T R E A S U R Y C R A S H C O U R S E. By Jawwad Ahmed Farid

Transcription

1 By Jawwad Ahmed Farid

2 CONTENTS WHAT IS A TREASURY? Treasury The Money Market desk The FX Desk The Equity Desk The Specialized Desks What do treasuries really do? How is a corporate treasury different from a bank treasury? THE TREASURY FUNCTION Trade Flows (FX desk) The Treasury Function Operations i. Introduction ii. Front Office Function a. User Roles b. Money Market Desk Activities c. Foreign Exchange Desk Activities d. Capital Market (CM) Desk Activities iii. Middle Office Function a. User Roles b. Activities iv. Back Office Function a. User Roles b. Activities c. Basic Treasury Back Office Tasks Related Terminologies i. Four eyes a. Ticket Approval b. Ticket Verification c. Ticket Authorization ii. Confirmation a. Society for Worldwide Interbank Financial Telecommunication (SWIFT) iii. Settlement a. Delivery versus payment (DVP) iv. Reconciliation a. Broker Reconciliation b. Securities Reconciliation v. Accounting vi. Price discovery vii. Proprietary Trading viii. Treasury Risks a. Credit Risk b. Market Risk c. Operational Risk Treasury Markets i. Foreign Exchange Market a. FX Ready/ Forward/ Split b. FX Swap c. FX Placements/ Borrowings d. FX Miscellaneous e. FX TMU Import/ Export/ Remittance/ Encashment f. FX TMU Foreign Bill Purchase (Bill Discounting) Page 3 of 230

3 g. FX TMU Close Out/ Take Up ii. Fixed Income /Money Market a. Call/ Clean/ Placements b. Repo/ Reverse Repo c. Sale against Reverse Repo (SARR) d. Outright purchase/ sale e. Inter branch iii. Capital Market a. Outright Sale/ Purchase -Ready Equity CROSS SELLING TREASURY PRODUCTS Five core themes for treasury customer discussions Price Risk or Volatility Value Models Relative Value Products Limits Wrap- up and overview Core Treasury products and TMU customer reactions Core Treasury Products TMU Customer Reactions Payoff profile Answers for customers reactions DERIVATIVES TERMINOLOGY The Terminology Crash Course i. Forward Contracts a. The Investment Bank Intern ii. Futures Contracts iii. Options a. Maturities and Exercise date vi. Payoff Profiles v. The Payoff profile for a forward contract vi. Payoff profiles for Calls and Puts vii. Building Blocks and Synthetic Configurations a. Comparing a Call with a Forward contract b. Comparing a Call and a Put with a Forward contract c. Combining a long call with a short put to create a long forward PRODUCTS & PRICING A Second Look at Derivative Contracts Standard Template for Evaluating Derivatives Options i. Option Price a. European option price b. American Option Price Forward Contracts i. Forward Price Futures Contracts i. Futures Price Swaps i. Interest Rate Swap (IRS) ii. Currency Swap Page 4 of 230

4 PRODUCT VARIATIONS Options i. Stock Options ii. Foreign Currency Options iii. Index Options iv. Futures Options v. Warrants vi. Employee Stock Options vii. Convertibles viii. Interest Rate Options a. Bond Options b. Interest Rate Caps/ Floors/ Collars c. European Swap Options ix. Exotic Options a. Bermuda Option b. Quanto Option c. Composite Option d. Digital or Binary or All or nothing options e. Barrier Options f. Asian Options g. Average Strike Options h. Look back Options i. Compound Options j. Chooser (As you like it) Options k. Exchange Options l. Forward Start Options m. Basket Options n. Shout Options Forwards i. Synthetic Forward Contract ii. Forward Rate Agreement (FRA) Futures i. Stock Index Futures ii. Futures Contracts on Currencies iii. Futures Contracts on Commodities iv. Interest Rate Futures a. Treasury Bond Futures b. Treasury Note Futures c. 5-year Treasury Note Futures d. Treasury Bill Futures e. Eurodollar Futures Swaps i. Fixed for fixed currency swap ii. Floating for floating currency swap iii. Cross-currency interest rate swap iv. Step-up Swaps v. Amortizing Swaps vi. Basis Rate Swap vii. Forward or Deferred Swaps viii. Compounding Swaps ix. LIBOR-in- Arrears Swap x. Constant Maturity Swap Page 5 of 230

