Treasury Market

Treasury- It is the heart of any institution and has almost become the synonym of business. This is the part of the institution that funds the activities of any business. Treasury in recent years have become a business in itself. Banks, Corporate and Financial Institutions(Broker firms, Hedge fund institutions etc) have found it so very beneficial that they have created their own business and exclusive department for treasury. What exactly does it represent? There are many divisions in treasury, the BIG and the main ones are the FX(Foreign Exchange and the Money Market or the deposits department), they also have the Options department. How does it work? Banks, FI(Financial Institutions) and Corporate make use of the fluctuating rates of the currencies from time to time. It goes like this, initially these techniques were used to safe guard them from future adverse changes, but now it has become a profit making technique. Nothing much has to be told about Money Markets as it is as simple as a deposit which we place with the banks. The banks offer different rates to different clients. This may depend on the size, business, popularity, credit-worthiness of the client. Suppose if the client has many business dealings with the bank, he may be offered at an extra interest rate. The main business of any Bank, apart from MM is FX/Options and other client customized products. The products which are created for the interest of specific clients are called STRUCTURED PRODUCTS( suiting to the specific needs of the clients and which are not conventional), but when these products are used by many banks then they become a standard product.
FX and FX Options : FX and FXO’s are the most common types of trades done by banks and are worth trillions everyday, USD 1.9trillion to be exact. The main difference between FX and FXO’s is that a FX trade is an obligation after it is entered until it is cancelled/fulfilled but in an option’s case, it is a right but not obligation on the part of the buyer. A buyer is a person who get the right(not obligation) to exercise the option. The counterparty is called the seller and he doesn’t has any such option, because the buyer has the right over the seller, he pays an amount in respect of that right which is called the premium amount. Please do not confuse between buying the option contract and the buying/selling currency in that FX Option contract. This premium to some extent off-sets the risk of the seller.
FX trades are basically the exchange of one currency with another. When a person enters into a FX trade he might use any of the following products viz SPOT(CASH-settled on the same date of trading/TOM-settled on the next business date from the trade date/SPOT-settled day after tomorrow after the trade date), OUTRIGHT(FORWARD) or a SWAP(it is a combination of a SPOT and FORWARD). Reason why one enters in a FX trade: 1. For want of a foreign ccy. 2.Making profit out of the buying rate and the selling rate.( The speed at which the value of a ccy changes is what determines the profit and loss made out of a particular transaction) The reason for existence of these products are because time plays an important role and for distinction purpose. These products are classified with respect to the TRADE DATE( The date on which the counterparties enter into an agreement). SPOT trades are trades wherein the settlement is done after 2 days from the date of entering into the agreement. This 2 day gap is given for preparation of the documents, funds and to compensate on the time zone difference. FX is a 24hrs market and basically a few major hubs are across the world from where trades are done, they are London, Chicago,Singapore,Hongkong, Tokyo and a few more. Though Spot is meant to settle 2 days after the trade date, these days it is also settled on the same date as the trade date, the reason being banks which trade often with each other already keep the documents(agreements) ready and funds is not a problem for them at all. Time zone differences is taken care in the form of Currency cut-off’s.
A currency cut-off is a time which is decided by the central bank of that particular country for clearing its currency on a particular day(In India it is 12 noon). This means that it will not accept funds to be cleared via its system for that particular day. For example, the cut-off for INR is 12noon IST, beyond which the Reserve bank will not clear payments for other banks. The concept of cut-off is then again ruled out when the payment is going within the same bank(internal account transfer) since the payment is not actually sent to the central bank. Ex: INR going from XYZ bank from party A’s account to party B’s account with XYZ bank, but if party B’s holds account with any other bank then it has to go through the central bank and cut-off’s are to be taken into consideration. OUTRIGHT/FORWARD As the name suggests, these trades are meant to be settled after trade + 2day(After SPOT date). The main idea behind using this product over SPOT is the time gap. This product can be used for a much future date. This product is used when a institution feels that the value of one currency might go up or down, and wishes to make profit out of such change(the exports, imports, external balance(balance of payments) etc of a country determines the value of its ccy). Say for example USD is worth 43rs and because of radical growth in the Indian economy, the value of USD in the near future will be worth only 39rs, then a person can enter into a trade to safeguard his income/expenses with regards to such changes. SWAP: A Swap trade is a combination of both SPOT and FORWARD with all the characteristics.
FXO’s: FXO’s are an integral part of FX, but with a hint a huge diversity. FXO’s are FX Options, I have explained the difference above. There are types in options as well, main of them being Plain Vanilla Options and other types which include Barriers and even more customer focused products which are called Structured products. A plain option(Vanilla) is an option where based on a condition the exercise or expiry of the trade is decided. This is mainly the rate of a currency, viz if a currency reaches a particular rate or not. The condition might be either way, exercising if the rate reaches the pre-agreed rate or exercising if it doesn’t or vice-versa. So, there are 4 possible ways. Though it is said that the buyer of the option has the right to exercise or not, but it has become conventional that the trade is usually exercised if the condition is achieved and expired if not achieved, this is because the attainment of such a condition is usually favorable to the buyer of the option. Two terms used in options are CALL and PUT where call means BUY and PUT means SELL and the trade is always from the point of view of the BUYER of the option. A Barrier option is an option wherein barriers(conditions) are placed for the fulfillment or exercising of such an option. An option with one barrier is called single barrier and one with 2 barriers in called double barrier option. The more barrier, the lesser the premium. The reason being since more conditions are placed and the probability of the trade being exercised becomes lesser, so the risk of the seller is also reduced and hence he is paid less. The premium amount is usually calculated based on many factors , one of the most important being the risk involved therein. Some other banking related terminologies are also listed below: Nostro : Nostro is our currency correspondent. There is a rule which states that a bank in one country is not allowed to directly deal with any other foreign currency, but in the growing treasury market, the need of dealing with other currencies has become unavoidable, for this purpose banks create subsidiaries in that particular country to be able to deal with that currency. This subsidiary is called a Nostro and is an independent entity. One might ask, instead of spending so much money in establishing another entity, why not get linked with a native bank there. It is so that banks prefer establishing a new branch there because of various operational benefits, the convenience of getting access to funds and the reduction in charges etc determine this. Over a long run these charges plus the local customers’ business worth etc overlap the initial cost and it is capitalized on.
SWIFT: Society for Worldwide Interbank Financial Telecommunications. This is an independent organization which helps link banks and to transfer funds from one bank to another bank/client. SWIFT has pre-determined forms of payments which are used for customized purposes. Eg : MT101(to debit a client who holds account with us or any of our subsidiaries), MT103 for client fund transfer, MT202 for bank fund transfer. Cover Payment : A cover payment means when a payment is sent to client and when he holds the ccy account in a place other than the native of that particular ccy. E.g.: If A holds his USD account with XYZ bank in London then USD is leaving its native and hence a cover is sent. It is kind of an assurance that the sending bank will pay the beneficiary’s correspondent in time. Cover payment emphasizes a kind of assurance. CLS: Continuous Linked Settlement, it is another independent organization. This is also a type of settlement wherein when the counterparty wishes to settle the trade via CLS(condition being the counterparty and the currency is CLS eligible) the payment is made to the CLS bank and it in turn netts everything in terms of counterparty and ccy and then makes a singe payment or receives a single amount from the counterparty. The main advantage of CLS is that security and promptness of the payment. Even if the client fails to make the payment, the CLS bank will make the payment and the debit the counterparty’s account.

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