Treasury Decision

Group Assignment

Group Members

No. Name Student ID.

1 Mohammed Jahid Hasan Zim 111100081
2 Jahirul Islam 111100027
3 Biplob Hossain 102120528
4 Nowshin Tabassum Promi 111100052

Submitted to
Mr. Hamid

Submission Date
20th December, 2013
Q1 (1). Ans:
Definition of Bank Run:
A circumstance that arises when a large number of bank or the financial organization’s clients,
fearing that their bank will be unable to pay back their deposits in complete and on time.
Concurrently, effort to withdraw their funds immediately. As more people withdraw their funds,
the possibility of default rises, so encouraging more clients to withdraw their deposits. In
dangerous cases, the bank’s reserves might not be enough to cover the withdrawals. A bank run is
normally the consequences of panic, instead of a factual insolvency on the part of the bank. On the
other hand, th bank does risk default as more and more persons withdraws funds-what arose as
panic can be converted into a true default condition.

Also called a “run”

However, this problems might generate due to the banks keeps a small portion of deposits on hand
in cash, they give the deposits to the borrowers or use the funds to buy other interest-bearing assets
such as government securities. While a runs derives, a bank must hurriedly increase its cash to
fulfil depositors’ demands. If their concerns about the bank’s wealth are not pleased, in the
equivalent market zone of the other bank, will achieve from reusing funds they get back to the
bank facing the run.

Anyways, if the depositors’ afraid are acceptable and the bank is thriftily bankrupt, other banks
will be improbable to throw worthy money after bad by reutilizing their funds to the insolvent
bank. Consequently, the bank cannot fulfil its liquidity and will be obligatory into default. But, the
run would not have initiated the insolvency; relatively, the acknowledgement of the prevailing
insolvency caused the run.

Example of crisis:
 Argentinian banking crisis: on April19, 2002, the Argentine Government was forced to
order to the indefinite closure of all the country’s banks. Dropping GDP, high government
spending, widespread corruption, prevalent tax evasion, expanding unemployment rate,
high public debt had put up savers in financial difficulties. Consequently, investors
withdraw their money and invest in another countries which created tougher moment for
Argentinian banks and they fall in bankrupts.
 Example of crisis in1907: in1907, the stock market was lost which created a financial
crisis in America. However, the banks and trust companies suffered countless and
catastrophic run and the National Bank of North America collapsed.
 Example of Lehman brothers crisis: According to leh man brothers the 18th centuries
noticed 1 banking and financial crisis and the 19 another 18 including American banking
crisis in 1819 , 1837, 1847, 1857,1873, 1884,1890 and 1896. There were a heavy 33 such
storms in the 20th century leading among them the Wall Street smash of 1929and the
Japanese’s financial disorder of the 1990s. All changeable units have affected substantial
 suffering to depositor and hoarders. Bulk money under your mattress may not be such a
crazy notion after all.

Q1 (2). Ans:
The differences between liquidity and solvency:

Liquidity
 Liquidity represents the capacity to
accomplish all payment obligations
as and when they fall due. Liquidity
connects to the flows of cash only.
 Not being able to perform leads to a
conditions of illiquidity.
 Liquidity is a vital because it provide
to take advantages of opportunities as
they arise, for new products,
acquisitions and timely investment.
 A liquidity crisis happens when a
company has a temporary cash flow
problems. Its asset is larger than its
debt, but some are illiquid which
cannot be sold within a short period
of time but its need long time to make
it liquidity.
 Liquidity: to have ability to meet
current liabilities with current asset.
Solvency
 Solvency indicates the company’s
ability to repay their debts. Solvency
is related to both long and short term
assets and liabilities.
 If a company is able to pay off all
their debts when they come due, they
are considered to be solvent. If an
entity is unable to pay back their
debts is considered insolvent.
 A solvency crisis arises while the
company becomes incapable of
paying back its debt. Even though, it
sold all asset but it cannot reach their
target to repay debts.
 Solvency: to have sufficient assets to
cover its liabilities.

However, Liquidity is the most important: Liquidity is the most important to operate a various
types of projects. If the company has enough liquidity, then they can do their transaction very well
and they will not fall in insolvency problems.
Q1 (3a). Ans:
The cash management model:
The purpose of cash management model is to make sure that cash does not exist indolent
unreasonably and the company does not face of cash shortage.

