ASSIGNMENT

SESSION JULY 2023

PROGRAM MASTER OF BUSINESS ADMINISTRATION (MBA)

SEMESTER IV

COURSE CODE & NAME DFIN402 – TREASURY MANAGEMENT

ROLL NUMBER 2114501799

NAME JITENDER JANGIR

Question: 1. What is a Financial Instrument? Discuss any four major Money Market Instruments?

Ans –
A tradable asset that represents a claim on an underlying asset or a legally binding agreement between
parties is called a financial instrument. In the financial markets, these tools are employed for a number
of tasks, such as speculation, hedging, and investment. Money market instruments and capital market
instruments are the two primary categories of financial instruments. Money market instruments are
short-term debt securities or assets, usually with a one-year maturity or less. They are frequently used
for short-term investment needs and are thought to be highly liquid and low-risk.

Four important money market instruments are as follows:

1. Treasury Bills, or T-bills, are government-issued, short-term debt instruments with maturities varying
from a few days to a year. Because they are supported by the full faith and credit of the government,
they are regarded as among the safest investments. Usually sold at a discount to face value, T-bills are
paid for with interest earned on the difference between purchase price and face value, which is given to
the investor upon maturity.

2. Commercial Paper: To raise money for their working capital requirements, corporations issue
commercial paper, which is an unsecured promissory note with a short maturity date. The maturities of
these notes typically range from a few days to 270 days. Investors receive a return based on the
difference between the purchase price and the face value of commercial paper, which is typically issued
at a discount to its face value.

3. Deposit Certificates (CDs): Banks and other financial institutions offer certificates of deposit, which
are time deposits with fixed terms varying from a few weeks to several years. At maturity, the investor
receives the principal amount plus interest, and they pay a predetermined interest rate. Government
deposit insurance programs insure CDs up to specific limits, making them a comparatively low-risk
investment.

4. Purchase Agreements (Repo): The money market is the main application for repurchase agreements,
or repos, which are short-term lending and borrowing transactions. In a repo, a central bank or another
financial institution buys a security from a first party (usually a financial institution) with the option to
buy it back at a later date for a slightly higher price. Repos are used by central banks to carry out open
market operations, manage liquidity, and provide short-term funding.

These money market instruments have a variety of uses in the financial system, including funding for
businesses and governments, short-term investment opportunities, and a source of liquidity. Because of
their shorter maturities and lower risk than longer-term capital market instruments, they are frequently
regarded as safer investments.

Question: 2. “Credit control is enforced by RBI over Banks to regulate money supply.” Justify the
statement by explaining tools used for controlling credit by RBI.

Ans -
In order to control the amount of money in the economy, the Reserve Bank of India (RBI) imposes credit
control measures on banks. In order to guarantee economic growth, preserve price stability, and
prevent inflationary or deflationary pressures, credit control is crucial. To manage credit, RBI employs
both quantitative and qualitative methods. The RBI uses the following important instruments to control
credit:

1. Cash Reserve Ratio (CRR): CRR is the proportion of total deposits that a bank must maintain in cash on
hand with the RBI. The RBI can manage the level of liquidity in the banking system by adjusting the CRR.
An increase in CRR limits banks' capacity to lend by requiring them to retain more money at the RBI.

On the other hand, a decrease in CRR gives banks more money to lend, which boosts credit in the
economy.

2. Statutory Liquidity Ratio (SLR): The SLR is the proportion of total deposits that a bank must hold in
approved securities and certain government securities. Similar to CRR, a rise in SLR results in less money
that is available for lending, whereas a fall in SLR frees up money for lending.
3. Repo Rate and Reverse Repo Rate: Banks can borrow money from the RBI at the repo rate, and they
can deposit excess funds with the RBI at the reverse repo rate. The RBI can affect the cost of borrowing
for banks by changing these rates. An increase in the repo rate raises the cost of borrowing from the
RBI, which raises lending rates overall and decreases the growth of credit. On the other hand, a drop in
the repo rate incentivizes banks to borrow money from the RBI at a reduced cost, which results in lower
lending rates and more credit.

