Integrated Treasury Operations

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Integrated Treasury Operations

The primary function of the treasury department is fund management by maintaining liquidity and managing excess cash profitably through appropriate investments in financial markets. This implies an active role of treasury in all the financial market segments such as forex, money market, securities, derivatives, etc. To achieve this, a bank must establish separate trading desks dedicated to money market operations, securities market operations, etc. The treasury department’s front office contains all these trading desks.

Some important short-term instruments of money markets, viz. call and term money, repos and dealing room operations. Borrowing operations such as repos blur the division between money markets and securities markets for shortterm fund management. Many of the operations of these desks involve more than one market. For example, if a dealer finds that he cannot cover a tailor-made forward contract exposure through outright forwards or FX swaps through the forex market, he might decide to use money market operations, which require lending and borrowing in different money markets in different currencies.

The FX dealer would also like to place excess funds in money markets and similarly bridge maturity gaps through money market or security market operations. He might also be interested in using derivative instruments such as Forward Rate Agreements (FRAs) to bridge maturity gaps by using fixed income derivative markets. All these imply that the financial markets are closely interrelated and no market can be dealt in isolation with other markets. Before liberalisation, the treasury scenario in Indian financial markets did not require involvement in more than one financial market for managing liquidity or market risks.

However, with liberalisation and related financial market reforms, markets have become closely interlinked. This requires that a dealer of any particular desk should be well-informed about other related financial markets. The financial markets are interlinked and the liquidity risk has implication on several markets. Therefore, it is beneficial for the treasury division to integrate various operations. An integrated treasury operation refers to the integration of foreign exchange, money and securities market operations.

Benefits of Integrated Treasury Operations

The benefits of the integrated treasury operations are as follows:

  • Arbitrage opportunities can be exploited. Dealers can exploit arbitrage opportunities between markets. For example, if the forward rates are not aligned according to the interest rate differential between currencies, risk-free arbitrage profits can be made when the forex dealers can move funds to money markets.

  • The efficient management of funds by using instruments in multiple markets. For example, a money market dealer who is not getting sufficient returns in a commercial paper investment can decide to shift the funds to global money markets in different currency through forex operations.

  • Manage funds in an integrated manner. Treasury can decide to borrow other currencies where funds are available at cheaper rates and use them for domestic currency liquidity needs.

  • When treasury functions in an integrated manner, there are wider options available for executing its strategies.

  • Efficient management of asset-liability mismatches. For example, shifting cash flows from short-term money market instruments to long-term government securities market, or changing cash flows from one currency to another and using derivatives to manage the related risks can help achieve the treasury objectives better.

  • Hedging and managing different types of risks can be achieved by deploying an integrated hedging strategy that requires simultaneous involvement in different markets.

  • Client needs can be met in a better manner. Needs of corporate clients cut across different markets, which require services of an integrated treasury division.

Money Market and Forex Market Coordination

As discussed earlier, the forex and money markets are closely integrated. The pricing of financial assets and liabilities pertaining to these markets depend on various variables. For example, the forward exchange rates in forex markets depend on the short-term money market interest rates. This means the forward rates and the lending/ borrowing rates in money markets are related.

Any deviation in two markets can give rise to risk-free arbitrage opportunities. The value and risks associated with the assets and liabilities pertaining to these two markets are interrelated for the treasury department as a whole. Therefore, coordination between these two desks is important in order to effectively manage liquidity and various market risks. The requirements of two desks in handling their risks can give rise to complementary advantages.

For example, if there are excess funds that cannot be profitably placed in money markets due to prevailing market conditions, funds can be moved to forex markets where forex dealers can find profitable strategies for deploying them. Similarly, forex dealers can find hedging their positions in money markets more profitable than by the usage of FX swaps and related tools.

Use of Forex Swaps and Money Market Swaps

An example of forex and money market coordination is the way the FX swaps can be hedged in money markets.

Let us consider an FX swap that involves the following transactions:

  • Spot purchase of USD 10 million against INR
  • Three-month forward sale of USD 10 million

The above FX swap can be hedged in money markets using the following steps:

  • Lend USD 10 million for three months
  • Borrow INR for equivalent of USD 10 million at spot rate for three months

After three months, the maturity amount repaid in dollars can be used to deliver the forward sale contract. It means that the proceeds from the forward sale can be used to pay off the INR borrowing. If the forward rate obeys the covered interest rate parity theorem, then the money market position would exactly hedge the FX swap position.

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