Treasury Management HANU-FMT

Tutorial 1: Introduction to Treasury Management

Briefly describe the role of treasury within an organization.

2. List and briefly explain the financial risks that need to be measured and managed by the treasury
operation of a large commercial bank.

3. You are a graduate of Monash University and have applied for a position with Mega Bank in
their treasury division. At the job interview you are asked to discuss your understanding of the
scope of a treasury operation.
List the scope of a treasury operation in point form, and explain each point using examples.

4. You are a consultant appointed by the board of directors of a large commercial bank and are
asked to report on issues that should be included in a proposed treasury management policy
document.
List in point form the issues you consider the board should cover in the policy document. (Note:
while you are only required to list the main points at this time, you should understand them
sufficiently to explain each point in detail should the board seek further information in the future)

5. Discuss the relationship between ALCO and the treasury operation of an organization.

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Tutorial 2: Treasury Management Questions

1. List the main components of the balance sheet and give examples for each type. Which is the
most important component on the asset side and which one on the liability side? Explain why.

2. It is said that ALM in Banking is a Liability driven process. Discuss the reasons

3. Why is capital reserve important? Under the Basel Accord, explain the difference between
Tier I capital and Tier II capital. Give examples for each type

4. List the 7 sources of Interest rate risk and give example on each of them.

5. A bank makes a $10,000 four-year car loan to a customer at fixed rate of 8.5%. The bank
initially funds the car loan with a one-year $10,000 CD at a cost of 4.5%. The bank’s initial spread
is 4%.
a. What is the bank’s one year gap?
b. What would happen the bank’s balance sheet when the interest rate rises/falls in one year?

6. Consider the following balance sheet

Calculate NII, NIM, GAP

Examine the impact of the following changes:
• A 1% increase in the level of all short-term rates?
• A 1% decrease in the spread between assets yields and interest costs such that the rate on RSAs
increases to 8.5% and the rate on RSLs increase to 5.5%?
• A proportionate doubling in size of the bank? Discuss the relevant risks.

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7. Examine the changes in Interest Income, Interest Expense and NII when interest rate changes.

8. Calculate the missing numbers in the following Statement of Structural Liquidity. Design
transactions to fill the gap in each bucket.

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Tutorial 3: Liquidity
1. State and discuss the common approach to liquidity management

2. Examine the five liquidity reports and discuss their purposes

3. Discuss why banks are often funding short? And discuss the relationship between liquidity
mismatch and profitability.

4.

Assume that the 10-year bund has an EU 68.10 DV01 (dollar value of a basis point)
The 10-year gilt has a £ 83.40 DV01
The £/EU exchange rate is 1.2767 Sterling Pound to an EUR

The current spread between the Gilt and the Bund is 91 bps. If you expect the spread to widen to 160
points in a month, how should you put on trades to benefit from such speculation? (You have
£100,000 to trade)

Assumption: The exchange rate does not change over the course of the trade
a. The gilt increases by 91bps
b. The bund decreases by 91bps
c. The gilt decreases by 9bps and the bund decreases by 100bps
d. The gilt increases by 105bps and the bund increases by 14bps. Examine the effect of changes in
exchange rate in this trade.

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Tutorial 3: ALM
1. What are the three main topics of ALM that we have covered? Briefly give the description
and role of each topic in treasury management.

2. Briefly describe the main missions of the ALCO in a bank.

3. What information does the ALCO reports must provide?

4. What factors should an ALCO consider in efforts to hedge away unwanted risks?

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Tutorial 4: The Bond Instrument

1. Explain the two-way quote in bonds’ price (bid – offer price)

2. Describe & compare: Government bonds of the US, UK & German

3. Bond valuation
The Bond Indenture or Loan Contract specifies the features of the bond issue. The following terms
are used to describe bonds. Explain each term.
- Par or Face Value. - Call Date
- Coupon Rate - Call Price
- Coupon Payments - Required Return
- Maturity Date - Yield to Maturity
- Original Maturity - Yield to Call
- Remaining Maturity
4. Distinguish
- Money market & Capital market - Call feature & Put feature
- Primary market & Secondary market - Clean price & Dirty price
- Public offering & Private offering - Par bond, Discount bond, Premium bond
- Domestic & International bonds - Yield to maturity & Yield to call

5. Define each type of bond as following:

- Convertible bonds - Income bonds
- Bonds with warrant - Indexed bonds
- Puttable bonds

6. State 2 main disadvantages of YTM

7. Last year a firm issued 20-year, 8% annual coupon bonds that sold at a par value of $1,000
a. Suppose that one year after issue, the going interest rate for these bonds was 6%.
What is the price of the bonds, assuming that the bonds now have 19 years to maturity?
b. Suppose that one year after issue, the going interest rate for these bonds was 10%. What is the
price of the bonds, assuming that the bonds now have 19 years to maturity?