4. Bank Rate: The long-term lending rate that the RBI charges commercial banks is known as the bank
rate. Though it isn't as common as the repo rate, it still has an effect on lending rates in the economy. 5.
Open Market Operations (OMOs): OMOs are the RBI's open market purchases and sales of government
securities. When the RBI purchases securities, it adds money to the banking system and makes more
available for lending; conversely, when it sells securities, it takes money out of the system. OMOs have
an impact on interest rates and are used to control liquidity in the banking system.
6. Regulation and Supervision: By regulating and overseeing banks, RBI employs qualitative measures as
well. In order to regulate credit quality and prevent excessive lending, it can publish guidelines on
lending procedures, risk management, and other areas of banking operations.

7. Credit Control through Moral Suasion: The RBI may also influence banks' lending practices through
moral suasion or informal persuasion. It might give banks counsel, suggestions, or orders to promote
ethical lending practices and preserve financial stability.

The RBI can modify the cost and accessibility of credit in the economy through the use of these
instruments, which in turn affects the total amount of money in circulation. By preventing overheating
or deflationary pressures, these policies aid in preserving financial stability, promoting economic
growth, and containing inflation.

Question: 3.

a) Differentiate between Liquidity and Solvency.

Ans –

In order to evaluate the financial health of people, companies, and financial institutions, two separate
but related concepts in finance—liquidity and solvency—are essential. The following are the main
distinctions between solvency and liquidity:

1. Definition:
• Liquidity: The ease with which a person, company, or financial institution can turn their assets into
cash or cash equivalents in order to pay their short-term debts when they become due is referred to as
liquidity. It is centered on the capacity to meet short-term financial obligations without suffering a
sizable loss in asset value.

• Solvency: The ability of an entity to pay off its long-term debts and obligations when they become due
is reflected in its financial condition. It shows whether an entity is long-term financially stable if its total
assets are greater than its total liabilities.

2. Time Period:

• Liquidity: This refers to the capacity to meet short-term cash flow needs, usually within the next 12
months or less, and short-term financial stability.

• Solvency: Solvency is the ability of an entity to meet long-term obligations, frequently over a period of
more than a year, and is concerned with the long-term financial health and sustainability of the entity.

3. Evaluate:

• Liquidity: An entity's current assets and current liabilities are examined in order to determine its
liquidity. Liquidity is typically assessed using the quick ratio, which is a more stringent measure of
liquidity, and the current ratio, which is calculated by dividing current assets by current liabilities.
• Solvency: The total assets and total liabilities of an entity are examined in order to determine its
solvency. Solvency is evaluated using a variety of financial leverage ratios, including the debt-to-equity
and interest coverage ratios.

4. Intention:

• Liquidity: The main goal of preserving liquidity is to guarantee that a company can pay its bills, salaries,
and other immediate expenses in a timely manner without running the risk of going bankrupt.

• Solvency: The major goal of preserving solvency is to guarantee that a company can fulfill its long-term
commitments, such as paying back loans, servicing debt, and continuing to operate for a considerable
amount of time.

5. Peril:
• Liquidity: When a company lacks the cash or liquid assets necessary to cover its immediate liabilities,
liquidity risk occurs. It may cause financial hardship and make it harder to make bill payments on
schedule.

• Solvency: The risk of insolvency arises when an entity's total liabilities surpass its total assets. In the
long term, it may result in insolvency and a lack of financial sustainability.

To sum up, solvency and liquidity are two different ideas in finance. Solvency is more concerned with
long-term financial stability and the ability to fulfill long-term commitments, whereas liquidity is more
concerned with short-term financial health and the ability to meet immediate obligations. Both are
essential for evaluating the overall financial health of an entity and are frequently examined in tandem
to give a complete picture of that entity's financial situation.

b. What are the objectives of Cash Management System?

