Treasury Division & its functions

TREASURY ACTIVITIES
Treasury Division Heart of the bank


Managing Asset & Liabilities of the bank The Balance Sheet Management. Thereby enhancing the risk-adjusted riskreturn on equity.

Objectives: Maximizing Risk Weighted Returns



Risk Weighted Returns take into account liquidity and interest rate gap risk associated with certain asset or liability instead of applying same interest rate to assess the cost/return of liability/asset

e.g.: Branch A
Assets: i. Cash ii. Running Finance & ERF iii. Advances linked with KIBOR, T Bills Short Term iv. Advances linked with PIBs Long Term Fixed v. Advances linked with PIBs Long Term Floating vi. Investments Advances converted into Bonds vii. Others
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Liabilities: i. Current Deposits ii. Savings Deposits iii. Term Deposits (TDRs) iv. Interest Payables v. Others

MONEY MARKET MECHANISM, MARKET & INSTRUMENTS

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Functions of Money Market Desk



The need for financial institutions to indulge in money market transactions arises primarily from the statutory reserve and liquidity requirements imposed by the State Bank. Bank.
Statutory Cash Reserve Requirement Statutory Liquidity Requirement

Average 5% of Total Time & Demand Liabilities for Week & Minimum Daily 4% of TDL

15% of TDL in Eligible Liquid Assets

A/C with SBP Rate of Return = 0% Opportunity Cost = Av. Weekly O/N Rate

1. Treasury Bills

2. FIBs/PIBs Not More Than 5% of TDL 3. Reverse Repos - Repos 4. Other Approved Assets i.e. NIT, Cash in Vault, Foreign Currency Held, Excess in SCR etc.

MARKET TYPES
Primary Market This constitutes all securities issued for the first time. Secondary Market The securities issued in the primary market are then traded in the secondary market among banks, investors etc.

MARKET PARTICIPANTS
Commercial Banks /NBFIs. State Bank of Pakistan. Corporate Treasuries. Public Sector/Government. InterInter-Bank Brokerage HousesHousesPlaying the role of facilitators.

Exchange Companies
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PRIMARY DEALER SYSTEM



The PDs are Price makers, quoting two-way twoprices reflective of market sentiment and actively participating in trading of all marketable securities. PD must be a Band/ DFI/ Investment Bank/ Listed Brokerage House. The PD status is assigned by the SBP.
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Money Market Activities

Money Market Transactions
Call/Term lending/borrowing
Clean lending/borrowing among banks. Providing KIBOR as a benchmark for term lending to the corporate sector. Less developed as compared to other countries because of the presence of more developed REPO/Reverse REPO market.

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Money Market Activities

Money Market Transactions Contd. Contd.


REPO/Reverse REPO
Repurchase of securities. Introduced in early 80s. Akin to Collateralized lending borrowing and Governed by Master REPO Agreement. Securities usually repurchased are T Bills, FIBs, PIBs etc.

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Money Market Activities

Money Market Transactions Contd. Contd.


Outright Purchase/Sale of Securities

Purchase of government securities i.e. Treasury Bills and Pakistan Investment Bonds (PIBs) for portfolio management. Purchase/Sale of securities is based on the portfolio strategy and market conditions.

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Money Market Activities

Major Money Markets instruments. instruments. Market Treasury Bills.


  

3, 6 and 12 months maturity, zero coupon instruments priced at discount. Issued by Govt. to finance current expenditure. Sold by SBP through auctions. Risk free, highly liquid and reserve eligible.
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Money Market Activities

Federal Investment Bonds. Bonds.


 

Half yearly coupon bonds. 3,5 & 10 years maturity. Discontinued in the Primary Market Issued by GoP, these bonds are only traded in the secondary market. Are SLR eligible security.

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Money Market Activities

Pakistan Investment Bonds. Bonds.


Launched in the year 2000 to replace FIBs as a long term investment. Half yearly coupon bonds. 3, 5, 10, 15 & 20 years maturity. Are sold to Primary Dealers through auction. Active secondary market catering to banks and institutional investors etc. Are SLR eligible securities up to 5% of DTL.

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Money Market Activities

Outstanding Stock
T-Bills PIBs DTL PKR 274.6 billion PKR 278.9 billion PKR 2,090 billion

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MARKET YIELDS
T-Bills
Tenor 3-Months 6-months 1-Year W.A.Rate(%) 3.9161 3.7321 4.4290 Cut-Off (%) Cut3.9462 3.8426 4.4946 Mkt.Yield% 3.75-3.60% 3.754.10-3.90% 4.104.70-4.50% 4.70-

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MARKET YIELDS
PIBs
Tenor 3-Year 5-Year 1010-Year 1515-Year 2020-Year Coupon Rate(%) 6.00 7.00 8.00 9.00 10.00 Cut-Off (%) Cut4.3500 5.3500 7.3700 8.9988 9.9942 Mkt.Yield(%) 5.60-5.40% 5.606.70-6.50% 6.707.75-7.65% 7.758.85-8.70% 8.859.85-9.70% 9.85-

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BENCHMARK RATES
Discount Rate


The SBP discount window facility offer funds to banks as the lender of last resort. Current rate is 7.5%.

