. The individual depreciation/ appreciation is considered. Hence the appreciation of security3 is ignored and provision is made for depreciation on security4.
Hence when securities are transferred from one category to other there is a cost attached to it in the form of Gross Depreciation.
In case of Non –SLR securities whose MTM data is not available the valuation is done as follows:
- Preference shares: the valuation of preference is done only once i.e. when they are purchased. it is a function of maturity period, market value, coupon, frequency of coupon.
- Unquoted equity shares i.e. privately placed equity shares: the valuation is done form the balance sheet of the company and intrinsic value of the share is found (maximum 18months balance sheet is required for this purpose). If the balance sheet is not received within 18months then Re.1 valuation is done i.e. if the share is worth Rs.100 and its balance sheet is not received within 18months then the value of the share will be Re.1 i.e. depreciation of Rs.99.
- Others: it includes CD’s, CP’s Mutual Funds, VC etc. here the net valuation is done compared to the holding cost.
Mid-Office of the Treasury Department
The functional role of the mid-office is to provide suitable control function and MIS, keeping in view the trading volumes.
The mid-office functions are:
- Limits Monitoring – The mid-office monitors the limits set for trading activities covering Daily Trading limit per dealer, the size of deals etc.
- Exposure Limits: The exposure limits sets for corporate / group and the overall exposure taken, are monitored.
- Broker Limits: - Broker wise transactions are tracked to check whether they are within limits.
- Transfer Pricing: - Movement of securities from Investment to Trading segment and vice-versa will be controlled for appropriate pricing as per policy.
- MIS: - They will provide the management with daily / monthly and other required reports for monitoring and control.
On the MIS side, the mid-office supplies information to Treasury Head Investment Committee and the Top Management on the compliance of various limits fixed for trading transactions. It also undertakes Risk Analysis of the portfolio as also assessment through benchmark index/return on trading performance.
Reporting of the Mid Office
The mid office reports to the head of the department and the top management on daily, weekly and fortnightly basis. It submits different reports to different heads along with checking the compliance with the various limits.
The daily basis report consists of the following details of the various operations of the treasury department.
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Money Market Activities: this part of the report gives the rates of all the money market instruments in which UBI was active for the particular day. It also states the reasons for the change in the rates. The sections also include the total volume of trade in the different instruments of the money market along with its comparative study with the previous day and the previous month money market operations of UBI. The report also includes the total interest paid because of the borrowing and the total interest earned because of lending of the funds with a cumulative interest as on 1st April.
- Debt/ Capital Market Activities: this part of the report gives the overview of the debt instruments held with respect to the yield and tenor of the securities. It also gives the comparative holding with respect to the previous day, one month ago and the holding that UBI had 1year back. It also gives the reasons for the fluctuations in the yields of the securities. With respect to capital market it gives the over view of the different indexs and the reason for the change in same. It also gives the best shares in the market on that particular day.
- VaR: this part of the report gives the details of the VaR limits of the securities in the SLR and Non-SLR category in different categories and whether any category exceeded the defined limits. At UBI VaR is calculated at 99% confidence level.
- Stop Loss: this part gives the details of the securities which have crossed the stop loss limit.
- CRR and SLR: this part deals with CRR and SLR compliance of UBI. The total CRR till date and the remaining CRR left for the compliance.
Similarly details of the Forex and Derivatives operations are also reported.
The mid office of the treasury also co-ordinates with the ALCO, IBD and the risk department of UBI
VaR- Value at Risk
Value at Risk (VaR) has become the standard measure that financial analysts use to quantify market risk. VaR is defined as the maximum potential change in value of a portfolio of financial instruments with a given probability over a certain horizon. VaR measures can have many applications, such as in risk management, to evaluate the performance of risk takers and for regulatory requirements,
VaR is a statistical measure of possible portfolio loss. Specifically value at risk is a measure of losses due to nominal market movements. Losses greater than VaR are suffered only with a specified small probability i.e. 1%, 5% etc. VaR aggregates the risk associated with the portfolio and is an aid to decision making.
Value at risk is most often used to assess the risk of a portfolio of assets. It is the maximum potential loss in a portfolio over a specific period of time given a certain probability. For example a VaR of Rs.100crores given a horizon period of 1 week and a probability of 5% would indicate that there is a 5% chance that the portfolio’s loss will be greater than Rs.100crores. Alternatively it can also be phrased as there is a 95% probability that the portfolio will not loos more than Rs.100crores in a week.
There are various methods to calculate VaR of a security in the portfolio. They are:
- Historical Method
- Monte Carlo Method
- Simulation Method
Historical Method for VaR calculation
Historical method graphs the actual daily returns over a user-specified past period into a histogram. For a two-year observation period (500 trading days) the 1% VaR would be the loss on the fifth-worst day, and the 5% VaR would be the loss on the 25th-worst day.
An advantage of the historical method is that it is non-parametric, which means it does not require assumptions for probability distribution. The disadvantage is that the past may have very different risk characteristics from the future.