Ans –
For individuals, companies, and organizations, cash management is an essential component of financial
management. A cash management system's goals are to maximize the use of available funds while
making sure that an entity's cash resources are used effectively and efficiently to meet a variety of
financial needs. Among the particular goals of a cash management system could be:

1. Liquidity management: Make sure the organization has enough cash on hand to cover short-term
financial obligations, pay bills, and cover daily operating expenses.

2. Reducing Idle Cash: Since idle cash costs money, it is best to avoid holding large sums of money that
aren't being actively invested. Invest extra money in short-term investments or interest-bearing
accounts to earn income.

3. Optimizing Cash Flows: To make sure that there is cash on hand when it's needed, evaluate and
control the timing of cash inflows and outflows. This could be settling on advantageous credit terms
with suppliers or quickening the collection of past-due invoices.
4. Cost Reduction: Cut down on transaction expenses related to managing cash, such as ATM, bank, and
check processing fees. Determine areas where money can be saved on cash management tasks.

5. Risk Management: Reduce the risks related to money, such as fraud, theft, and variations in cash flow.
To safeguard cash assets, put internal controls and security measures in place.

6. Improving Investment Returns: Invest extra money in a way that strikes a balance between liquidity
needs and the desire for larger returns. Invest available funds in low-risk, interest-bearing instruments
to generate extra income.

7. Working Capital Optimization: To support business operations, maintain an ideal level of working
capital without allocating too many resources to non-earning assets.

8. Debt Service: Make sure there are enough resources to pay off debts on schedule, including principal
and interest.

9. Emergency Funds: Make sure you have funds on hand to deal with unforeseen expenses by setting
aside reserves for unforeseen emergencies or contingencies.

Question: 4. a) Briefly explain the factors that have an impact on forex trade.

Ans -

Trading in foreign exchange, also known as forex or FX, entails purchasing and selling currencies from
various nations. The foreign exchange market is influenced by a multitude of factors that both create
opportunities and risks for traders. The following are some of the major variables that affect forex
trading:

1. Interest Rates: Interest rates are determined by central banks, and they have a big influence on the
value of currencies. A nation's currency is in greater demand when it has higher interest rates because
they tend to draw in foreign investment. The currency appreciates as a result. Lower interest rates, on
the other hand, may cause a decline in currency value.

2. Economic Indicators: Trade balances, GDP growth, employment numbers, and inflation rates are
examples of economic data that can affect forex markets. Currency appreciation is frequently
correlated with positive economic data, whereas depreciation is correlated with negative data.

3. Political Stability and Performance: Investor confidence can be impacted by both the political stability
and the general efficacy of a nation's government. Foreign investments can be drawn to a stable and
effective government, which will boost the value of the currency. On the other hand, political instability,
corruption, or incompetent leadership can have the opposite impact.

4. Market Sentiment: In the forex markets, traders' perceptions and the general mood of the market are
important factors. Demand for a currency can be driven by positive sentiment, whereas selling can
result from negative sentiment.
5. Speculation: Speculative trading has an impact on the forex markets. Exchange rates are affected by
the decisions and actions of traders, who frequently forecast currency movements based on their
analysis of numerous variables.

6. Central Bank Interventions: In order to affect exchange rates, central banks may buy or sell their own
currency in the forex market. The direction of currency movements may be impacted by such
interventions.

7. Geopolitical Events: Uncertainty in the forex markets and fluctuations in currency values can result
from geopolitical events like wars, trade disputes, or diplomatic tensions.

8. Market Liquidity: The amount of liquidity in forex markets varies based on the currency pair and time
of day. Exotic currency pairings might have less liquidity than major currency pairs like EUR/USD, which
typically have more liquidity. Volatility and trading spreads can be impacted by liquidity levels.

