Examination Paper

Solutions and Examiner’s Report

Paper:

Certificate in International Cash Management

April 2014

1 ICM

SECTION A - Answer ONE COMPULSORY question

QUESTION 1

Fleurel Inc: Overview

Fleurel’s vision is to make the world a more fragrant place. The company manufactures, markets and sells a range of exclusive and mid-range fragrances. These include perfumes, eau de toilettes, colognes and body sprays. The company is best known for its luxury products ‘Katerina’ and ‘Stephano’ and mid-range products, ‘Tattoo’ and ‘Floral Spring’. Fleurel is incorporated in the USA.

Table 1: Financial Information for Fleurel for the year ended 31 March 2013:

USD million Sales Revenue 357 Cost of Sales 126 Current Assets Cash and cash equivalents 29 Inventories 28 Receivables 54 Current Liabilities Accounts payable 37 Short term borrowing 1

Manufacturing Approximately 80% of Fleurel’s products are manufactured in the company’s manufacturing facilities located in the USA and South Africa. The remaining 20% are manufactured by third parties in India and France, subject to strict quality controls. The third party manufacturers are paid in their local currency.

Purchasing Fleurel has a Central Buying Facility, based in the USA. The Central Buying Facility purchases all the raw materials and packaging that are required by both the company’s own manufacturing facilities and the third party manufacturers, with delivery direct to the manufacturers. The materials are sourced from a number of different countries. Approximately 50% of materials purchased are invoiced in the currency of the supplier and the remaining 50% are invoiced in USD.

Sales The company has customers in 75 countries worldwide. Fleurel’s customers include major retail chains, pharmacies, perfumery groups, prestigious department stores and global duty free shops. All customers are invoiced in their local currency. In major markets, sales are arranged by Fleurel’s own sales team. In those markets where Fleurel has its own sales team, the local sales office raises invoices, collects sales proceeds and orders replacement goods from manufacturers. In minor markets, Fleurel supplies smaller retailers via a network of third party local distributors and the third party distributors collect sales proceeds direct from customers and pass these on to Fleurel’s Head Office in the USA.

2 ICM

Treasury Structure

Fleurel has two Regional Treasury Centres and a Central Treasury in Atlanta, USA. Their location and geographic areas of responsibility are shown in Table 2 below. In addition to being responsible for the domestic cash management in the USA, Canada and Latin America, the Central Treasury in Atlanta also has responsibility for co-ordinating global cash management.

Table 2 Location of Regional /Central Treasuries

Sales region Sales for year ended 31 March 2013 USD million

Location of Regional /Central Treasuries

USA 200 Atlanta USA Asia Pacific 60 Singapore Singapore Europe, Middle East and Africa 46 London England Latin America and Canada 51 Atlanta USA Total 357

Required:

a) Define Cash Management from a Corporate perspective and briefly discuss what is involved in each of the major areas with specific reference to Fleurel.

(7 marks) b) i) Calculate the cash conversion cycle for Fleurel.

(2 marks)

ii) Comment on Fleurel’s cash position and discuss why well managed cash positions are important to Fleurel’s shareholders.

(3 marks)

iii) What factors are most likely to cause fluctuations in Fleurel’s cash flows?

(5 marks)

c) Describe and illustrate with a diagram an appropriate bank account structure for Fleurel’s Central Treasury in the USA. State all your assumptions and the reasons for the structure suggested.

(7 marks)

d) Define ‘Supplier (Supply) Chain Financing’ (SCF). Describe how Fleurel would use SCF.

(4 marks)

e) Describe the key features of Repos. Explain whether or not Repos would be a suitable investment instrument for Fleurel.

(4 marks)

f) Define Sensitivity Analysis and VAR. Describe areas where Fleurel might find these techniques useful.

(3 marks)

(Total 35 marks)

3 ICM

SECTION B - Answer ALL questions QUESTION 2 Required: a) Describe the features and functions of a Smart Card. How does it work

and what may it be used for? (3 marks)

b)

i) Define Value, Availability and Finality. (3 marks)

ii) Use a diagram to show the cheque clearing process in the UK through

the Cheque and Credit Clearing Company (C&CCC). Describe the risks to all the parties involved with respect to Value, Availability and Finality.