5 xi. Constant Maturity Treasury Swap xii. Differential Swap or Quanto xiii. Variance or Volatility Swap xiv. Equity Swap xv. Commodity Swap xvi. Asset Swap xvii. Accrual Swap xviii. Cancellable Swap xix. Extendable Swap ADVANCED PRODUCTS Structured Products i. Cross Currency Swaps ii. Participating Forwards iii. Equity Linked Notes iv. Capital Protected / Capital Guaranteed Notes v. Commodity Linked Notes vi. Range Accruals vii. Switchable viii. IRD (Interest Rate Differential) Trades a. Swap basis b. Note basis c. Quanto d. Cumulative Cap e. Steepener/ Flattener Note f. Inverted Curve Instrument g. Ranges Credit products i. Credit Default Swaps ii. Total Return Swaps iii. Collateralized Debt Obligation (CDO) CALCULATING FORWARD PRICES AND FORWARD RATES IN EXCEL Introduction How to calculate the forward price of security Forward Price of a security with no income Forward Price of a security with known cash income Forward Price of a security with known dividend yield How to determine Spot Rates and Forward Rates & Yield to Maturity How to determine Forward Rates from Spot Rates How to determine Spot Rates from Forward Rates How to calculate the Yield to Maturity (YTM) of a bond Trial and error process EXCEL s Goal Seek How to calculate the values of Forward Rate Agreements (FRA) Value of an FRA (zero coupon rate calculated on a discrete basis) Value of an FRA (zero coupon rate calculated on a continuously compounded basis) How to calculate Forward Exchange Rates Interest Rates compounded on a discrete basis Interest Rates compounded on a continuous basis How to calculate the value of a forward contract Value of a long forward contract (continuous) Page 6 of 230

6 Value of a long forward contract (discrete) Value of a long forward contract (continuous) which provides a known income Value of a long forward contract (continuous) which provides a known yield Value of a forward foreign currency contract OTHER TREASURY FORMULAS Cost of deposit ASSET LIABILITY MANAGEMENT Introduction i. Interest Rate Risk ii. Liquidity Risk Duration and Convexity i. Duration a. Macaulay Duration b. Modified Duration iii. Convexity a. Impact of convexity b. Modified, Effective, Positive, Negative c. Convexity in Asset Liability Management ALM Risk Measurement Tools i. Fall in Market Value of Equity ii. Earnings at Risk iii. Cost to Close iv. Rate Sensitive Gap v. Price Sensitive Gap vi. Liquidity Gap vii. Net Interest Income (NII) at Risk viii. Duration Gap Analysis Applications i. Bank a. Duration matching/ immunization ii. Pension Funds and Insurance a. Portfolio dedication LIQUIDITY MANAGEMENT Liquidity Ratios and Analysis a. Current Ratio b. Quick Ratio c. Unused lines of credit d. Borrowing/ Debt-to-Equity Ratio e. Net Working Capital Ratio f. Loan-to-Deposit Ratio g. Loan- to- Asset Ratio Liquidity Management i. Contingency Funding Plan a. General requirements for a liquidity contingency plan b. Specific requirements for a liquidity contingency plan ii. Liquidity enhancement tactics a. For Systemic Crisis b. For company specific crisis SETTING LIMITS Risk Limits and Control Process Page 7 of 230