8. A firm’s bonds currently sell for $975. The bonds have a seven-year maturity, pay an annual
coupon of $90 & have a par value of $1,000. What is their YTM? What is their current yield?
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9. Find the yield to maturity on a semiannual coupon bond with a face value of $1000, a 10% coupon
rate, and 15 years remaining until maturity given that the bond price is $862.35?

10. Find the price of a semiannual coupon bond with a face value of $1000, a 10% coupon rate, and
15 years remaining until maturity given that the required return is 12%?

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Tutorial 4 - DURATION
1. Determine how the duration of a bond would be affected if the coupons are extended over
additional time periods.

2. Does a bond’s time to maturity ever equal its duration? Please explain.

3. What is the effect of raising the coupon payment on the duration of a bond? Assume that the
bond’s yield to maturity does not change.

4. What is the effect on a bond’s duration of increasing the bond’s maturity?

5. How convexity affects the theoretical linear price-yield relationship of bonds? What are the
implications of bond convexity for estimating changes in bond price?

6. A bond has a duration of 5 years and a yield to maturity of 9%. If the yield to maturity
changes to 10%, what should be the percentage price change of the bond?

7. What is the duration and modified duration of a bond with a 7% coupon, 10-year maturity,
yield to maturity of 8%, selling at a price of $950?

8. Calculate the duration of the following bond Price = 927.50, Coupon Rate = 6.35% Years to
Maturity = 8 years

9. Calculate the duration of a three-year, $1,000 face value bond that pays an annual coupon of
9 percent. The bond is selling at par.

10. A trader holds a long position of $3 mil of the 10-year bond which has coupon rate of 9.5%.
The duration of the bond is 8.95, its price is $125, yield is 9%. To protect against the rise in interest
rates, the trader decides to hedge the position using zero-coupon bond which has a BPV of 0.0673.
Suppose that the yield beta is 1.5, what nominal value of the zero-coupon bond must be sold in order
to hedge the position?

11. A bond for the Chelle Corporation has the following characteristics:
Maturity 12 Years; Coupon 10%; Yield to Maturity 9.50%, Macaulay duration 5.7 Years, Convexity
48;Binh
Noncallable
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a) Calculate the approximate price change for this bond using only its duration assuming its yield
to maturity increased by 150 basis points. Discuss the impact of the calculation, including the
convexity effect.
b) Calculate the approximate price change for this bond (using only its duration) if its yield to
maturity declined by 300 basis points. Discuss (without calculations) what would happen to your
estimate of the price change if this was a callable bond.

12. Calculate the duration of an 8 percent, $1,000 par bond that matures in the three years if the
bond's YTM is 10 percent and interest is paid semi-annually.
a) Calculate this bond's modified duration.
b) Assuming the bond's YTM goes from 10 percent to 9.5 percent, calculate an estimate of the price
change.

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Tutorial 5: Yield Curve 1

1. Consider the following zero-coupon market rates:
- One year (1y): 6.000%
- (2y): 6.300%
- (3y): 6.500%
- (4y): 6.655%
- (5y): 6.788%
Calculate the zero-coupon discount factors, prices and yield of following annual coupon
bonds (par value = 100):
1. A 8% 3-year bond;
2. A 8.5% 5-year bond
3. A 9% 4-year bond

2. The one-year cash market yield is 7%. Market expectations have priced one- year rates in one
year’s time at 8.1%, in two years’ time at 8.7%- and three-years’ time at 9.5%.
What is current four-year spot rate that would produce these forward rate views?

3. Consider the following spot yields: 1-year: 8.5%, 2-year: 11%

An investor is debating between 2 alternative investment strategies, both of which must provide
the same return:
- Strategy 1: Invest funds for 2 years at 11%
- Strategy 2: Invest funds for 1 year at 8.5% and re-invest the proceeds for a further year at
the forward rate calculated today.
Using the no-arbitrage principle, calculate the one-year implied forward rate

4. Currently, zero-coupon rates were:

1y: 7.5%
2y: 8.2%
3y: 8.75%
4y: 9.4%
5y: 9.85%
6y: 10.25%
An investor wants to borrow funds for 6 years on a zero-coupon basis and lend these funds in the
market for 4 years then re-invest the proceeds for 2 further years at the forward rate calculated
today. Calculate that forward rate.
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5. Describe yield curve risk and explain why duration does not account for yield curve risk for
a portfolio of bonds.