(3 marks)

c) Given the following set of circumstances, state how Company A and Company B would make the required payments and from which account and location. Give full reasons for your decisions.

i) Company A is based in the Netherlands. Sales within the

Eurozone are denominated in EUR and all other sales are denominated in USD. Total sales revenues are EUR 700 million and USD 250 million annually. No sales are made in the USA. Company A has 10 suppliers in Switzerland and these are paid in CHF. Total annual CHF payments are USD 300 million equivalent and are subject to specific value dates.

(3 marks)

ii) Company B, based in the USA, only has USD revenues from customers in the USA. It makes a large number of payments in the Eurozone in EUR.

(2 marks)

d) Describe the factors that a company should consider when making international payments.

(3 marks)

(Total 17 marks)

4 ICM

QUESTION 3

Bobaloong, based in Australia, has a subsidiary in the USA that has USD 1,500,000 surplus to requirements for the next 90 days. Bobaloong also has AUD 950,000 in Australia which is surplus to requirements for the next 90 days. 90 day interest rates: % per annum

USD. 360 day basis AUD. 365 day basis Tiers apply to both currencies

Applied on a stepped basis Applied on a banded basis

1 to 1,000,000 0.1450 1.5000 1,000,001 to 2,000,000 0.1982 2.0000 Over 2,000,000 0.2741 2.7100

FX rates Spot USD/AUD 1.2272 – 1.2282 90 day points 62 77

Required:

a) i) Calculate the financial benefit, in AUD, to Bobaloong of

concentrating the USD to Australia for the 90 days. Assume that the US subsidiary is left in the same position as if it had been left to act independently.

(5 marks)

ii) Explain what other factors should be considered before transferring the funds to Australia.

(2 marks)

Q3 continued overleaf

5 ICM

Delspeedy plc summary financial data is as follows: Statement of Financial Position for the year ended 31 December 2013 and projected figures for the year ending 31 December 2014 (in GBP Millions): Assets 31 Dec 13

(actual) 31 Dec 14 (forecast)

Liabilities 31 Dec 13 (actual)

31 Dec 14 (forecast)

Cash 278 ? Payables 165 382 Receivables 825 819 Short term Borrowings 3 33 Inventory 550 546 Long Term Borrowings 550 550 Net Fixed Assets

800 ? Equity 1,735 ?

Total Assets 2,453 ? Total Equity and Liabilities

2,453 ?

Forecast income statement for the year ended 31 December 2014:

GBP million

Notes

Sales revenue 5,460 Cost of Goods Sold ? 75% of sales revenue Selling and Admin costs ? 5% of sales revenue Depreciation 145 Interest expense ? Profit before tax ? Tax @ 30 % ? Profit after tax ?

Additional information:

There will be capital expenditure of GBP 40 million in the year ending 31 December 2014

The average cost of existing borrowings shown above is 4.5 % Delspeedy intends to pay a dividend of GBP 55 million during 2014 Delspeedy plans to take out new short term debt of GBP 30 million at an

interest rate of 1.5% per annum on 2 Jan 2014. This is not yet included in the forecast data given above

Assume that the tax due is paid in the year There were no disposals in the year

Required:

b) i) Given the information above, calculate, for the year ending 31 December 2014:

profit after tax for the year ending 31 December 2014

the forecast net cash position on 31 December 2014

Show all your workings. (4 marks)

ii) What are the implications for the Cash Manager of your results above?

(2 marks)

6 ICM

XYZ is an UK company with a Treasury Centre in the Netherlands which also acts as a multi-lateral netting centre. It has the following pattern of intercompany payments and receipts for the current month.

Figures are in 000’s

Rates GBP/CAD 1.5912 GBP/USD 1.5902 GBP/AUD 1.5301 Required: c) i) Calculate the net cash flows for each country into and out of the

netting centre after applying multilateral netting and show these on a diagram.