7 i. Operational (Exception or Management Action) Limits ii. Capital Loss & Stop Loss Limits iii. Inventory Age Limits iv. Concentration Limits v. Transaction Limits vi. Exposure and Sensitivity Limits vii. Pre Settlement Risk (PSR) and Potential Future Exposure (PFE) Limits viii. Hierarchy of Limits A More Detailed Look at Limits i. Capital Loss and Stop Loss Limits ii. Value-at-Risk Limits iii. Regulatory Approach Limits iv. Other Limits a. Duration Limits b. Convexity Limits c. PVBP Limits v. Credit Risk Limits a. PSR Limits b. Settlement Risk Limits c. Financial Institution (FI)/ Counterparty Limits d. Regulatory Limits e. Internal / Concentration Limits vi. Application to Products vii. Setting Limits for Liquidity Risk a. Cash flow mismatch or gap limits b. Maturity Limits c. Target Liquid Reserves d. Concentration Limits e. Contingent liability limit f. Review ix. Setting Limits for Interest Rate Risk Repricing limits x. Limit Breach, Exception processing, Action Plan for Trigger Zones a. Exception Handling b. Example of an Action Plan for Trigger Zones TREASURY PROFITABILITY Treasury Profitability - Foreign Exchange Desk Treasury Profitability Capital Market (Equity (EQ)) Desk ANNEXURE A- CALCULATING VALUE AT RISK Introduction VaR Methods a. Variance Covariance Approach b. Historical Simulation Method c. Monte Carlo Simulation d. Quick Review e. Implementing VaR Methodology i. Setting the Scene Sample Portfolio ii. Preliminary steps iii. VaR Approach Specific Steps a. Variance-Covariance (VCV) VaR Page 8 of 230

8 b. Determining Historical Simulation daily VaR iv. Scaling of the daily VaR Caveats, Qualifications, Limitations and Issues ANNEXURE B: BUILDING MATURITY & LIQUIDITY PROFILES FOR DEPOSITS AND ADVANCES FOR ALCO, LIQUIDITY COVERAGE & ICAAP REPORTING Lesson Zero: Introduction and Course Overview Bank Deposit & Asset Maturity profiles for ALM - Objectives Advances and Deposits Maturity & Liquidity Profile - Methodology & Sample output Step 1: The Core Banking Dump Step 2: Pre-processing the data and adding intelligence for the purpose of building a pivot table. 189 Step 3: Creating the ivot Table and Generating Presentation Graphs using Pivot Charts Lesson One: Preparing the Core Banking Dataset Extracting Relevant Data The DTM (Days to Maturity) formula Lesson Two: Adding Intelligence for the Pivot Table Deposit Size Bracket Maturity Bucket Bracket Cost of Deposits Bracket Lesson Three: Creating the Pivot Table Lesson Four: Reading the PivotTable and PivotChart Lesson Five: Quick Review & Extending the framework Lesson Six: Pivot Shoot Out- Pivot Tables and Pivot Charts Galore Lesson Seven: The Pivot Chart Shoot out for Advances Maturity Profile Bucket Advances Size Bucket Pivot Table and Chart Variations Lesson 8: Wrap up and building the ALM profile for the banking book BIBLIOGRAPHY LIST OF FIGURES DISCLAIMER Page 9 of 230

9 BIBLIOGRAPHY Options, Futures and Other Derivatives, John C. Hull, 7th Edition, Prentice Hall, 2009 The Handbook of Fixed Income Securities, Frank J. Fabozzi, 7th Edition, McGraw-Hill, 2005 Risk Management and Financial Institutions, John C. Hull, Low Price Edition, Pearson Education, Inc., 2007 Exotic Equity Derivatives Manual, Salomon Smith Barney, August 1998 Understanding Market, Credit and Operational Risk- The Value at Risk Approach, Linda Allen, Jacob Boudoukh and Anthony Saunders, Blackwell Publishing, 2004 Beyond Value at Risk, The New Science of Risk Management, Kevin Dowd, John Wiley & Sons, 1998 Higher-Order Simulations: Strategic Investment Under Model-Induced Price Patterns, Gilbert Peffer and Bàrbara Llacay, Journal of Artificial Societies and Social Simulation vol. 10, no. 2, 6 < VaR Applications: Setting VaR-based Limits, Carlos Blanco and Sally Blomstrom, Financial Engineering Associates, Inc., May 1999 Commonly Used Market Risk Limits, Guidelines on Risk Management of Derivatives and other traded instruments, Annex D Quantitative Finance, Second Edition, Paul Wilmott, John Wiley&Sons, Ltd., 2006 Liquidity Risk Management, Leonard M. Martz, 2007 Back Office and Beyond- A guide to procedures, settlements and risk in financial markets, Mervin J. King, Harriman House Ltd., 1999 Mastering Treasury Office Operations- Denis Nolan & Gordon Amos, FT Prentice Hall, 2001 Valuation of interest-sensitive financial instruments, Babbel David F., SOA Monograph M-FI196-1, 1996 Page 225 of 230

