Treasury and Fund Management Commercial Banks & Asset Management

1. Treasury and Fund ManagementCommercial Banks&Asset Management

2. An Intro…. With the growth of International business and the spread of Multinational Enterprise, the treasury function has acquired a new meaning. No longer the treasury operations restricted to borrowing and lending of funds only to one money market. The treasury function now includes a diversity of currencies which can be converted into one another through the exchange markets and which are transacted in money markets.

3. The Role…. Managing Asset & liabilities of the bank. Managing 'gaps' and the 'risks'. Maximizing profits operating within acceptable risk parameters, Maximizing yield on treasury/inter bank investment. Providing rates to branches and customers.

4. Inter-Dept Chart….

5. Functionality…. Lending to Branches Borrowing Funding Borrower Excess Liquidity TREASURY Front Office Spread Branch Investment Treasury Back Office Functions Reserve Requirement Depositor • Branches Receive Deposits • Branches Lend To Customers • Branches Remit Excess liquidity to try at an average rate (Pool Rate) • Try maintenance reserve with SBP. • Invest in MM Instruments • Invest in Govt. Securities • Invest in Debt Securities • Capital Market • Fund FCY Trade Nostro Account • Lend to Other Branch

6. Interest Rate…. The interest rate used in determining the present value of future cash flows. OR The interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Central Bank.

7. Yield…. The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment's cost, its current market value or its face value. There are two stock dividend yields.Cost Yield & Current Yield. Bonds have following yields: Coupon(the bond interest rate fixed at issuance), current (the bond interest rate as a percentage of the current price of the bond), and Yield to maturity (an estimate of what an investor will receive if the bond is held to its maturity date).

8. Yield Curve…. • The shape of the yield curve is closely monitored because it helps to give an idea of future interest rate change and economic activity. A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates”. OR “The yield curve is the relationship between an interest rate and the time to maturity for a given debt”.

9. Normal Yield Curve: Is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. Inverted Yield Curve: Is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of upcoming recession.

10. Flat Yield Curve: Is one in which the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition.

11. Money Market…. The money market is a wholesale market for low risk, highly liquid, short-term & long term debt instruments. It serves as an avenue through which banks and financial institutions can offload their excess liquidity or meet their funding requirements. To the government an organized money market represents a means for it to implement it’s monetary policies in a more efficient manner. Moreover, it provides it with a liquid market for securities through which it can finance it’s own borrowing requirements. The large role of commercial banks in the money market can be easily envisioned by looking at their assets and liabilities. A major portion of their liabilities are demand deposits. Another large portion of bank liabilities are time deposits. On the asset side, in addition to loans banks have part of their assets invested in marketable securities.

12. M.M Objective…. Managing liquidity and interest risk. Coordinating with corporate/retail banking departments for assets/liability pricing. To deploy excess funds in order to save liquidity wastage To manage funding requirements which may arise from time to time keeping in view the cost and interest scenario.

13. Purpose of M. M…. The need for financial institutions to indulge in money market transactions arises primarily from the reserve requirements imposed by the State Bank. All commercial banks are required to maintain 25% Statuary Liquidity Requirements (SLR) of their Demand and Time Liabilities (DTL). Commercial banks also have to maintain a certain portion of their DTL in a cash reserve maintained with the SBP at 0% interest. This ratio is known as the CRR (Cash Reserve Requirement) and stands at 5.00%.

14. M.M Instruments & Transactions…. Pakistan Investment Bonds Treasury Bills Repo / Rev. Repo Transactions Call / Clean Money Term Finance Certificate Certificate of Investments Commercial Papers

15. M.M Instruments & Transactions…. Pakistan Investment Bonds:These are long term bonds of three, five, ten, fifteen, twenty & 30 years, maturity issued at market price and carrying a different coupon rate according to the interest rates scenario. Moreover, another reason for issuing PIBs is to set up a yield curve and corporate, mutual funds etc. to invest in long term. Treasury Bills:T-Bills are short term securities issued by the State Bank on behalf of the Ministry of Finance through auctions. They are zero-coupon bonds issued at a discount, have a par value of Rs 100 and a maturity of three, six or twelve months. Bank borrowing is one of the various measures the government takes to fill it’s budgetary deficit and this bank borrowing currently takes place against T-Bills. Term Finance Certificate: TFCs are redeemable capital instruments and may be issued by a company directly to the general public, which includes institutions. Unlike straight bonds, they are redeemable capital and are of long tenors. Issued by corporate to raise long-term fund.