Models categories in two sections such as:

Firstly, Inventory type models and
Secondly, Stochastic models.

However, the important factor is to make sure a company’s wealth and financial steadiness. The
treasurers or companies managers are accountable to operate cash management.

Q1 (4). Ans:
Various Type of Risks:
 Bank loan risks
There are many risks associated with bank loans, both for the bank and for those who receive
the loans. Loan risks can be divided into two-

 Depositor's Risks

Depositors of banks have several risks. Most significantly, the depositor is worried about
credit risk if the bank fails, the depositor always think about if he will be able to get back
the money he put in. Other risks that depositors worry about the risk that banks won't pay
out interest, or won't pay out high enough interest rates.

 Borrower's Risks

Like depositor’s borrower has some risks Firstly, the borrower get a loan for a reason, and
if he borrows logically and want to invest in any project he need to make sure that the
return on investment is higher than the cost of borrowed. This means that the borrower has
risk that the return on the investment will be too low and the costs of the loan too high, The
borrower faces other risks (credit risk associated with the investment, for instance),.but The
biggest risk for a borrower is that something will go wrong with the investment and he
won't be able to pay back the loan.

 Credit risks
 The credit risk associated with some factors. It depends on exogenous factors (ie, "outside" of
the state of the economic environment, market conditions) and endogenous factors (the
"internal market conditions, environment). In theory, credit risk, can be distinguish between
individual credit risk and credit risk across all portfolios. Individual credit risk is the probability
of incurring losses on bank default by a borrower of a specific agreement. Credit risk is a credit
transaction - the objective-subjective economic category associated with that the borrower
cannot fulfill its obligations to the bank to repay the debt under the terms of the loan agreement,
and at the same bank cannot be promptly and fully take advantage of providing a loan to cover
possible losses from it. The source of this credit risk is the individual specific counterparty
bank - borrower, debtor. Portfolio risk might be occur because of giving more loan on a
combine projects that has higher risks.

 Maturity Risk

Maturity risk is not borrower-specific. Since it relates to time, the time your money is
committed for, it is not diversifiable. Interest rates are expressed in annual terms, and maturity
risk is a function of time. Maturity risk is really an opportunity risk because the longer we
commit your money for, the greater is the likelihood that there will be an opportunity to invest
we money at a higher rate, except that the money has already been committed. It applies to
loans with a term longer than one year. The maturity premium increases the longer the term of
the loan.

Consider this example. Suppose we agreed to lend $1,000 for five years. We would agree on a
rate and complete the transaction. Now suppose, two years into the term of the first loan,
another associate offers you a better deal. Because the first loan used up the available money,
we cannot take advantage of the new deal. The maturity premium provides the lender with at
least some reward for the risk of missed opportunities. For this reason, the longer the loan
contract, the higher the maturity premium. This is the principal reason that long-term interest
rates are generally higher than short-term interest rates.

Q1 (5). Ans:
Types of Interest Instruments:
There are two types of interest instruments which varies in case of amount of fund received by the
borrowers at beginning and paid on maturity. Those are:

 Interest-bearing Instruments and

 Discount Instruments
 1. Interest-bearing Instruments: It gives lower yield than discount instruments and also
considered to be not better for investment as the borrower have to pay more on maturity.
But it is better for banks and loan providers.

For example, if Ahmad purchase a 1 year loan of RM100 at 8.0% interest rate. Considering
interest-bearing instruments, he will receive RM100.00 at the beginning and will have to
pay RM108.00 on maturity which is slightly larger than discount instruments.

2. Discount Instruments: It gives a higher yield to the borrower, so better for borrowers to
do investment using discount instruments. But it is not better for banks and loan providers
as it pays lower amount of money to them on maturity.

For example, in Ahmad’s case, considering discount instruments, he will receive RM92.00
at beginning, but have to pay only RM100.00 on maturity which is lower than interest-
bearing instruments.

Q2 (4). Ans:
Explain how central bank can use repo market to conduct its monetary policy?

