25. The Treasury function

What is the role of the treasury management function within a business?

• To manage the firm’s financial resources in the short term

• To manage the exposure to risk

What is the money market?

• The money market is one part of the overall financial market and deals with short-term (usually up to thirteen months) borrowing and lending.

• It serves to allow companies with surplus funds to be able to invest such that companies needing funds are able to borrow

• It allows governments to raise money and also to implement monetary policy

Which three functions of the money market are relevant to the Treasury function?

• The provision of short-term liquidity

• The provision of short-term trade finance

• Allowing the business to manage its exposure to foreign currency risk and interest risk

What is the role of Commercial banks?

• They are the centre of the money markets

• They act as an intermediary between lenders and borrowers

• Commercial banks lend money to eachother (interbank lending) which enables them to comply with regulations regarding the amounts that the bank must have in reserves

• The rate of interest that they charge eachother is the LIBOR (London interbank offer rate) and this acts as a benchmark for all short-term borrowing and lending by the banks (e.g. a bank may decide to lend money at LIBOR plus 2%)

What is the role of Governments?

• They also participate in the money markets

• They raise money by issuing short term Treasury Bills

• The state via the Central Bank influences the supply of money and the interest rates by selling or buying back Treasury bills to or from the banks, and by changing the reserve requirements of the banks

What is the role of companies?

• They also participate in the money markets

• They deposit with or borrow from the banks

• They issue their own “commercial paper” - their equivalent of Treasury bills - which are short-term borrowings

Describe Certificates of Deposit (CDs)

• Deposit with a bank for fixed periods, usually carrying fixed interest

• The rate of interest offered by the bank will depend on the amount deposited and the time period

• On maturity, the money is withdrawn together with the interest that has accrued

Describe Treasury Bills

• Short-term borrowings by governments with fixed maturity dates (a maximum of 12 months)

• They do not pay interest (zero-coupon), but instead are issued at a discount on par value, so the lender receives more on maturity than they originally lent

Describe commercial paper

• Similar to Treasury Bills, but are issued by large corporations

• Unsecured, so are only issued by companies with excellent credit ratings

What are Repurchase agreements (REPOs)?

The borrower sells securities to the lender together with an agreement to buy them back at a later date at a price higher than the original sale price

• difference = repo rate

Describe Eurodollar deposits

Time deposits (for fixed periods, carrying fixed interest) in dollars with banks that are outside the USA.

Describe derivatives

• Financial products whose values come from the price of a particular money market instrument

• E.g futures have value from interest rates