Karachi Inter-bank Offer Rate (KIBOR): Inter

Lending rate for 1, 2 weeks and 1, 3, 6, 9 and 12 months. Recently established as a benchmark rate for all corporate term lending.
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BONDS
Investments for period of more than 1 year. Currently, PIBs are auctioned by SBP (traded in Primary Market). FIBs are no more auctioned and are traded in the secondary market. Riskier than T-Bills because of longer Tmaturity and presence of coupons.
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Bonds Pricing
A Bonds price is simply the present value of its:


Coupons to be received during life of the bond, and Principal repayment at the maturity.
C1 1+ i
+

Price =

C2 (1+ i)2

+ .+

Cn (1+ i)n

FV (1+ i)n

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Bonds Pricing
Issued / traded at Premium or Discount depending upon the coupon rate and the market yield for the tenors. Bond trades at Premium when:
Coupon Rate > Market Yield and vice versa.

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Bonds Pricing
Bonds price (whether at premium or at discount) converges to its par value as the bond reaches its maturity.
Premium Bond Par Value Discount Bond
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Maturity

Sensitivity Measures for Bonds

Duration Price Value of a Basis Point (PVBP or PV01) Convexity

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Duration
Measures the Interest Rate Risk or Price Risk. Measures the change in price of the bond w.r.t change in the yield.
Price
Change in Price as the yield drops by 1%

Yield
3% 4%
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Duration
Higher for papers with longer maturity. Lower for bonds with higher coupon rate. For a zero coupon bond, duration is approx. equal to life of the bond. However, duration of a zero coupon security is higher compared to that of coupon bonds.

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PVBP
Calculates the change in price as a result of 1 basis point (0.01%) change in yield. As Duration measures the change in price for 100 basis point change in yield, PVBP is: PVBP = Duration (for 1%) / 100

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Convexity
The change in duration for a change in yield. Convexity adjusts the flaw in the price estimated by duration, especially for larger changes in the yield.
Price
Convexity Adjustment

Price estimated through Duration

Yield
1% 4%
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Convexity
Duration underestimates the increase in Bonds price and overestimates the decline. Therefore, Convexity adjustment is to be added to the duration estimate in both the cases of price increase or decrease.

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Interest Rate Derivatives

Interest Rate Swap (IRS) Forward Rate Agreement (FRA)

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The Derivatives Market

A Derivative transaction is a contract whose value depends on (or derives from) the value of an underlying asset, reference rate or index. (Group of Thirty, Global Derivatives Study 1993). Underlying asset may refer to:
   

Currency Interest Rate Stock Price Commodity

Derivatives are sometimes referred to as contingent claims. Derivatives contracts are of two types:
 

Exchange traded contracts. OTC (Over the Counter) Contracts.

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Forward Rate Agreement (FRA)

An agreement to fix interest rate for a future transaction based on a certain benchmark. Agreement to borrow/lend an amount of money (nominal principal)
  

At a specified future date (settlement date) For a specified tenor For a specified interest rate (forward rate)

FRA buyer hedges against rising interest rates. Buy a 6-over-9M FRA for PKR10 Million at 9% 6-over

Agreement to...
Borrow PKR 10 Million for 3M At a date 6M from today At 9% cost
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FRAs A Practical Example

A bank needs to fund a six month fixed rate Dollar Loan. Two choices are available:   Borrow for six months at KIBOR, 8 3/8%. Fund the first three months using its own funds at a cost of 8 1/16%.

In choosing option 2 the runs the risk that interest rates will rise within three months and that overall funding cost will be above 8 3/8% To guard against this risk, the bank could buy a three against six FRA which is being quoted at 8 - 8 .. By buying a 3/6 FRA at 8 % the bank locks in a borrowing cost of 8 % from the third to the sixth month. The overall cost of borrowing in this fashion is 8.36% almost exactly the same as borrowing for six months at 8 3/8 %.
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Forward Rate Agreements - Settlement

Suppose after three months, three month KIBOR has risen to 10 %. The bank receives the difference between the current KIBOR and the agreed FRA rate (10 - 8 = 2%). Suppose FRA bought had been for a notional principal of PKR 10 M. Settlement would be as under: The buyer of the FRA would gain 2% on PKR 10 M for three months, discounted to take account of the fact that it is being paid at the start rather than the end of the three month period. This comes to : PKR 10,000,000 * 2 * 0.25 = PKR 48,721.07 1+ (10.5*0.25)
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Interest Rate Swaps

An Interest Rate Swap is an agreement between counter parties in which each party agrees to make a series of payments to the other on agreed future dates until maturity of the agreement. Each partys interest payments are calculated using different benchmarks by applying the agreement terms to the notional principal amount of the swap. An agreement to exchange:
Floating rate payments for fixed rate payments (or vice-versa) vice At regular intervals over a pre-specified period pre On a certain principal amount Typical features:  Payments denominated in the same currency  Payments are netted  Principal in not exchanged  Tailor made  Off Balance Sheet


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IRS Floating to Fixed Swap

Fixed 3.8% ABC Ltd 6m KIBOR Current 2.25% 5 year Floating rate Loan
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Bank

IRS - Applications
If the borrowers view is that PKR interest rates will go higher an IRS synthetically converts a floating rate loan into a fixed rate loan (or vice versa). Users may be able to better match assets and liabilities using an interest rate swap; matching dates, floating or fixed interest rates. Exchange certainly for uncertainty Synthetically convert a fixed rate liability into a floating rate liability if the borrowers view is that PKR interest rates will move lower.
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