9. Trade and Capital Flows: Currency exchange rates are impacted by trade balances and capital flows
between nations, which affect a variety of asset classes. Currency depreciation can result from a trade
deficit, whereas currency appreciation can occur in a nation with a trade surplus (exports > imports).

10. Natural Disasters and Economic Shocks: Unexpected occurrences can cause currency markets to
fluctuate quickly and unpredictably. Examples of these events include natural disasters and economic
shocks.

To effectively manage risks and make well-informed decisions, traders and investors in the forex market
must have a thorough understanding of these factors and how they interact. Furthermore, because the
forex market is intricately linked to other financial markets, changes in one market may have
repercussions for a variety of asset classes.

b) Your company is expecting GBP 100000 after one month. The Indian rupee is weakening against
GBP continuously. You are confident that it will further weaken till the end of the month. Is your
company carrying any exchange risk? What will be your action if you anticipate INR to improve in one
month?

Ans –

You are in fact carrying exchange rate risk in the scenario you outlined, where your business anticipates
receiving GBP 100,000 in a month—more precisely, the possibility of unfavorable exchange rate
movement. This is due to your exposure to changes in the GBP/INR exchange rate and your expectation
that the Indian rupee (INR) will continue to depreciate against the pound sterling. When you convert
your GBP into INR after a month, you will receive less INR than if the exchange rate had stayed the same
or improved, if the exchange rate does, in fact, weaken as predicted.

You can do the following to lessen the risk associated with exchange rates:

1. Forward Contract: A financial institution or a provider of currency exchange services may allow you to
enter into a forward contract. By locking in the current exchange rate for a future date, a forward
contract guarantees that, when the contract matures, you will receive a fixed amount of INR for your
GBP. This protects against the INR's predicted decline.

2. Options Contracts: You might think about employing put and other currency options contracts. A put
option gives you the option, but not the duty, to sell GBP on or before the option's expiration date at a
given exchange rate. You can let the option expire and execute the forex trade at the more
advantageous rate if the INR strengthens as you expect.

3. Diversify Revenues: You should think about diversifying your cash flows and revenues if your business
deals with foreign exchange on a regular basis. This entails looking for partners, suppliers, or customers
in various geographic areas to lessen your exposure to fluctuations in a single currency.

4. Remain Informed: Pay careful attention to worldwide political and economic events that may have an
impact on exchange rates. Making informed decisions can be aided by having current knowledge of
currency markets.

5. Speak with a Currency Expert: Financial advisors or currency experts can offer advice on how to
manage the particular exchange rate risk you face. You might think about holding off on converting your
GBP to INR until that more advantageous exchange rate is achieved if you anticipate that the INR will
strengthen against the GBP in a month. It's crucial to remember, though, that exchange rate movements
can be difficult to predict with accuracy and that currency markets can be very erratic. Consequently, in
order to safeguard the financial interests of your business, it is wise to consult a professional and think
about risk management techniques.

Question: 5. What is Cash Conversion Cycle. Briefly explain Days inventory outstanding, Days sales
outstanding and Days payable outstanding. What are the types of comparisons required to assess the
effectiveness of cash conversion cycle management?

Ans –

The Cash Conversion Cycle (CCC) is a financial metric that measures the time it takes for a company to
convert its investments in inventory and other resources into cash flow from sales. It provides insights
into a company's operational efficiency and liquidity by assessing the efficiency of managing working
capital components.