6. Define LIBOR and explain its importance to funded investors who borrow short term

7. Explain the basic theories of the term structure of interest rates and describe the implications
of each theory for the shape of the yield curve.

8. Compute, compare and contrast the various yield spread measures.

9. 1-, 2- and 3-year spot rates on Treasuries are 4%, 8.167% and 12.377% respectively.
Consider a 3-year, 9% annual coupon corporate bond trading at 89.464. The YTM is 13.50% and
the YTM of a 3-year Treasury is 12%. Compute the nominal spread and the zero-volatility spread of
the corporate bond.

10. If the current 1-year rate is 2%, the 1-year forward rate (1rf1) is 3% and the 2- year forward
rate (1rf2) is 4%. What is the 3-year spot rate?

11. If the current 1-year rate is 1rf0 = 4%, the 1-year forward rate for lending from time 1 to
time 2 is 1rf1 = 5%, the 1-year forward rate for lending from time 2 to time 3 is 1rf2= 6%. Calculate
value of a 3-year annual pay bond with a 5% coupon and a par value of $1,000.

12. Given the term structure of interest rates for maturities at the particular time to which the
bond price quotations refer as following exhibit:
Theoretical spot rates:

Period Years Spot rate (%)

1 0.5 5.25
2 1.0 5.50
3 1.5 5.76
4 2.0 6.02
5 2.5 6.28
6 3.0 6.55

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Consider the following 2 investment alternatives for an investor who has a one-year investment
horizon.
- Alternative 1: Buy a one-year instrument
- Alternative 2: Buy a six-month instrument and when it matures in 6 months, buy another
6-month instrument

Suppose that the investor expects that 6 months from now, the 6-month rate will be 5.6%. Should
the investor select the Alternative 2 rather than Alternative 1?

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Tutorial 6: Yield Curve 2
1. Given the following zero-coupon yield curve
1 year 5%
2 year 6%
3 year 6.5%
4 year 6.75%
5 year 7%
a. Calculate the price and YTM for a 5-year 5% coupon bond, a 2-year 6% coupon bond
b. Calculate the zero-volatility spread (ZS) for the 2-year coupon bond in part (a). Knowing
that the 2-year T – note 5.5%. Calculate nominal spread if the bond is sold at $95.50.

2. 1 year spot rate is 10%, 1r2 = 11%, 2r3 = 13%.

a. Calculate 3-year spot rate using no – arbitrage principle.
b. There are 2 strategies:
o Strategy 1: Invest fund for 3 years
o Strategy 2: Invest 1 year at a time for 3 years
Using spot rate, forward rate and 3-year spot rate calculated from (a), what are the returns of
two strategies? Are they equal? If they are equal, please answer (c)
c. Although returns of two strategies are the same, two investors do not take the same decision.
One takes strategy 1, the other takes 2. Please give your explanation for this difference.

3. Given the same zero-coupon bond rates in question 1. A 3 – year 6% coupon bond is
selling at $97. Should you strip the bond? If so, calculate potential profit

4. You observe in the market that the current 1-year deposit rate is 9%, 2-year Zero coupon
bond price at 80, 3-year zero coupon bond price at 70. You receive loan application for
a. 2-year corporate loan paying semi-annual interest
b. 3-year corporate loan paying annual interest
Price the loans (i.e. calculate the interest of the loan) assuming loan amount is $100.

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Tutorial 7: Repo Instruments

1. Explain the difference between a classic repo and a sell/buy back transaction

2. What is haircut? Why does it exist? Suppose a haircut of 2% is applied to a repo trade
where the market value of the collateral is $10m. How much cash will the borrower receive
and on which amount will the repo interest be calculated on?

3. Classic Repo trade details:

Principal: $10,000,000
Bond price: 100%
Repo Principal: $10,000,000
Repo rate: 5.00%
Actual/360 term: 7 days
Bond price at maturity: 101%
Calculate the repo interest and the repurchase value at maturity

4. A trading house borrows $100,000 of 9% AA bond using 7% AA bond as collateral.

Term 15 days
Market price 9% AA 102
Market price of 7% AA 98.5
Borrowing fee 50 bps
Calculate the nominal amount of the 7% AA bond needed to be fully collateralized; Calculate
the borrowing fee.

5. On 21st June 2015, a corporate wished to invest DEM 50 million against German
government bonds for 7 days. The collateral is the 5½% bunds due in April 2015. The repo
rate 5.6%. The bund clean price is 101.2305, which together with 1.0542 accrued interest (69
days).
‐ Calculate the face value of bunds required at the current market price which will equate to
DEM 50 million.
‐ Calculate amount of termination money

6. Consider the same term as Exercise 5 above, but in this case as a sell/ buy back transaction.
How much is the forward bond price?

