Page 43 - Banking Finance July 2022

ARTICLE

Just like equity prices and foreign exchange markets, short- term, as opposed to investment which is long
interest rates (yields) on debt instruments are determined term. The aim is to earn trading profits from
through the interplay of various economic, financial and movements in security and forex prices during a day or
political factors like liquidity, inflation, government's/RBI's a few days of trading. These are mostly directional
policies, growth, forex demand and supply, domestic vis-a- trades.
vis global interest rates etc. The recent hit of pandemic took
Under this, a dealer may buy (say) 8% Government of
the yields to one of the all time low level and bond prices
India security 2030 at Rs.116.50 at a yield of 6.56% in
soared as both these are inversely proportional to each
anticipation of the yield falling to 5.90%, on
other. Given this, as in the case of equities and forex rates,
fundamental or technical grounds. If this happens, the
bond yields can also vary every moment and with that the
bond appreciates and the bank exits the position with
bond prices also move up and down.
a profit.
Forex trading is also directional, involving, for example,
So treasuries make most of it by dealing in every possible
buying dollar/yen in the expectation that the dollar will
way. In a rising market they can buy at lower prices and sell
appreciate, or selling euro/dollar hoping that the euro
at higher prices by booking profit. In a falling market bank
will decline.
can short-sell at higher prices and then buys later at lower
prices, thus books profit once again. But it is never easy to ii) Investments: Here banks earns a higher yield than its
book such profits always as market can change it direction cost of funds. An example is buying a corporate bond
any time depending upon the factors discussed above. So yielding 8% and maturing in three years, financed by
the inherent risk is also being managed by risk management deposits which are being received in branches costing
department attached to treasury. Apart from this only 6%.
sometimes banks just prefer to receive the coupon by
iii) Subscribing to IPO: Banks treasuries are also allowed
holding the gilts till maturity.
to subscribe for initial public offerings as Qualified
Institutional Bidders (QIBs) and exit the position after
The volatility in interest rates (yields) is at the heart of the
listing at a higher price.
transformation of bank treasuries from mere CRR and SLR
iv) Spreads: In his treasuries leverage the spreads
keepers to a profit centre.
between the rates of source of fund and the use of fund.
In money market The bank may, for instance, borrow
Similarly, the rupee's exchange rate has become volatile.
short- term for 5% and deploy in commercial paper with
There is sufficient fluctuation both intraday and inter-day
returns of 6%.
prices enabling one to earn trading profits on buying and
selling the currency. Cross-currency (dollar/yen, sterling/ v) Arbitrage: Arbitrage is an activity where the bank or
dollar, dollar/Swiss franc) trading opportunities have also for that matter any trader or investor exploits
come to life in Indian banks after liberalization. anomalies in market prices. It allows the investors to
buy at lower prices in one market and sell it in other
For executing these activities properly treasuries have well with high prices without taking any risk. The bank may
equipped and high tech dealing rooms. The Dealing Room, have an 'AAA' bond, which yields only 6%, compared to
which acts as the bank's interface to international and another with the same rating and maturity, but of a
domestic financial markets, is known as the front office of a different issuer, which offers 6.5%. It is worthwhile to
treasury. The officers posted in dealing rooms are known as sell the first bond and invest in the second and improve
dealers and they are responsible for managing the the yield by 50 bps without any incremental risk, as
investment and market risks as per the instructions of the both bonds have the same credit quality.
investment committee and asset-liability committee (ALCO)
In another form of arbitrage banks may enter into a
of the bank.
buy/sell swap agreement in the forex market, where
the bank converts its rupee funds into a dollar deposit,
Profit Generating Activities of Treasury: earns LIBOR, if LIBOR plus the forward premium on
i) Proprietary Trading: In this, the focus is entirely on dollar/rupee is more than the domestic interest rate

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