In repo transactions, securities are exchanged for cash with an agreement to repurchase the
securities at a future date. The securities serve as collateral for what is effectively a cash loan and,
conversely, the cash serves as collateral for a securities loan. There are several types of transactions
with essentially equivalent economic functions - standard repurchase agreements, sell/buy-backs
and securities lending - that are defined as repos for the purposes of the report. A key distinguishing
feature of repos is that they can be used either to obtain funds or to obtain securities. This latter
feature is valuable to market participants because it allows them to obtain the securities they need
to meet other contractual obligations, such as to make delivery for a futures contract. In addition,
repos can be used for leverage, to fund long positions in securities and to fund short positions for
hedging interest rate risks. As repos are short-maturity collateralized instruments, repo markets
have strong linkages with securities markets, derivatives markets and other short-term markets
such as interbank and money markets.

Repos are useful to central banks both as a monetary policy instrument and as a source of
information on market expectations. Repos are attractive as a monetary policy instrument because
they carry a low credit risk while serving as a flexible instrument for liquidity management. In
addition, they can serve as an effective mechanism for motioning the stance of monetary policy.
Repos have been widely used as a monetary policy instrument among European central banks and
with the start of EMU in January 1999, the Euro system adopted repos as a key instrument. Repo
markets can also provide central banks with information on very short-term interest rate
expectations that is relatively accurate since the credit risk premium in repo rates is typically small.
In this respect, they complement information on expectations over a longer horizon derived from
securities with longer maturities.
A number of features are important for sound and efficient repo markets:
1. An adequate and efficient legal framework.
2. Secure and efficient settlement systems.
3. Appropriate haircuts and margin call practices.
4. Adequate transparency.

Q2 (5). Ans:

a) Call Money
Call/Notice money is the money borrowed or lent on demand for a very short period. When money
is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays are
excluded for this purpose. Thus money borrowed on a day and repaid on the next working day,
"Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice
Money". No collateral security is required to cover these transactions.

The call/notice money market forms an important segment in Money Market. Under call money
market, funds are transacted on overnight basis and under notice money market; funds are
transacted for the period between 2 days and 14 days. The most active segment of the money
market has been the call money market, where the day to day imbalances in the funds position of
scheduled commercial banks are eased out.

Participants in call/notice money market currently include banks and Primary dealers both as
borrowers and lenders. Non-Bank institutions are not permitted in the call/notice money market.
The regulator has prescribed limits on the banks and primary dealers operation in the call/notice
money market.

Call money market is for very short term funds, known as money on call. The rate at which funds
are borrowed in this market is called `Call Money rate'. The size of the market for these funds in
India is between Rs 60,000 million to Rs 70,000 million, of which public sector banks account for
80% of borrowings and foreign banks/private sector banks account for the balance 20%. Non-bank
financial institutions like IDBI, LIC, and GIC etc. participate only as lenders in this market. 80%
of the requirement of call money funds is met by the nonbank participants and 20% from the
banking system.

Call markets represent the most active segment of the money 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.

b) Treasury bills
Short-term debt instrument backed by the U.S. government with a maturity of less than one year.
Short term promissory notes issued US government to finance shot term funds.T-bills are sold in
denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities
of one month, three months six months.

T-bills are issued through a competitive bidding process at a discount from par, which means that
rather than paying fixed interest payments like conventional bonds, the appreciation of the bond
provides the return to the holder.

• Characteristics of T-bills
– Sold on discount basis.
– Maturities up to one year.

– Minimum denomination is usually $10,000, but smaller investors can invest in

multiples of $1,000 through the Treasury Direct Program offered by the Fed.
– Lowest interest rate of all MM securities is the 3-month T-Bill

– T-bills are sold through an auction process using both competitive and
noncompetitive bids.
– Low risks

c) Certificate of Deposit
A bank-issued security that documents a deposit and specifies the interest rate and the maturity
date. Actually it is short term debt instrument issued by bank which has following features-
1. Denominations range from $100,000 to $10 million
2. Large denomination time deposit, less than six month's maturity.
3. Negotiable - may be sold and traded before maturity.
4. Issued at face value with coupon rate.
5. Interest computed on a 360 day year.
6. Primary market sales have CDs of denominations of at least $100,000.
7. Deals in secondary market.

8. Interest rates on CDs are higher than on T-Bills - higher credit risk, lower marketability and
higher taxability

Q3 (1). Ans:
Anadarko Petroleum is an American company, does trading of oil and gas, gets payment for export
in each month in the form of British Pound currency. Expecting the depreciation of British pound
against the USD, it tends to forego for currency futures contracts and thus hedge against exchange
rate risk.