(5 marks)

The Global Cash Manager of XYZ has been informed that the Australian company is short of funds this month and will have to increase its borrowing from its bankers if it is to meet its obligations. All the other participants have surplus balances. Required: c) ii) Advise the Global Cash Manager how netting could be used to fund the

Australian company, considering all relevant factors. (3 marks)

(Total 21 marks)

Co A UK GBP

Co B USA USD

Co C Canada CAD

Co D Australia AUD

GBP 4,250

AUD 3,750

CAD 1,800

USD 3,300 CAD 2,000

7 ICM

QUESTION 4 a) Define the terms below. For each one, state the type of investment policy

that would be suitable.

Operating cash Liquidity reserve

Strategic balance (3 marks)

b) Describe the purpose of Negative Covenants. Which covenants would

typically be included under this heading? (3 marks)

c) Describe the process involved in ‘Interest Apportionment’. (3 marks)

d) Define Systemic Risk and explain its importance to a Cash Manager.

(4 marks)

e) Describe a bank’s role in respect of Disclosure and Reporting within Anti-

Money Laundering regulations. (2 marks)

f) Describe the purpose and content of an RFI.

(3 marks)

(Total 18 marks)

8 ICM

QUESTION 5

a) Which one of the following statements is true? i) Public key encryption assures confidentiality and also authentication of

the sender, preventing repudiation ii) Public key encryption has a performance advantage over private key

encryption iii) Private key encryption, also known as asymmetric, uses different keys

to encrypt and decrypt messages iv) Encoded messages are known as ‘cleartext’ or ‘plaintext’ v) A socket is defined as the ‘startpoint’ in a connection

(1 mark)

b) Which one of the following statements is correct? i) EURO1 is the same day low value euro payment system developed

by SWIFT ii) TARGET2’s Information and Control Module allows participants to

gain online access to standardised information iii) Using TARGET2 makes tracing lost items easy iv) EBA-STEP1 is a payment system for commercial transactions and is

designed for bulk cross border payments v) EBA-STEP2 was designed to process low value bulk payments in

euro and other selected European currencies (1 mark)

c) Which one of the following statements about cheque clearing in the USA is

correct? i) With the exception of Alaska, the Fed provides a nationwide cheque

collection facility ii) Each Regional Federal Reserve Bank settles all net cheque

settlements between its regional member banks through the New York Federal Reserve

iii) Regional Clearing House Associations settle all net transactions with the Federal Reserve Bank in New York

iv) With Trilateral or indirect send networks, settlement is made through correspondent accounts

v) Cash letters will be sent to a local bank in the clearing district on which the cheques are drawn

(1 mark)

9 ICM

d) Which one of the following statements is correct?

i) In Brazil the Banco Central do Brazil is responsible for the supervision of all the banks and the Comissao de Valores Mobiliaros (Securities Commission) is responsible for all other financial institutions

ii) In Brazil cheques are cleared via COMPE for next day settlement iii) The Central Bank of Russia’s electronic net settlement system typically

settles within four working days iv) India Pay is used to process all ATM, credit and debit card transactions v) In India, in theory, resident and non-resident companies are not

allowed to participate in cross border sweep structures

(1 mark)

e) Which one of the following statements is correct?

i) With a BSP, the company still manages the function e.g. payroll or bookkeeping

ii) With an ASP the company outsources the function to the ASP iii) Small and mid-sized companies may be attracted to BSP’s because

they have low start-up costs iv) SaaS stands for Services as a Solution v) Traditionally both ASP’s and BSP’s are web enabled

(1 mark) f) Which one of the following statements is true?

i) The serial method of international transfer uses the MT202 to make the payment order

ii) The serial method of international transfer uses the MT101 to advise the beneficiary bank

iii) The serial method of international transfer uses the MT 210 to inform the beneficiary bank

iv) The cover method of international transfer uses the MT210 to debit the originating bank’s correspondent account

v) With the cover method of international transfer the originating bank uses the MT 950 to initiate a credit to its account with its correspondent

(1 mark) g) Which one of the following statements is correct?