10 LIST OF FIGURES Figure 1: Treasury Desks Figure 2: Money Market Desk Figure 3: FX Desk Figure 4: Equity Desk Figure 5: Specialized Desks Figure 6: Flow chart for Treasury Function Figure 7: Foreign Currency Asset and Liability balances import functionality on a Treasury system Figure 8: Foreign Currency Asset and Liability balances input screen on a Treasury system Figure 9: Day Start and End functionality on a Treasury system Figure 10: Five core themes for approaching TMU customers Figure 11: WTI price graph Figure 12: Price and trailing volatility for WTI Figure 13: Gold Price Model Actual and Simulated Prices Figure 14: Gold WTI Ratio Figure 15: Gold-WTI with USD/CHF Figure 16: Product wise payoffs Figure 17: Potential Future Exposure over life of contract Figure 18: Core Treasury Products and Exposure Estimation Figure 19: Difference between FX Forward Sale and Purchase contract and Bill Discounting Figure 20: TMU customer reactions Figure 21: Payoff Profile Tool Figure 22: Pay off profile for a long forward contract Figure 23: Payoff profile for a long call option Figure 24: Treasury strategies and structures Figure 25: Pay off profile for a short call option Figure 26: Payoff profile for a combination of a short call and long call Figure 27: Payoff profiles for forwards & futures contracts Figure 28: Payoff profiles for option contracts Figure 29: Quadrant IV - Payoff profiles for a long forward contract Figure 30: Payoff profile for a long forward contract Figure 31: Payoff profile for underlying security Figure 32: Payoff profile for the holder of a call option Figure 33: Payoff profile for the writer of a call option Figure 34: Payoff profile for the holder of a put option Figure 35: Payoff profile for the writer of a put option Figure 36: Building blocks for synthetic configurations Figure 37: Synthetic forward contract creations Figure 38: Comparative payoff profiles for calls & forwards Figure 39: Comparative payoff profiles for calls, puts & forwards Figure 40: Payoff profile for a synthetic long forward Figure 41: Revised payoff profile for a synthetic long forward Figure 42: Template for evaluating derivatives Figure 43: Comparative look at derivatives Figure 44: Payoff to the buyer & seller of a call option Figure 45: Payoff to the buyer & seller of a put option Figure 46: Binomial tree - prices of the underlying asset Figure 47: Using a Binomial tree to calculate the price of an American Call Option Figure 48: Payoffs for the buyer & seller of a forward contract Figure 49: Plain Vanilla Interest Rate Swap Figure 50: Interest Rate Cap Figure 51: Interest Rate Floor Figure 52: Sample trade ticket for a Cap/ Floor Figure 53: Sample term sheet for a double barrier Figure 54: Sample term sheet for a look back swap Figure 55: Sample term sheet for a basket option Figure 56: Payoffs for the buyer of a call & seller of a put i.e. of a synthetic forward contract Figure 57: Sample term sheet for an amortizing swap Figure 58: Sample term sheet for a variance swap Figure 59: Term sheet for an Equity Linked Note Figure 60: Key elements of a Capital Protected Note term sheet Figure 61: Term sheet for a Commodity Linked Note Figure 62: Term sheet for a Range Accrual Option Figure 63: Sample Trade Tickets for Switchables Figure 64: Sample Trade Ticket for an IRD swap Figure 65: Sample Trade Ticket for an IRD note Figure 66: Sample Trade Ticket for a Quanto Figure 67: Sample Term Sheet for a Cumulative Cap Figure 68: Sample Trade Tickets for Steepener Notes Figure 69: Sample Trade Ticket for an inverted curve instrument Page 226 of 230