Process of Trading through Currency Futures Contracts:

 Anadarko Petroleum needs to open a margin account with the brokers to trade foreign
currency through futures contract.
 Anadarko Petroleum then needs to pay a deposit (initial margin) to the brokers first, which
is a fixed amount per contract equal to 10% and 20% per contract.
 Then Anadarko’s position will be tracked on a daily basis so that whenever his (exchange)
account makes a loss for the day, Anadarko will receive a margin call (or variation margin),
requiring the company to pay the losses.
 During purchasing the future contracts, Anadarko must look into particular specifications
such as the size of the contract, the minimum price increment and the corresponding tick
value.
 The expiry date of the contract depends on the contract signed, it can be 30 days or even
90 days.
 Currency futures contracts can be traded through a centralized order book provided by the
brokers or an order placement at their online trading service.

While Anadarko expects depreciation of British Pound in future, it may use currency futures
contracts to hedge against currency risk. The processes are the following:
Process of ‘locking-in’ and hedging using Currency Futures Contracts:

 If the current exchange rate of British Pound against US Dollar is favorable to Anadarko
today, it may ‘lock-in’ the exchange rate for favorable payment in the upcoming months.
 If there is a profit, it will be directly delivered to Anadarko’s account, but if there is a loss
in a day prior to the expiry date, the broker company will recover the losses for Anadarko
and help it to gain additional amount of British Pound in the upcoming next months

Advantages of Hedging using Currency Futures Contract

 Futures are geared products, which means currency traders do not have to deposit cash to
cover the full value of the position, only a minimum upfront deposit is enough.

 Futures allow traders i.e. Anadarko to take a view on the movement of the currency futures
rate and provide them with access to favorable rates usually reserved for larger corporate
clients.

 Tight spreads and low currency trading costs allow clients currency futures traders to enter
and exit positions depending on the profit or loss each time on the trading.

 Anadarko can dynamically hedge its currency risk far more efficiently using futures due to
the ease of entering and exiting futures positions and the low cost per trade.
 The presence of dedicated market makers ensures market liquidity of the currency futures
trading.

 The daily mark-to-market process allows clients i.e. Anadarko the ability to track their
profit or loss situation and to adjust their portfolio accordingly.
 Anadarko can receive daily statements showing your margin and cash movement
 Once the contract is signed out and sold, it can again be purchased before the expiry date
ends.

Disadvantages and Limitations of Hedging using Currency Futures Contract

 Legal Obligation: The futures contract is a legal obligation rather than options contract,
and Anadarko like traders will be obliged to either buy or sell the foreign currency on this
contract before or at the expiry date.
 Standardized features: As there are some associated features in the futures contract such
as contract size, expiry date etc., perfect hedging may be impossible. Since over-hedging
is also not advisable, some part of the spot transaction will have to go unhedged.
 Initial and delay variation margins: The initial and daily margin may cost Anadarko like
traders to face a cash flow burden since initial margin only will be paid back, when the
contact is closed and daily margin will be added depending on losses occurred.
  Forego favourable movements: In hedging suing futures contract, profit or losses are to
be hedged by either selling the futures or going for favourable movements.
 Risks: Each currency future trade is unique and comes with its own associated risks,
including

 volatility,
 exchange rate risk,
 credit risk,
 monetary risk,
 interest rate risk, and
 the possibility of government intervention in the financial markets.

Currency future trading requires a high appetite for risk, time to watch the markets and an
expert knowledge of the currency markets and associated trading process.

Q3 (2). Ans:

However, if Anadarko wants to do trading through foreign currency options, it needs to follow the
following process:

Process of trading through Foreign Currency Options:

 Anadarko has to pay an up-front premium, which also goes as a compensation to the seller
of the currency as the seller is giving right, not obligation to the buyer.
 Anadarko then become the buyer or holder of an option and acquires the right to do trading
through either call or put options, to exchange specific amount of a specific currency at the
agreed strike price.
 Against this right, the seller has then an obligation to deliver the British pounds when the
option is exercised by Anadarko.