i) SOX applies to all public and private companies in the USA ii) Liquidity structures will not impact Thin Cap rules iii) Transfer pricing rules are only applied on the prices of intra-company

service provision iv) The Belgian Co-ordination Centre form of tax advantaged vehicle is

closed to new entrants. v) WHT is applied to the net amount of a dividend or royalty payment

(1 mark)

10 ICM

h) Which one of the following statements best describes a promissory note?

i) A Promissory Note may be transferred and discounted ii) A Promissory Note is a cheque made out to the payee iii) A Promissory Note is a credit transfer system through which

information may be transmitted along with the funds iv) A Promissory Note is another name for a Bill of Exchange v) A Promissory Note can be used for trade related transactions between

counterparties that are usually well known to each other

(1 mark)

i) Which one of the following statements concerning Basel lll is true? i) The Liquidity Coverage Ratio requires a bank to hold sufficient liquid

assets to meet its total net cash outflows over a 60 day period ii) Under Basel lll, the new rules will be phased in from January 2014 to

January 2016 iii) In the context of bank capital requirements, CAR stands for the

Capital Asset Ratio iv) In the context of bank liquidity standards NSFR stands for the Net

Stable Funding Ratio v) Implementation of Basel lll rules is unlikely to decrease annual GDP

growth

(1 mark)

(Total 9 marks)

11 ICM

FORMULAE Leverage ratios Gearing % = __Debt__ Equity

Leverage % = _Debt__ (Debt + Equity)

Interest cover (TIE) = Operating profit (or EBIT) Interest charge

Performance measures ROE = Profit after tax Total equity

EPS = Profit attributable to ordinary shareholders Number of shares Weighted average cost of capital WACC = (After tax cost of debt x % Debt) + (Cost of equity x % Equity) Where: After tax cost of debt = (1- Tax rate) x Cost of debt% Exponential smoothing Ft + 1 = Ft + α (xt-Ft) Calculating issue proceeds

basisYear

DaysrateInterest1

ValueFutureProceeds

All-in cost of borrowing commercial paper Annualized All-In Cost

= Total issue costs x Year basis Issue proceeds Days All-in cost of borrowing using a committed credit line Annualized All-In Cost

= Interest charges + Commitment fee x Year basis Average net drawdown Days

12 ICM

April 2014 ICM Suggested Solutions QUESTION 1

a) Reference Chapter 1.12

Cash management is the effective planning, monitoring and management of liquid/near liquid resources and includes: Day to day cash control. This means having the information to monitor balances and the tools to move liquidity to ensure that the company has enough cash or near cash reserves to meet the short term obligations of the company. For Fleurel with the spread of sales offices around the world and customers being invoiced in their own currencies maintaining an accurate picture of cash positions could be difficult. At least with a central purchasing facility the payment obligations should be easier to monitor. Bank account structure. Having an efficient account structure that minimises borrowing costs and maximises interest earned and facilitates liquidity management. With local currencies involved it implies that sales subsidiaries will need local accounts for efficient collection of local sales receipts. It is presumed that these will be large enough for normal payment to be received via EFT but cheques may be used in some countries e.g. USA, UK , India. Receipts and items in the course of being received. This involves having an account structure for collections and concentration and for managing items in the course of collection. Fleurel will need to be able to collect efficiently a wide range of payment types e.g. cheques, EFT’s and maybe cards. Payments. Controlling liquidity and making payments efficiently and cost effectively. This includes managing balances in the course of disbursement. With the central purchasing facility this should be easier to control with presumably local sales offices being responsible for their own payments e.g. salaries, rent etc. Short term investments. Optimising the use of surplus funds with an investment of less than a year. Given the problems of possibly many accounts in many currencies around the world, optimising liquidity management may be difficult with some countries difficult to move funds out of at will. Short term borrowing. The CM will be responsible for procuring cost effective credit facilities with less than one year’s maturity including intra-day, overnight and short term overdrafts. Fluctuations in Fleurels cash flows, perhaps due to seasonality and the problems of moving funds easily from one country to another may give rise to short term shortfalls around the world. Fleurel will need to be able to forecast these and with forward planning handle the funding requirements as efficiently as possible. Also may include FX, forecasting, trade finance etc. Fleurel will undoubtedly have FX exposures with sales and purchases in many currencies. With some purchases and sales in the same currencies some natural hedging should be available.