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7.TreasuryAManagement
hedge fund manager funds a long position in US Treasury securities against HANU-FMT
sterling, to
value the following day. It is offered a bid of 5.4% in the 2-week, and the market maker also requires
a 1.5% margin.
Nominal amount: $100,000,000
Clean Price: 99.17
Accrued interest (5days): 0.0085762
Exchange rate: 1.63 EUR/ USD
Calculate amount of Sterling termination money.

8. Consider a 90-day repo transaction in the 6% Government bonds, take a margin of 2%.
Nominal amount: $1,000,000. The repo rate is 7%, start date is 4 May 2009.
Suppose that the clean price of the bond is 97.85. Interest has been accrued for 14 days (Day-count
basis: act/ 365).
a. Calculate the amount of termination proceed
b. On 6 Jun 2009, there has been a fall in the bond market and the price decreased to 93.65 (clean
price). Calculate the variation margin

9. A market maker borrows $100,000,000 nominal value of bonds (face value: $100) with the
following info: (Loan term: 25 days)
‐ Coupon: 8.2% (annual, Act/365)
‐ Clean price: 105.85
‐ Accrued day: 40 days
‐ Accrued interest: ???
‐ Total accrued interest: ???
‐ Dirty price: ???
‐ Loan value: ???
‐ Stock loan fee: 65 bps

a. Fill in missing items then Calculate total stock loan fee amount
b. The loan is required to be collateralized with the following bond at haircut of 4%:
‐ Coupon: 7%
‐ Clean price: 102.5
‐ Accrued day: 35 days
Calculate nominal amount of the collateral stock.

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Tutorial 8: Money Market 1

1. If investors require a 7% annualized return on a one-year T-bill with a $10,000 par value,
how much is the price that they are willing to pay for the T-bill? What would happen with the price
if they require a higher return?

2. If investors require a 6% annualized return on a 6-month T-bill, with a $10,000 par value,
how much is the price that they are willing to pay for the T-bill?

3. An investor purchases a T-bill with a 6-month (182-day) maturity and $10,000 par value for
$9,600. (Year day-basis is 365)
a. If this T-bill is held to maturity, how much is its yield?
b. Suppose the investor plans to sell the T-bill after 120 days and forecasts a selling price of $9,820
at that time. Calculate the expected annualized yield based on this forecast.

4. An investor purchases a T-bill with a 6-month (182-day) maturity and $10,000 par value for
$9,600. Year day-basis is 360. Calculate the T-bill discount.

5. A T-bill with a remaining maturity of 54 days is quoted at a discount of 5.7%.

Compute the equivalent yield and the settlement proceeds from trading in the secondary market?
(Year day-basis is 365)

6. An investor purchased a 6-month T-bill with a $10,000 par value for $9,000 and sold it 90
days later for $9,100. How much is the yield? (Year day-basis is 365)

7. Newly issued 3-month T-bills with a par value of $10,000 sold for $9,700. Compute the T-
bill discount. (Year day-basis is 360)

8. An investor initially purchased securities at a price of $9,852,217 with an agreement to sell

them back at a price of $10,000,000 at the end of a 60-day period. Calculate the yield on this
repurchase agreement. (Year day-basis is 360)

9. You paid $98,000 for a $100,000 T-bill maturing in 120 days. If you hold it until maturity,
what is the T-bill yield? What is the T-bill discount? (Year day-basis is 360)

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10. If an investor purchases a 30-day commercial paper with a par value of $1,000,000 for a price
of $990,000. Compute the yield of the commercial paper if it is held to maturity. (Year day-basis
is 360).

11. An investment of $500,000 after 250 days gives total proceeds equal to $540,000. Compute
the simple and effective rates of return on a 360-day basis.

12. A 3-month CD has a face value of $300,000,000, annual coupon of 7.8%. It is issued on 11 May
20XX and matured on 11 Aug 20XX. Year day-basis is 365.
a. Compute the total maturity proceed
b. On 1 July 20XX, the CD is traded in the secondary market in which the prevalent yield at that
time is 7.95%. How much is the settlement proceeds?
c. Compute the rate of return earned from holding the CD from 1 July to 5 Aug

13. A corporation plans to issue Commercial paper with the expected discount rate of 8.5%. The
CP has a nominal value of $1,000,000 and maturity of 60 days. Year day- basis is 365.
a. Compute the issue price for CP?
b. Compute the money market yield on this note for investors?