Options are mainly suited to companies with contingent cash flows from overseas project, like
Anadarko’s export trading which may involve foreign exchange risk. If Anadarko wants to hedge
against credit risk using the foreign currency options, they need to follow the steps below:

Process of ‘Locking-in’ and ‘Hedging’ using Foreign Currency Options:

 In hedging with options, Anadarko can use call options, if the risk is an upward trend in
price and use put options if the risk is a downward trend in price.
  Since the British pound is expected to be depreciating, Anadarko would need to buy put
options on British pound.
 If British pound were to actually depreciate by the time Anadarko receives British pound
revenue, then Anadarko would have to exercise its right and exchange pounds at the higher
exercise rate.

Therefore the options market allows traders to enjoy unlimited favorable movements while
limiting losses.

However, an option market plays similar role of an insurance market, where one bidder pays
premium to hedge against the risk from foreign currency trading and other bidders or companies
in the market enjoy potential benefits; and if there is no loss, the company has to lose the premium
paid. The seller plays here the role of an insurance company.

Advantages of Hedging using Options

The advantages of options over forward sand futures are basically the limited downside risk and
the flexibility and variety of strategies possible. Also in options there is neither initial margin nor
daily variation margin since the position is not marked to market. This could potentially provide
significant cash flow relief to traders.

Disadvantages and Limitations of Hedging using Options

 Because options are much more flexible compared to forwards or futures, they are thus
more expensive. The price is therefore a disadvantage.
 In case of hedging with options, if the foreign currency depreciates, the bidder i.e.
Anadarko has to practice its rights and make profits from favorable movement of the
exchange rate, whereas in case of hedging with futures and forwards, the firm would
automatically placed in a speculative position in the event of unsuccessful bidding, with no
limit to its downside losses.
Group Assignment 2

Main Factors that Influence Exchange Rates

1. Inflation

Inflation rate has great effects on exchange rate. Suppose if inflation in the UK is relatively lower
than elsewhere, then UK exports will become more competitive and there will be an increase in
demand for Pound to buy UK goods. Also foreign goods will be less competitive and so UK
citizens will buy less import. Therefore countries with lower inflation rates tend to see
an appreciation in the value of their currency.

2. Interest Rates

Interest rate is also responsible for affecting exchange rate.If UK interest rates rise relative to
elsewhere, it will become more attractive to deposit money in the UK. You will get a better rate
of return from saving in UK banks, Therefore demand for pound will rise. This is known as “hot
money flows” and is an important short run factor in determining the value of a currency. Higher
interest rates cause an appreciation and lower interest rate causes depreciation.

3. Speculation

If speculators believe the pound will rise in the future, they will demand more now to be able to
make a profit. This increase in demand will cause the value to rise. Therefore movements in the
exchange rate do not always reflect economic fundamentals, but are often driven by the sentiments
of the financial markets. For example, if markets see news which makes an interest rate increase
more likely, the value of the pound will probably rise.

4. Change in Competitiveness

If UK goods become more attractive and competitive this will also cause the value of the Exchange
Rate to rise. This is important for determining the long run value of the Pound.

5. Relative strength of other currencies

In 2010 and 2011, the value of the Japanese Yen and Swiss Franc rose because markets were
worried about all the other major economies – US and EU. Therefore, despite low interest rates
and low growth in Japan, the Yen kept appreciating.

6. Government Debt
Under some circumstances, the value of government debt can influence the exchange rate. If
markets fear a government may default on its debt, then investors will sell their bonds causing a
fall in the value of the exchange rate. For example, Iceland debt problems in 2008, caused a rapid
fall in the value of the Icelandic currency.

For example, if markets feared the US would default on its debt, foreign investors would sell their
holdings of US bonds. This would cause a fall in the value of the dollar.

7. Employment Outlook
Employment levels have an immediate impact on economic growth. As unemployment increases,
consumer spending falls because jobless workers have less money to spend on non-essentials.
Those still employed worry for the future and also tend to reduce spending and save more of their
income. An increase in unemployment signals a slowdown in the economy and possible
devaluation of a country's currency because of declining confidence and lower demand

8. Trade Balance
A country's balance of trade is the total value of its exports, minus the total value of its imports. If
this number is positive, the country is said to have a favorable balance of trade. If the difference is
negative, the country has a trade gap, or trade deficit. Trade balance impacts supply and demand
for a currency. When a country has a trade surplus, demand for its currency increases because
foreign buyers must exchange more of their home currency in order to buy its goods. A trade
deficit, on the other hand, increases the supply of a country’s currency and could lead to
devaluation if supply greatly exceeds demand.