The role of the treasury management function

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Question 4b

Wardegul Co, a company based in the Eurozone, has expanded very rapidly over recent years by a combination of acquiring subsidiaries in foreign countries and setting up its own operations abroad. Wardegul Co’s board has found it increasingly difficult to monitor its activities and Wardegul Co’s support functions, including its treasury function, have struggled to cope with a greatly increased workload. Wardegul Co’s board has decided to restructure the company on a regional basis, with regional boards and appropriate support functions. Managers in some of the larger countries in which Wardegul Co operates are unhappy with reorganisation on a regional basis, and believe that operations in their countries should be given a large amount of autonomy and be supported by internal functions organised on a national basis.

Assume it is now 1 October 2017. The central treasury function has just received information about a future transaction by a newly-acquired subsidiary in Euria, where the local currency is the dinar (D). The subsidiary expects to receive D27,000,000 on 31 January 2018. It wants this money to be invested locally in Euria, most probably for five months until 30 June 2018.

Wardegul Co’s treasury team is aware that economic conditions in Euria are currently uncertain. The central bank base rate in Euria is currently 4·2% and the treasury team believes that it can invest funds in Euria at the central bank base rate less 30 basis points. However, treasury staff have seen predictions that the central bank base rate could increase by up to 1·1% or fall by up to 0·6% between now and 31 January 2018.

Wardegul Co’s treasury staff normally hedge interest rate exposure by using whichever of the following products is most appropriate:
– Forward rate agreements (FRAs)
– Interest rate futures
– Options on interest rate futures

Treasury function guidelines emphasise the importance of mitigating the impact of adverse movements in interest rates. However, they also allow staff to take into consideration upside risks associated with interest rate exposure when deciding which instrument to use.

A local bank in Euria, with which Wardegul Co has not dealt before, has offered the following FRA rates:
4–9: 5·02%
5–10: 5·10%
The treasury team has also obtained the following information about exchange traded Dinar futures and options:
Three-month D futures, D500,000 contract size
Prices are quoted in basis points at 100 – annual % yield:
December 2017:   94·84
March 2018:   94·78
June 2018:   94·66

Options on three-month D futures, D500,000 contract size, option premiums are in annual %

Calls Strike price Put
December March June December March June
0·417 0·545 0·678 94·25 0·071 0·094 0·155
0·078 0·098 0·160 95·25 0·393 0·529 0·664

It can be assumed that futures and options contracts are settled at the end of each month. Basis can be assumed to diminish to zero at contract maturity at a constant rate, based on monthly time intervals. It can also be assumed that there is no basis risk and there are no margin requirements.

Required:

(b) Discuss the advantages of operating treasury activities through regional treasury functions compared with:
 – Each country having a separate treasury function.
 – Operating activities through a single global treasury function. (7 marks)

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