TREASURY AND HEDGING NOTES
Centralized vs Decentralized
Centralized – treasury acts as the ‘bank’ of the group, ensuring that each department
has access to the correct funds at the correct times
Decentralized – each subsidiary/department within the group – manages their own
funds
Advantages of being Centralized
Avoid mix of surpluses/deficits – in subsidiaries/departments bank accounts
Larger amounts of money – can be invested
Borrowing – can be done in bulk
Expertise of EEs – ability to specialize
Buffer cash – is lower
Better control – due to standardized procedures and risk management
Advantages of being Decentralized
Sources of finance – can be diversified and paired with local assets
Greater freedom and responsibility – given to subsidiaries and departments
The local treasury function – can respond better/quicker to local operating units
Treasury as a Cost or Profit Centre
Cost Centre
- Aim – keep costs as low as possible and keep costs within budgeted targets
- Perform a service – to other departments
Profit Centre
- Aim – to generate a profit for the co
- Usually through – speculative transactions
Advantages & Disadvantages of a Profit Centre
Advantages Disadvantages
- Staff motivated – to obtain best possible - If treasury speculates with futures – can
return for the co lead to huge losses
- If treasury asks a fee – subsidiaries would - If treasury asks a fee – subsidiaries might
be more aware of costs and use treasury use 3rd parties instead of internal
department diligently department
- Difficult to measure and judge performance
- Admin costs – can increase
DERIVATIVES – IFRS 9
, A financial instrument or other contract – with ALL:
Its value changes – in response to the change in a specified interest rate, FI price,
commodity price, foreign exchange rate or other variable
Requires no/small initial investment – compared to other types of contracts with
similar reaction
Settled on – a future date
Examples – option, forward contracts or futures contracts
Primary Derivative Instruments
1. Option – Right, but not obligation, to buy/sell at a specified price on a future date
2. Forward Contract – Commitment to buy/sell on a specified date at a specified price –
not standardized
3. Futures – Commitment to buy/sell on a specified date at a specified price – standardized
1. OPTIONS
Option Terminology
Seller/Writer – party that sells the option
Buyer/Holder – party that buys the option
Premium – price paid by the buyer to the seller of the option
Strike/exercise price – contract price at which the holder CAN buy/sell the asset
Call option – right to buy an asset at a set price (exercise price)
Put Option – right to sell asset at a set price (exercise price)
Option premium – usually a percentage of the spot price
How are Options Created
Co acquire options – to hedge against volatility of e.g. commodity prices and exchange
rates
Issue options to investors – as source of finance
Share options to employees – in form of share based payments – mostly to senior
management
Options on large listed companies – are created by independent parties e.g. investment
banks
- These are called warrants – and are listed on the JSE.
Can be traded on the JSE Derivatives Market or Over the counter (OTC)
Value of Options
Centralized vs Decentralized
Centralized – treasury acts as the ‘bank’ of the group, ensuring that each department
has access to the correct funds at the correct times
Decentralized – each subsidiary/department within the group – manages their own
funds
Advantages of being Centralized
Avoid mix of surpluses/deficits – in subsidiaries/departments bank accounts
Larger amounts of money – can be invested
Borrowing – can be done in bulk
Expertise of EEs – ability to specialize
Buffer cash – is lower
Better control – due to standardized procedures and risk management
Advantages of being Decentralized
Sources of finance – can be diversified and paired with local assets
Greater freedom and responsibility – given to subsidiaries and departments
The local treasury function – can respond better/quicker to local operating units
Treasury as a Cost or Profit Centre
Cost Centre
- Aim – keep costs as low as possible and keep costs within budgeted targets
- Perform a service – to other departments
Profit Centre
- Aim – to generate a profit for the co
- Usually through – speculative transactions
Advantages & Disadvantages of a Profit Centre
Advantages Disadvantages
- Staff motivated – to obtain best possible - If treasury speculates with futures – can
return for the co lead to huge losses
- If treasury asks a fee – subsidiaries would - If treasury asks a fee – subsidiaries might
be more aware of costs and use treasury use 3rd parties instead of internal
department diligently department
- Difficult to measure and judge performance
- Admin costs – can increase
DERIVATIVES – IFRS 9
, A financial instrument or other contract – with ALL:
Its value changes – in response to the change in a specified interest rate, FI price,
commodity price, foreign exchange rate or other variable
Requires no/small initial investment – compared to other types of contracts with
similar reaction
Settled on – a future date
Examples – option, forward contracts or futures contracts
Primary Derivative Instruments
1. Option – Right, but not obligation, to buy/sell at a specified price on a future date
2. Forward Contract – Commitment to buy/sell on a specified date at a specified price –
not standardized
3. Futures – Commitment to buy/sell on a specified date at a specified price – standardized
1. OPTIONS
Option Terminology
Seller/Writer – party that sells the option
Buyer/Holder – party that buys the option
Premium – price paid by the buyer to the seller of the option
Strike/exercise price – contract price at which the holder CAN buy/sell the asset
Call option – right to buy an asset at a set price (exercise price)
Put Option – right to sell asset at a set price (exercise price)
Option premium – usually a percentage of the spot price
How are Options Created
Co acquire options – to hedge against volatility of e.g. commodity prices and exchange
rates
Issue options to investors – as source of finance
Share options to employees – in form of share based payments – mostly to senior
management
Options on large listed companies – are created by independent parties e.g. investment
banks
- These are called warrants – and are listed on the JSE.
Can be traded on the JSE Derivatives Market or Over the counter (OTC)
Value of Options