13 ICM

b) i) Chapter 4.6

Days inventory 28/126 x 365 = 81 Days receivables 54/357 x 365 = 55 136 Days payables 37/126 x 365 = 107 CCC = 29 ii) Chapter 1.17

Fleurel has cash and cash equivalents of USD 29 million compared to days payables of 107. The cash conversion cycle of 29 days indicates how reliant Fleurel is on their long payables time, twice that of their receivables. If there should be a fall in sales for any reason Fleurel could have a liquidity problem and should ensure adequate backup credit facilities. Managing the cash position is important to Fleurel as it is important to the shareholders. Shareholders need to know that the company has enough cash to remain solvent and to fund their working capital. They will also like to know that Fleurel has enough cash to pay the dividend. This information is used to generate confidence that the management has the business under control.

iii) Chapter 2.4

Timing. Outflows often occur before inflows and the liquidity gap has to be managed. For Fleurel’s CM there will potentially a seasonality issue although the global nature of their business may smooth this for the group CM. The individual countries/ regions may experience this and therefore have to forecast the deficit/surplus liquidity.

Mismatches Outflows and inflows may not be evenly matched. For Fleurel, with large outflows from the centre to suppliers, these may or may not be matched by large inflows from the customers in the USA. Other inflows are not coming straight to the USA.

Economics Given the discretionary nature of the purchase for the ultimate shopper, economic activity may give rise to fluctuations. On the supply side the specialised nature of some of the inputs may give rise to seasonal buying patterns or having to buy and stockpile e.g. Frankincense, Rose oil etc.

Currency Fleurel is buying and selling in a variety of currencies that will be continuously changing their relationships with each other and the dollar.

Location Cash flows are sometimes directed to or from geographically dispersed locations. This is true of Fleurel as they are paying suppliers from the USA but receiving revenue from everywhere. Moving the liquidity from one place to another at the right time will be a challenge.

14 ICM

c) Chapters: 6, 10 & 16

The USA has global responsibility. It is assumed that funds from around the world will be concentrated/funded/defunded periodically and at the control of the centre. In the USA there will be two, possibly three, USD zero balanced disbursement accounts to aid reconciliation. One account will be used for disbursement for domestic USA, ACH or Fedwire payments and depending on volume /cost benefit, maybe a controlled disbursement account for domestic cheque payments. Another disbursement account would be used for the overseas payments to be made via fx from the USA. No currency accounts will be held in the USA as it is not a very efficient environment for currency accounts and where a currency account is warranted, through volumes of payments and receipts, these will be held in the currency centres. These could either be in the name of the Group Treasury or the local subsidiary and some overseas payments would be made from other Fleurel accounts, to match currency flows, by agreement with the local/regional cash managers where allowed and there are no ‘for and behalf of’ issues. Receipts are assumed to be a mixture of large and small and received via a number of different instruments. Domestic USA receipts via ACH or Fedwire will go straight to a concentration account. For cheques, again depending on volumes and cost benefit, there will be retail/wholesale lockboxes or possibly hybrid lock boxes. Lock boxes will zero or target balance to the concentration account depending on how the services are paid for and the volumes/values passing through them. Receipts of USD from overseas will also go to the concentration account. The concentration account would be used to fund the zero balanced disbursement accounts and any request from overseas for funding. This could be done directly or through USD accounts held in the USA by the regional cash managers. (Note: Fleurel could have USD accounts in the USA for the regional Treasuries which would be concentrated and swept overnight). Surplus funds would still either be auto swept offshore as this is still assumed to be best for overnight management (assumed still needed post reg Q) or where worthwhile, using forecasts, placed in specific investment vehicles for specific periods to increase yield. For account structure diagram, see below:

15 ICM

d) Chapter Reference 5.18

Supply Chain Finance, also known as reverse factoring, allows a company to facilitate the provision of credit to its suppliers.