At UBI the VaR is obtained from the Bloomberg software and is calculated for the portfolio on daily basis and the reports are submitted to the higher authorities for decision making.
Generally VaR is calculated using the historical data and the predicted value of the security in the future i.e. if vaR of a security is to be calculated on 26th May 2009 with historical data of 1month, then the historical data form 26th April 2009 to 25th May 2009 will be considered and the future value of the security say till 15th June 2009 is considered. The future valuation days depend upon the type of security for which VaR is calculated. The future values are predicted based on the past performance of the security. Bloomberg calculates VaR using this logic. Var for the mentioned example is explained as follows.
The differences in the Cost Price and the market Price are arranged in ascending order.
Now the total number of days used to calculate the VaR is
1month (past data form 26th April to 25th may) + 20 days ( future valuation form 26th May to 15th June) = 30+ 20 = 50 days
Now VaR at 99% level of confidence i.e. 99% of the time the losses associated with the security wont cross the VaR limit i.e. out of 100 days 99days the security wont cross the VaR limit calculated.
Hence the VaR value for the security at 99% confidence level is: 1% of 50 i.e. the 5th value from bottom in the difference table. Say the value is 5. Hence the VaR limit associated with the security will be 5 into the quantity of security held. If 1000 securities are held then the VaR will be 5000 for the securities worth 1lakh.
The VaR limits are also specified by the Investment committee and these values are higher than the VaR calculated using Bloomberg.
Stop Loss limits
Stop Loss limit is the value beyond which the security must not be held. It is difference between the MTM yields and the holding cost yield of a security. The difference gives the notional loss associated with the security and the security must be sold before it reaches the stop loss limit or explanation must be given to the higher authority for holding the security even if it has crossed the stop loss limit. The Risk department calculates stop loss limits on daily basis and reports them to the traders and the higher authorities to aid decision making.
The stop loss limit is different for different securities.
- Government Securities is 25 basis points and Maximum Limit is 50 basis points
- For Equity shares its 20% of the holding price
- For Debentures its 25% of the holding price
Stop loss calculation for equity and government security is done on daily basis and on weekly basis for debentures. The dealers can exit the scrip earlier at lower levels of stop loss.
The stop loss in case of Government Securities is calculated from the data available from FIMMDA. The data gives the market value of the securities from which the yields are calculated.
Eg: IGS7.56 11/03/2014
Holding price: 106.839 yield: 6.0617
Market price: 105.42 yield: 6.3624
The difference in the Market yield and Holding yield = 0.3107 > 0.25
Hence the stop loss limit is triggered in this case.
Ideally holding yield must be greater than market yield.
CRR and SLR Compliance
The CRR and SLR compliance takes place on daily basis. As per RBI norms a bank has to maintain 70% of its CRR requirements on daily basis and 100% of the requirement on fortnightly basis. In case of SLR the bank has to maintain 24% of Demand and Time Liabilities in the form of SLR securities on a daily basis. The SLR securities are well defined by RBI.
The CRR and SLR calculation are done on fortnightly basis. They are calculated from the DTL statement of the bank i.e. the Demand and Time Liabilities of the bank. The DTL statement of the bank includes the liabilities to the banking system in India, liabilities to others and the assets with the banking system. DTL is calculated by collecting the data from all the branches of the bank and the data from the other operations.
The liabilities are demand and time liabilities:
Demand liabilities:
It includes all the liabilities which are payable on demand and they include current deposits, demand liabilities of savings bank deposits, margins held against letters of guarantees/ credit etc.
Time Liabilities:
It includes those liabilities which are payable on demand, they include fixed deposits, time liability portion of savings bank account etc.
The DTL is calculated of fortnightly basis and it is applicable for the next fortnight.
The fortnights in the month of April, May and June are as follows:
1st fortnight: 25th April 2009 to 08th May 2009
2nd fortnight: 9th May 2009 to 22nd May 2009
3rd fortnight: 23rd May 2009 to 5th June 2009
In the above example the DTL for the 3rd fortnight i.e. 23rd May to 5th June will be calculated in 9th May 2009. Hence the DTL calculated during the 2nd fortnight is applicable in the 3rd fortnight.
INVESTMENT COMMITTEE
Investment Committee comprises of the Chairman and Managing Director, Executive Director, General Managers nominated by CMD and Functional Head of Treasury Branch and the heads of the other departments.
In respect of the following transactions (SLR/NON-SLR) the powers are delegated to the Investment Committee.
- Direct subscription to Central / State Government securities, other trustee securities and such other securities which rank for SLR.
- Outright purchase and sale of the securities.
- Tendering bids in auction for TB, GOI stocks.
- Purchase of Government Securities from RBI for the purpose of SLR compliance and short-term investment.
- Purchase/sale of non-SLR securities in primary/secondary market :
- CDs of financial institutions like IDBI, EXIM Bank etc.
- CPs and other money market instruments.
- Units of UTI, Other Mutual Funds, Venture Funds and Exchange Traded Funds.
- Public Sector bonds and bonds issued by financial institutions like IDBI, EXIM Bank, IDFC etc.