11 Figure 70: Sample Trade Ticket for a single range step up Figure 71: Sample Trade Ticket for a tiered range Figure 72: Sample Trade Ticket for a range note Figure 73: Structure of a Credit Default Swap Figure 74: Sample Term Sheet for a Credit Default Swap Figure 75: Structure of a Total Return Swap Figure 76: Sample Term sheet of a Total Return Swap Figure 77: Sample Term sheet of a Collateralized Debt Obligation Figure 78: Forward price of a security with no income Figure 79: Forward price of a security with known cash income Figure 80: Forward price of a security with known dividend yield Figure 81: Spot Rates and Forward Rates time line Figure 82: Deriving forward rates from spot rates Figure 83: Deriving spot rates from forward rates method Figure 84: Calculating accumulation factors Figure 85: Deriving spot rates from forward rates method Figure 86: Iterations for determining YTM using the trial and error process Figure 87: Determining YTM using EXCEL s Goal Seek functionality setting up the input and out cells Figure 88: Determining YTM using EXCEL s Goal Seek functionality selecting the Goal Seek function Figure 89: Determining YTM using EXCEL s Goal Seek functionality defining the values in the Goal Seek pop-up window Figure 90: Determining YTM using EXCEL s Goal Seek functionality solving for the YTM Figure 91: Value of an FRA (zero coupon rate calculated on a discrete basis) Figure 92: Value of an FRA (zero coupon rate calculated on a continuous basis) Figure 93: FX rates (interest rates compounded on a discrete basis) Figure 94: FX rates (interest rates compounded on a continuous basis) Figure 95: Value of a long forward contract (continuous) Figure 96: Value of a long forward contract (discrete) Figure 97: Value of a long forward contract (continuous) which provides a known income Figure 98: Value of a long forward contract (continuous) which provides a known yield Figure 99: Value of a long forward foreign currency contract Figure 100: Price-yield relationship Figure 101: Impact of convexity Figure 102: PKRV rates Figure 103: Calculated return series Figure 104: Days to maturity/ reset Figure 105: Weights of each asset/ liability Figure 106: Weighted average return series Figure 107: Daily volatility and holding VaR Figure 108: Weighted average YTM for each asset in the fixed income bond category Figure 109: Weighted average YTM for assets Figure 110: Holding VaR, YTM and Rate Shocks for Asset and Liability Figure 111: Weighted average Duration for each asset in the fixed income bond category Figure 112: Weighted average Duration for interest sensitive assets Figure 113: Fall in Market Value of Equity Figure 114: PKRV rates Figure 115: Calculated return series Figure 116: Sample on and off balance sheet item Figure 117: Expected Cash flow and Days to Maturity Figure 118: Expected Cash flows slotted into rate buckets as per their DTM Figure 119: Calculation of weights for each sub-bucket Figure 120: Weighted average return series Figure 121: Rate VaR Figure 122: Weighted average base rate Figure 123: Weighted average DTM Figure 124: On-balance sheet and cumulative gaps Figure 125: Earning at Risk Figure 126: Buckets definition Figure 127: Determination of future instalments due and time to receipt/ payment Figure 128: Slotting cash flows into appropriate buckets based on time to receipt/ payment Figure 129: Cost to close Figure 130: Rate Sensitive Gap Figure 131: Term sheet for coupon bearing instrument Figure 132: Limit monitoring and review process Figure 133: Risk reporting process Figure 134: Capital Loss calculation example Figure 135: Allocation of actual stop loss limits by lines of investment Figure 136: Example of slippage Figure 137: Odds, Confidence Levels & Limits Figure 138: Example - Setting VaR limits for sub portfolios Figure 139: Determination of multiple for setting an upper bound on VaR limit Figure 140: Setting Duration & Convexity limits Figure 141: Setting PVBP limits Figure 142: Limits applicable to Money Market Products Page 227 of 230