Is used by large companies with solid credit ratings when negotiating extended credit terms with suppliers

The buyer approves invoices presented by the supplier. The supplier then presents them to the buyer’s bank for financing

Usually the supplier can select which invoices to present The bank discounts the invoices and makes early payment to the supplier When credit terms have been completed the bank debits the buyer for the full

amount Invoices can be selected and the total advanced to any one single supplier can

be limited. The process is normally electronic.

Given the extended payment terms and the likely character/ size of many of their suppliers i.e. small specialty producers of fragrances Fleurel might well be the best credit in the supply chain. By using SCF they could be extending their days payables thus releasing liquidity and preserving their own balance sheet.

Central Treasury. USA

USD Concentration a/c

o/n sweep if still needed

Funds from/to overseas regions via fx (swaps, spot, forwards) including Latin America and Canada

Disbursement a/c Payments overseas via FX e.g. to South Africa

Controlled Disbursement a/c Zero balanced

Disbursement a/c Domestic payments via ACH, Fedwire

Cheques

Fund using Fedwire as different bank

Fund using Dr/Cr a/cs as same

Fund using Dr/Cr a/cs as same bank

e.g. on behalf of US manufacturing

Receipts from ACH, Fedwire

Wholesale lockbox

Wholesale lockbox

Wholesale lockbox

Zero balanced

c h e q u e

s

16 ICM

e) Chapter reference 12.13 Repurchase agreements or Repos, from the investors perspective (sometimes referred to as reverse repos) are short term, often overnight, investment agreements. An investor agrees to purchase certain securities from the borrower and at the same time the borrower agrees to repurchase the securities at a specified price. The return to the investor comes from the difference between the buy and sell prices. Repos are a fully collateralised loan to a bank or broker. Restrictions are usually placed on the securities to be used (often treasuries) and the counterparties. Repos would be a suitable investment for Fleurel given the ability to keep the investment short and liquid. As it is fully collateralised the lending is very secure and so would fit the SLY principle, the amount of 29 million USD Fleurel has to invest and the time frame.

f) Chapter reference 17.9 Sensitivity analysis measures the change in value of an exposure for a given change in market prices of, e.g. foreign exchange or commodities. It may be used to show how much Fleurel would gain or lose for a given movement in prices. Fleurel could use this to measure their exposure to FX risks, especially any exotics which might be difficult to cover, interest rate risks and commodity prices and measure their effects on profitability.

VAR or value at risk does much the same thing but aims to quantify the worst loss that might be expected over a period of time (or gain) given a specified level of probability, known as the confidence level. It could be used by Fleurel in the same way as sensitivity i.e. to measure potential loss given a percentage price movement. QUESTION 2

a) Chapter Reference 7.18

A Smart card contains an embedded micro-chip processor that requires a special reader. It is capable of performing many tasks such as storing information, storing value, providing access to specified locations and acting as an identity card. Its primary use is as an electronic wallet capable of paying multiple vendors. Every transaction updates the card’s memory. Value may be replenished at a bank’s ATM or via giro credit. Security features include a PIN, private keys and digital signature. b) i) Chapter Reference 2.5

Value is the moment when funds cease to be useable to the payor or when they become useable to the beneficiary in the sense that they reduce an overdraft balance or start to accrue interest. Banks may forward value i.e. credit an account a day later than they should or back value i.e. debit an account a day before they should.

17 ICM

Availability is the date on which a company will have access to the funds that have been deposited at the bank. They may be paid away by the company. Finality is the time after which a payment is considered to be irrevocable and cannot be returned without the beneficiary’s permission. b) ii) Chapter Reference 8.8

The C&CCC operates a 2-4-6 system for value, availability and finality (except under some specific circumstances). The risks for the payor are minimal mainly that a cheque could be cleared when it should not and they might be unable to have it returned, perhaps stopped too late. For the banks there is little risk as long as cheques are processed/ returned in time as they merely reverse the entry to an account. For the beneficiary there is the risk that they use the funds which are then reclaimed before finality and they find themselves deeply in overdraft.

c) i)

Company A would have an EUR account in the Eurozone depending on where the funds are mainly coming from and how paid (if cheques then may need more than one). They would also have a USD account, probably in the Netherlands but could be elsewhere depending on the pattern of their USD receipts. The CHF would be paid from the USD account(s) using fx to avoid round tripping and made in plenty of time to accommodate delays and vagaries of international payments. Balance of payables not covered by USD income would be made from EUR account via fx.