- Corporate Bonds and other instruments like PTC /CBO/MBS/ABS etc.
- Subscription in public/rights issue of shares/debenture purchase and sale of shares/ debentures in the secondary market including renunciation of right shares and debentures.
- Placement of short term funds in inter-bank market.
The Investment Committee meeting takes place every morning and decisions regarding the treasury operations for the day are taken. The issue of various instruments and auctions are discussed and accordingly decisions are taken which are followed by the treasury department.
The Investment Committee report consist the following:
- The new instruments that will be issued i.e. auctions of Gsec or TB etc.
- The rates of different instruments like Call, CBLO etc.
- The HTM, HFT, AFS composition and any sale/ purchase in these categories
- Decisions on CP, CD
The Investment Committee report also consists of the previous day’s operations and reports. They are as follows:
- Funds Application
- High Cost deposits
- Ratification
- Compliance
- CRR
- Depreciation
- Defeasance
- Refinance Availed
- Dealing of various securities
- Dealings in Forex
- Funds Application:
This part of the report gives the amount of liquidity available with the bank hence it aids the decision making of the Investment Committee regarding deployment of the surplus funds by the bank. It gives the details of the CRR requirement and various inflows and outflows. The format is as follows:
Funds Available: CRR (-)
RBI Balance (+) {Lending to RBI}
RBI Borrowing (-) {Borrowing from RBI}
Inflows (+) {Inflows from other branches}
Outflows (-) {Outflows to other branches}
The Net value of the funds available gives the amount of liquidity available with the bank. The positive figure shows surplus funds available with the bank and hence deployment of the same. The negative figure shows deficit with the bank and hence borrowing to cover the deficit.
- High Cost Deposits:
These are the bulk deposits available with the bank. As the deposits are in bulk they have a higher interest rate. These deposits must be as low as possible as they interest rate attached to them is high. But these deposits are essential as they have longer maturity hence these deposits must be maintained at a particular level.
- Ratification:
Decisions regarding purchase of CD, CP and other securities in AFS and HTM categories are taken by the investment committee. In case the deals have not been struck or the deals are to be modified then they come under ratification title. It also includes the suggestions by the traders which will be considered by the investment committee.
- Compliance:
Implementation of the decisions taken by the investment committee is included under compliance. It also includes those decisions which have to be executed within a specified period of time or those decisions which were taken in the previous committee meetings and have been implemented.
- CRR:
This part of the report shows the level of CRR maintained. It gives the details of the average CRR to be maintained, the amount of CRR that has been maintained and the balance CRR required. Banks need to maintain minimum 70% of the CRR on daily basis and 100% on the fortnight. UBI maintains CRR on average basis.
- Depreciation:
Depreciation is calculated on Net basis and it is provided for AFS and HFT category. The depreciation amount is either added or subtracted from the provision provided for depreciation. This part of the report also shows the depreciation till date and the depreciation for the previous financial year.
- Refinance Availed:
This column includes the various refinance options available and the amounts of refinance that can be availed by different refinance agents. This refinance amount depends upon the loans and services provided by the bank to different sectors for eg. depending upon the loans and services provided to the small and medium scale industries sector (SME), refinance can be availed by SIDBI. The refinance availed is available at a pre defined rate of interest. The amount from refinance is supposed to be used for banks asset liability miss match.
- Dealing of various securities:
The detail of various securities purchased/ sold in different categories like AFS, HTM, HFT, Non-SLR etc is provided in the report. It also includes the profit/ loss associated with sale of each security. The report also provides the holding price and the selling price associated with each security sold/ purchased. It also provides the yield of the corresponding deals. The report also gives category vise the total profit/ loss associated with the sales of securities.
- Dealings in Forex:
The report gives the details of the forex operations and the value of Indian Rupee in different currencies.
The report also compares the current performance of the treasury branch with the last year’s performance and it also gives the forecasted values of for the month.
Conclusion/ Recommendations
- The study gave me an overview of the functioning of a bank’s treasury. I learnt about the significance of a treasury department, the objective of a treasury department and its function in the new evolving banking sector. I also learnt about the risk management department and the various kinds of risks that a bank faces. I gained insight into the daily functioning of a treasury department.
- In addition to the above, I learnt the dynamics of debt markets in India. The reason for issue of securities by the government, the trend in the debt markets, the process of issuance of the various SLR securities etc. In addition I got an insight into the operations of the markets- the auctioning process, allotment of securities, the clearing process etc as well.
Overall the study project added to my knowledge about the banking sector considerably. The opportunities and insights I got from being a part of the bank’s activities and interacting with the personnel were immense.
The recommendations to UBI would be:
- Integration between the different departments. Because of this the paper work will reduce and it would also avoid multiple entry of same data or operation at different departments.
- The department was completely dependent on few employees for the some of its integral operations hence absence of such employees affects the treasury operations.
Bibliography
Stock Exchange, Investments and Derivatives- V Raghunathan & Prabina Raji B
Treasury Management- ICFAI
RBI Master Circulars
NSE Debt Modules
Treasury Manuals
UBI Treasury manual
Weblography