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Tutorial 9: Money Market 2

1. What is “Liquidity facility” using in Commercial paper programs?

2. What are the methods applied in order to issue Commercial Paper?

3. What are the advantages for companies in using securitization a funding instrument?

4. What is the difference between Credit enhancement and Liquidity support?

5. What are 2 maturity dates under the SLNs

6. How CCNs are different from SLNs?

7. Is FRA an On-balance sheet instrument of Off-balance sheet instrument?

8. Explain the quoting way in a 3v9 FRA

9. A company purchased $2mil notional of a 3v6 FRA which will be dealt at rate 6%.
a. If market rate on the fixing date is 7%, what would happen with the buyer and seller of FRA?
b. If market rate on the fixing date is 5.5%, is there any gain or loss for the “short”
position?

10. Consider a 1v4 FRA that:

‐ Is based on a notional principal amount of $1 mil
‐ Is based on 90-day LIBOR
‐ Specifies a forward rate of 5%
Suppose that the actual 90-day LIBOR 30 days from now is 6%. Compute the cash
settlement payment at expiration. Which party makes the payment? (day-count basis: 360/360)

11. A 2v6 FRA is priced at 6.4% for the contract period from 17 May to 17 Sep.
Another 6v12 FRA is priced at 6.55% for the period from 17 Sep to 17 Mar.
a. Compute the 2v12 FRA price
b. Compute the 2v10

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12. Suppose that the 3-month rate is 6% and the 9-month rate is 6.5%. How much is the value
of 3v9 FRA on a notional principal of $3mil?

13. A notional amount of $200 mil 3v6 FRA is set at the rate of 6.5%. The market maker is exposed
to the risk that interest rates will have raised by the FRA settlement date in 3 months’ time. Suppose
that the 3-month current spot rate is 5.75%.
Compute the hedge ratio for the risk.

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Tutorial 10: SWAP & IRS

1. The data below show the rates at which firm X and firm Y are able to borrow in the fixed-
rate and floating-rate debt markets. Construct a direct swap that would advantage both firms.
Indicate which firm will initially borrow fixed-rate debt and which firm will borrow floating-rate
debt. (The comparative advantage net differential is to be shared equally between the companies)
Debt markets Firm X Firm Y
Fixed-rate funds 12% 14%
Floating-rate LIBOR + 0.5% LIBOR + 1.7%

2. You work at the swaps desk of the treasury division of Mega Bank. Two companies have
approached the bank each seeking to enter into a $1 million intermediated interest rate swap. You
have ascertained the following information in relation to the borrowing capacity of each company:
Debt markets Firm X Firm Y
Fixed-rate funds 9.25% 7.75%
Floating-rate LIBOR + 1.5% LIBOR + 0.6%

You construct a swap that will benefit all parties based on the following
conditions:
- The bank will obtain a spread of 0.1%
- The beneficial gains will be allocated 60% to Firm X and 40% to Firm Y.
Present your offer to the companies. Draw a diagram to show the construction and cash flows of
the intermediated swap.

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Tutorial 11: BASEL II, RWA, CAR

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Tutorial 12: Credit Derivatives

1. Bank made a $200M loan at 12%. The bank wants to hedge the exposure by entering a TRS with
a counterparty. The bank promises to pay the interest on the loan plus the change in market value in
exchange for LIBOR+40bp. If after one year the market value of the loan decreased by 3% and
LIBOR is 11% what is the net obligation of the bank?

2. A credit spread option has a notional of $100M with a maturity of one year. The underlying
security is an 8% 10-year bond issued by corporation XYZ. The current spread is 150bp against 10-
year Treasuries. The option is European type with a strike of 160bps. Assume that at expiration
Treasury yield has moved from 6.5% to 6% and the credit spread widened to 180bps.

3. A portfolio consists of one (long) $100M asset and a default protection contract on this asset. The
probability of default over the next year is 10% for the asset, 20% for the counterparty that wrote the
default protection. The joint probability of default is 3%. Estimate the expected loss on this portfolio
due to credit defaults over the next year assuming 40% recovery rate on the asset and 0% recovery
rate for the counterparty.

4. Portfolio consisting of a $10 million, 10%, 3-year par yield corporate bond and a long position in
a 3-year CDS. The payout will be Notional*(100-B) where B is the price of the bond at expiration,
if the credit event occurs; Expected default probability in each of the next three years is 4%; recovery
rate is 30%. Assuming that CDS premium is paid the year end and default only happens exactly at
the middle of the year; T-note trades at 7%. Calculate the CDS premium using:
a. The risk neutral probability approach
b. The actuarial approach
c. The bond credit spread approach

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