16. M.M Instruments & Transactions…. Repurchase Transactions: Borrowing secured by collateral in the form of securities. Rev. Repo Transactions: Lending secured by collateral in the form of securities. Call Money: Call transactions consist of non-collateralized lending and borrowing of Funds. Clean Money: Clean funds are similar to call funds in the sense that this is unsecured lending/ borrowing of funds. The only difference is that this sort of borrowing is done by investment banks and leasing companies.

17. FX MARKET…. Domestic markets trade in local currency and operate under regulations governing domestic market. When funds in any other currency are traded outside the regulations governing domestic markets, then we have the transaction of Foreign Exchange Markets. Nostro Management. Exposure Management Blotter Management

18. FX TRANSACTION…. Any financial transaction that involves more than one 'convertible' currency is a foreign exchange transaction. Most important characteristic of a foreign exchange transaction is that it involves foreign exchange risk/Exposure. The exchange rate is determined by the market forces of demand & Supply. Exchange Rate is the price of one currency in terms of another.

19. Net Open Position • A measure of foreign exchange risk. • NOP is the Net Asset/Net Liability position in all FCs together • Net Asset Position is also called "LONG" or "Overbought" position. • Net liability Position is also called "SHORT" or "Oversold" position • NOP is a single statistic that provides a fairly good idea about exchange risk assumed by the bank.

20. Net Open Position • Currency-wise NOP in equivalent PKR • NOP calculating in the following manner. TOTAL -549/84 NOP -6.53

21. Foreign Exchange Exposure Limit • FX Exposure is the higher of the long and short positions in Foreign Currency. • FEEL is the 10% of the paid-up capital of the bank or PKR1.5bln whichever is higher. • FEEL(PKR) = -1389/84 • FEEL(USD) = -16.53

22. Corporate Desk…. Dealing with branches and large clients. Treasury acts as a separate profit unit versus branches. FORWARD RATES: Forward rates depend upon interest rate differential between the two currencies. Currency with higher interest rates is at discount w.r.t currency having lower interest rate. Currency with lower interest rates is at premium w.r.t currency having higher interest rate.

23. Equity Market…. The investment of the bank will be structured around passive management with majority of the portfolio invested for a medium to long term horizon based on the fundamental developments in the economy.

24. E.M Objective…. The key investment objective behind developing an equity portfolio for the bank is to create and manage an investment portfolio that allows earning of superior yields in comparison to other alternate investment opportunities.

25. Risk Mitigation…. The risk of the equity portfolio will be managed through: Comprehensive focus on fundamental research and equity analysis; Diversification of the investment portfolio; Rigorous investment review procedures; and Development of controls and procedures for the trading portfolio.

26. Equity Trading Mechanism KSE Clearing House T+2 Settlement Buyer Broker Broker Seller Payment Shares

27. ARBITRAGE Opportunity taken for higher return to avoid market risk. This opportunity arises from inefficiency of the market. • ARBITRAGE OPPURTINUITIES IN EQUITY MARKET • There are mainly two types of arbitrage in equities. • Simple Arbitrage • Ready Future Arbitrage

28. SIMPLE ARBITRAGE Price differential between two exchanges or market of the same instrument. PTC Rs. 30 PTC Rs. 32 T+2 Settlement Buy Sell K.S.E L.S.E

29. READY FUTURE ARBITRAGE Price differential between ready and future contracts of the same instrument in the same exchange or market. PTC (ready) Rs. 30 PTC (future) Rs. 34 T+15Settlement T+2Settlement K.S.E

30. EQUITY PORTFOLIO MANAGEMENT • Introduction • The equity portfolio of the bank envisages a passive portfolio management strategy • Focused on developing a fundamentally strong and truly diversified portfolio. However, • a trading portfolio will be maintained to supplement and enhance the overall yield of the • equity portfolio. • The Equity Portfolio is to be distributed between growth stocks and income stocks; the initial indication is to equally distribute the portfolio however this would depend on the overall performance of the sector and sub-sectors. • Every transaction or trade should be based on strong reasoning and should be justifiable on fundamental, valuation and/or market expectations; • Generate recurring income through dividend yield from specific securities which is higher than the yields on Government securities; and • Reduce the cost and undue risk through maintaining an appropriate balance between volumes and duration of the transaction.