The CCC is calculated as follows:

Cash Conversion Cycle (CCC) = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days
Payable Outstanding (DPO)

Now, let's briefly explain the three components of the CCC:

1. Days Inventory Outstanding (DIO): DIO measures the average number of days it takes for a
company to sell its inventory. It indicates how efficiently a company manages its inventory. A lower DIO
is generally better, as it implies faster turnover and reduced carrying costs. The formula for DIO is:

DIO = (Average Inventory / Cost of Goods Sold) x Number of Days in the Period
2. Days Sales Outstanding (DSO): DSO represents the average number of days it takes for a
company to collect accounts receivable from its customers. It helps assess the effectiveness of the
company's credit and collection policies. A lower DSO suggests quicker cash collection. The formula for
DSO is:

DSO = (Accounts Receivable / Total Credit Sales) x Number of Days in the Period

3. Days Payable Outstanding (DPO): DPO measures the average number of days it takes for a
company to pay its suppliers. A higher DPO can be advantageous as it allows the company to hold onto
cash longer. The formula for DPO is:

DPO = (Accounts Payable / Cost of Goods Sold) x Number of Days in the Period

To assess the effectiveness of cash conversion cycle management, companies can make several types of
comparisons:

1. Benchmarking: Compare the CCC of the company to industry benchmarks or best practices. A
shorter CCC than competitors can indicate more efficient working capital management.

2. Historical Comparison: Analyze the company's CCC over time. A decreasing CCC may suggest
improved efficiency in working capital management.

3. Peer Comparison: Compare the CCC of the company to that of its peers or similar companies in
the same industry to identify relative strengths and weaknesses.

4. Optimal CCC Analysis: Determine the optimal CCC for the company by considering factors like
industry standards, market conditions, and the company's strategic goals. Compare the actual CCC to
the optimal CCC to identify areas for improvement.

5. Sensitivity Analysis: Assess how changes in the components of the CCC (DIO, DSO, and DPO)
impact the overall CCC. Evaluate scenarios where improvements in working capital management can
lead to shorter cash conversion cycles and increased liquidity.

Effectively managing the Cash Conversion Cycle is essential for a company's financial health. A shorter
CCC typically indicates efficient use of working capital and faster cash flows, which can lead to improved
liquidity, reduced financing costs, and increased profitability.

Question: 6.

a) . Explain major techniques of Asset Liability Management.

Ans –

Financial organizations, including banks and insurance providers, use asset liability management (ALM)
as a strategic tool to efficiently manage the risk attached to their assets and liabilities. To maintain
financial stability and accomplish the institution's financial goals, asset and liability management (ALM)
entails striking a balance between the maturity, interest rate, liquidity, and other attributes of assets
and liabilities. ALM employs a number of key techniques, including:
1. Gap Evaluation: Sorting assets and liabilities according to their maturity or repricing periods is a step
in the gap analysis process. The "gap," or the difference between interest rate-sensitive assets and
liabilities for particular time buckets, is what needs to be calculated. By evaluating how changes in
interest rates may impact the institution's net interest margin, the gap analysis assists in identifying
potential interest rate risk.

2. Duration Gap Analysis: This is an extension of gap analysis that takes into account the cash flow
characteristics of assets and liabilities as well as their timing. The duration concept is employed, which
quantifies the degree to which a security's market value is susceptible to fluctuations in interest rates.
Interest rate risk can be reduced by institutions by matching the durations of their assets and liabilities.

3. Net Interest Income Simulation: In order to evaluate the impact on net interest income, various
interest rate scenarios are modeled. This method enables institutions to create plans to reduce possible
risks and helps them understand how changes in interest rates would effect their profitability.

4. Immunization: Immunization is a risk management strategy designed to guard against changes in

5. Cash Flow Matching: This technique aims to more closely align the cash flows from assets and
liabilities by matching them. Insurance companies frequently employ this strategy to make sure they
have enough cash flows to cover policyholder obligations in the future.

6. Scenario Analysis: This technique examines how different financial and economic scenarios affect the
assets and liabilities of an organization completing their risk management goals.

This method assists in identifying weak points and possible hazards in various scenarios, allowing
organizations to create backup plans.

7. Interest Rate Swaps and Other Hedging Tools: To control their interest rate risk, financial institutions
can make use of interest rate swaps and other derivative tools. Depending on their goals for risk
management, they might, for instance, engage in interest rate swaps to change variable-rate liabilities
into fixed-rate liabilities or vice versa.