12 Figure 143: Limits applicable to Capital Market Products Figure 144: Limits applicable to Foreign Exchange Products Figure 145: Types of FX Deals Figure 146: Components of FX Transactions Figure 147: Treatment of FX Swap Figure 148: Currency Convention Figure 149: Example 1 Single Currency Buy Figure 150: Example 2 Cross Currency Buy Figure 151: Types of EQ Trades Figure 152: EQ Inventory Figure 153: Realized Gain/ Loss on AFS transaction Figure 154: Realized Gain/ Loss on HFT transaction Figure 155: Unrealized Gain/ Loss on AFS transaction Figure 156: Unrealized Gain/ Loss on HFT transaction Figure 157: Dividend Income Figure 158: Dividend Income Figure 159: Treasury EQ Profitability Figure 160: Value at Risk Figure 161: Distribution of returns Figure 162: Variance Co-variance Approach Figure 163: Historical Simulation Method Figure 164: Monte Carlo Simulation Method Figure 165: Comparison of VaR Methods Figure 166: Daily time series data Figure 167: Interpolated Interest Rates Figure 168: Derived Bond Price Series Figure 169: Daily return series Figure 170: Calculation of portfolio weights Figure 171: Portfolio daily return series Figure 172: Squared differences of the returns series Figure 173: Calculation of weights under EWMA Figure 174: Scaling of weights Figure 175: Calculation of EWMA variance Figure 176: SMA and EWMA daily VaRs Figure 177: Ordered portfolio return series Figure 178: Holding Period VaR Figure 179: Core banking data Figure 180: Pivot Table - Maturity profile of deposits by size Figure 181: Pivot Chart - Deposits by maturity bucket Figure 182: Pivot Chart Deposits size versus maturity profile Figure 183: Pivot Chart Deposits cost versus size Figure 184: Pivot Chart Loan size versus maturity Figure 185: Pivot Chart Loan Segment versus maturity Figure 186: Pivot Chart loan product versus maturity Figure 187: Core banking data extract - deposits Figure 188: Days to Maturity Formula Figure 189: Months to Maturity Formula Figure 190: Applying formulas to dataset Figure 191: Adding additional columns to data set for deposit size, maturity and cost Figure 192: Grades/ Categories for bucketing deposit data Figure 193: Assigning grades for deposit size Figure 194: Assigning grades for maturity bucket Figure 195: Assigning grades for deposit cost Figure 196: Applying formulas to entire data set Figure 197: Selecting pivot table functionality from Excel spreadsheet Insert Tab Figure 198: Selecting pivot chart option from pivot table functionality Figure 199: Pivot Table information capture pop-up Figure 200: Selecting the data range for the pivot table functionality Figure 201: Pivot table information capture pop-up after data range selection Figure 202: Selecting the location for display of the Pivot Table and Pivot Chart Figure 203: Display of the Pivot Table and Pivot Chart output field before population Figure 204: Data fields and Pivot Table and Chart output construction customization functionality Figure 205: Data fields and Pivot Table only output construction customization functionality Figure 206: Data fields selection and allocation for rows (axis) and columns (legends) Figure 207: Rows (axis) and columns (legends) polluted in pivot table and chart output Figure 208: Data field selection and allocation for Values Figure 209: Values populated in pivot table and chart Figure 210: Pivot table output before number formatting Figure 211: Number formatting functionality in EXCEL Figure 212: Pivot table and chart output after number formatting Figure 213: Grades/ Categories for bucketing deposit data Figure 214: Functionality for changing Value field settings Figure 215: Functionality for changing Value field settings Page 228 of 230

13 Figure 216: Functionality for changing Value field settings Figure 217: Updated values field after value field setting is changed Figure 218: Maturity profile versus size concentration by amount and number Figure 219: Selecting data fields for displaying size and cost Figure 220: Pivot table for deposit size and cost Figure 221: Pivot table and chart combo for deposit size and cost Figure 222: Pivot table and chart combo maturity and cost Figure 223: Pivot table and chart combo for deposit size and product Figure 224: Pivot table and chart combo for cost and size by number of accounts Figure 225: Pivot table and chart combo for total deposit amounts by maturity Figure 226: Pivot table and chart combo for total deposit amounts by cost Figure 227: Core banking data for loans extract Figure 228: Grades/ Categories for bucketing loan data Figure 229: Assigning grades for maturity buckets Figure 230: Assigning grades for loan size Figure 231: Pivot chart for loan size against maturities Figure 232: Pivot table for loan size against maturities Figure 233: Pivot chart for business line against maturities Figure 234: Pivot table for business line against maturities Figure 235: Pivot table for advances product against maturities Figure 236: Pivot chart for advances product against maturities Figure 237: Pivot table and chart for advances maturities Figure 238: Pivot table and chart for concentration of advances in size versus maturity brackets by number Figure 239: Maturity profile- advances Figure 240: Maturity profile- deposits Figure 241: Maturity profile-results Page 229 of 230