31. Portfolio Management Guidelines • The general guidelines with regards to portfolio management are as hereunder: • Every equity investment has to be classified as “Overnight Portfolio”, “Short Term Portfolio”, “Investment Portfolio” or “Strategic Portfolio” based on the asset allocation policy and departmental strategy for execution of a certain trade; • The above mentioned portfolio classifications are defined as: Overnight Portfolio: Daily Trading Positions; Short Term Portfolio: Any trading position with more than overnight horizon but less than a 3 months horizon; Medium to Long Term Portfolio: The stocks purchased based on the fundamental earnings or valuation strength. The investment exits will be laid down in terms of the target price and/or time horizon, which will be at least 90 days. The initial time horizon can be extended based on investment committees approval; and Strategic Investment Portfolio: The stocks purchased for either a horizon of more than 2 years and/or acquiring significant stake to allow the bank to turn around the company and/or any company which fits the strategic focus of the bank.

32. WORKFLOW • The overall department will be divided into two sub units: Front Office and Back Office. • Typically the equity market unit should be able to manage the following activities: • 1. Strategy Formulation • Yearly Asset Allocation Strategy Paper; • Target Yield Setting on the Investment and Trading Portfolio; • Quarterly Review of the Asset Allocation Strategy; • Management of Research Resources; and • Daily Trading Guidelines. • 2. Front Desk Trading • Execution of the investment decisions; • Distribution of stocks for trading; • Identification of trading opportunities; and • Delivering on the trading yieldtargets.

33. WORKFLOW • The overall department will be divided into two sub units: Front Office and Back Office. • Typically the equity market unit should be able to manage the following activities: • 3. Risk Management • Development of Standard Operating Procedures (“SOPs”); • Development of Risk Management Policies and Alert Mechanism; • Ensuring Adherence to the Policies and Procedures; and • Development of discretionary investment and trading authorities. • 4. Settlements • Settlement of the T+2 and Futures transaction; • Assistance in managing the badla book; • Providing counter trading reports to management to reconcile with Front Office report; • Providing value date cash flow statement to the accounts / finance department • Ensuring compliance with the prudential and other related regulations.

34. Myths about the stock market • “The market will collapse!” • “Investing in stocks is just like gambling.” • “Stocks should be bought when they have momentum.” • “Heavyweights manipulate the market.” • “To begin investing, I need to accumulate a lot of money first.”

35. Inflation gradually erodes the value the Rupee Nominal Value of PkR 1,000 : PkR 6,727 Today: PkR 1,000 Inflation Adjusted Value of PkR 1,000: PkR 122

36. Investments provide protection from inflation

37. “The market will collapse!”

38. …zoomed-in view of the crash of 2005

39. It pays to stay invested Riding out short-term depression in the market can pay off in the long-run

40. Gambling/ Trying to catch the momentum

41. “Investing in stocks is not like gambling.” Investments are made using a systematic approach based on studies of business dynamics. Scrips are selected on the basis of their potential for long-term earnings growth driven by fundamentals. Portfolio allocations are adjusted periodically to reflect a change in the underlying dynamics of the company.

42. Do heavyweights manipulate the market? • Yes! • Speculators facilitate price discovery in any market – financial institutions look to take advantage of any pricing opportunity created by the actions of the speculators. • However, manipulation doesn’t last long • In the long-run, it’s earnings and cash flows that move stock prices – not the punters

43. “To begin investing, I need to accumulate a lot of money first.” • No, A person can make investment with only PKR 500 in a mutual fund and gradually build its investment through SIP.

44. “To begin investing, I need to accumulate a lot of money first.”

45. Comparison with fixed-income returns and inflation

46. In fact, equities have outperformed all other asset classes in the past 15 years

47. Drawbacks of direct investment in equities • Un-informed decision-making • Monitoring costs • Diversified exposure not possible with small amounts • Brokerage fees

48. How A Mutual Fund Works A large number of people with money to invest buy shares in a mutual fund. They pool their money for buying power. The fund manager invests the money in a collection of stocks, bonds or other securities. If the manager is successful in selecting good companies that generate value, the fund will grow. Investors receive periodic distributions and can book capital gains by redeeming their investments.

49. Why Equity Funds?

50. The Reasons… • Diversification • Active management • Hedge against inflation • Professional Management • Benefits of automatic re-investment • Rupee-cost averaging • Investment Options: SIP, STP, SPT