8. Duration Management: To match an institution's risk appetite and interest rate outlook, duration
management entails actively controlling a portfolio's duration. Institutions can reduce interest rate risk
by modifying the proportion of assets and liabilities in their portfolio.

9. Liquidity Risk Management: Another aspect of ALM is managing liquidity risk, which is making sure an
organization has enough liquid assets on hand to cover its immediate needs. This could entail keeping an
asset mix under control, creating backup funding plans, and keeping a liquid reserve.

10. Capital Adequacy Assessment: As part of ALM, an institution's capital adequacy is assessed in
relation to its risk profile. One of the most important aspects of ALM is making sure that capital reserves
are enough to cover losses and preserve solvency.
These strategies are combined in an effective asset liability management strategy that is adapted to the
unique requirements and goals of the financial institution. In order to ensure that the institution can
meet its financial obligations, it seeks to strike a balance between risk and return by maximizing
profitability and lowering risks.

b) . ABC bank invested in a 6 month deposit for Rs.1 crore at 3% (Floating Rate), in a 12-month bond @
5.5% (Fixed rate Coupon payment every six months) for the similar amount. After six months, the
deposit was renewed @ 3.5%.

i) Calculate NII for each six months period.

ii) How interest rate risk could have been avoided by the Bank in the given scenario?

To calculate the Net Interest Income (NII) for each six-month period, we need to consider the interest
earned on both the 6-month deposit and the 12-month bond. Given the interest rates and amounts, we
can calculate the NII as follows:

Initial Investment (6-month deposit):

• Amount: Rs. 1 crore

• Interest Rate: 3%

• Period: 6 months

Interest Earned = (Principal Amount x Interest Rate x Time) / 100

Interest Earned for the 6-month deposit = (1,00,00,000 x 3% x 6/12) / 100 = Rs. 1,50,000

12-Month Bond (Fixed Rate Coupon Payment):

• Amount: Rs. 1 crore

• Interest Rate: 5.5%

• Period: 6 months

Interest Earned for the first 6 months on the 12-month bond = (1,00,00,000 x 5.5% x 6/12) / 100 = Rs.
2,75,000

Renewed 6-Month Deposit:

• Amount: Rs. 1 crore

• Interest Rate (after renewal): 3.5%

• Period: 6 months

Interest Earned for the renewed 6-month deposit = (1,00,00,000 x 3.5% x 6/12) / 100 = Rs. 1,75,000

i) NII for each six-month period:

• Second 6 months: Rs. 1,75,000 (renewed 6-month deposit) + Rs. 2,75,000 (12-month bond) = Rs.
4,50,000

ii) How interest rate risk could have been avoided:

In the given scenario, the bank is exposed to interest rate risk because the interest rates on the 6-month
deposit are floating (i.e., they can change over time). To avoid interest rate risk, the bank could have
considered the following strategies:

1. Use Fixed-Rate Investments: Instead of the 6-month deposit, the bank could have invested in
fixed-rate instruments for the entire duration. This would eliminate the risk associated with floating
rates.
2. Interest Rate Swaps: The bank could enter into interest rate swap agreements to hedge against
the risk of fluctuating interest rates. For example, they could enter a swap to convert the floating rate to
a fixed rate.

3. Diversification: The bank could diversify its investments to include a mix of fixed-rate and
floating-rate instruments. This would help mitigate interest rate risk by balancing the effects of rate
changes on the overall portfolio.

4. Monitoring and Reinvestment Planning: The bank should closely monitor the interest rate
environment and plan for reinvestment accordingly. If they expect interest rates to rise, they may want
to invest in shorter-term, floating-rate instruments to take advantage of higher rates.

By adopting one or more of these strategies, the bank can better manage interest rate risk and
potentially optimize its Net Interest Income over time.