18 ICM

c) ii)

Company B would open an EUR account in the Eurozone maybe Netherlands or Germany with cheap domestic tariffs and make the payments using the most suitable payment system to take advantage of SEPA rules and regulations on cross border payments etc. Maybe use PEACH.

d) Chapter reference 9.5

Point of origin. Can the payment be made from a local currency account or will it have to be a cross border payment?

Which bank? Will the payment be made through a bank using a correspondent bank or one using its own branches or an alliance?

What method? Will the payment be by cheque or eft? Fees. What fees, charges or value days will be levied on both the payor and

the payee? Will there be any taxes or other charges e.g. commissions be due and are

they recoverable? Regulations. Are there any AML or exchange control regs, central bank

reporting or permissions required? Formatting. What does the company need to know to format the payment

correctly for local systems to ensure STP and to standardise?

QUESTION 3

a i) Chapter Reference 18

US position 1,000,000 x .001450 x 90/360 = 362.50 500,000 x .001982 x 90/360 = 247.75 610.25

Therefore total at day 90 = 1,500,610.25 USD

AUD position

950,000 x .01500 x90/365 = 3,513.70 = AUD 953,513.70

Swap USD to AUD

USD 1,500,000 x 1.2282 = 1,842,300 Plus AUD 950,000 Total to invest 2,792,300 2,792,300 x .0271 x 90/365 = 18,658.68 Total at T90 2,810,958.68 To repay USD1,500,610.25 x 1.2359 = 1,854,604.21 Leaving 956,354.47 So net benefit = AUD 2,840.77

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ii)

To consider:

certainty of the funds being available for the full period in GBP and USD Any other suitable or better uses for the funds Access to credit lines and ability to do the deal Views on rate movements, fx and interest rates What additional costs might there be e.g. transaction costs or tax

implications, corporate or withhold Would it give rise to an inter-co loan and the implications? Would it be better to concentrate to the USA? Any rules regs or central bank reporting Any better use of time

b) i) Chapter Reference 11.23

Note: There are two potential answers below.

Answer 1) assuming that the 30 million of short term debt was in addition to that shown in the forecast balance sheet

Answer 2) assuming that the 30 million shown in the short term balance sheet was the extra 30 million and only the interest cost had to be forecasted. Both versions were accepted as well as any minor variations around the interest cost. Answer 1: Statement of Financial Position for the year ended 31 December 2013 and projected figures for the year ending 31 December 2014 (in GBP Millions): Assets 31 Dec 13

(actual) 31 Dec 14 (forecast)

Liabilities 31 Dec 13 (actual)

31 Dec 14 (forecast)

Cash 278 1,259 Payables 165 382 Receivables 825 819 Short term

Borrowings 3 63

Inventory 550 546 Long Term Borrowings

550 550

Net Fixed Assets

800 695 Equity 1,735 2,324

Total Assets 2,453 3,319 Total Equity and Liabilities

2,453 3,319

Forecast income statement for the year ended 31 December 2014: GBP million

Notes

Sales revenue 5,460 Cost of Goods Sold 4,095 75% of sales revenue Selling and Admin costs 273 5% of sales revenue Depreciation 145 Interest expense 27 Profit before tax 920 Tax @ 30 % 276

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Profit after tax 644 Less Div 55 Retained Earnings 589

Interest expense if 30 considered to be added. ST debt total to go to 63 Then 583 (550 LTdebt + 33 of short) at 4.5% 583,000,000 x .045 = 26,235,000 30,000,000 x .015 = 450,000 26,685,000 = 27 Reconcilliation

! Also note that the cash balance at year end could be arrived at either by completing the balance sheet or by the ‘reconciliation’. Answer 2:

Expected P & L for next year:

Expected Sales 5,460 Cost of Goods Sold 4,095 75 % of sales Selling and Admin costs 273 5 % of sales Depreciation 145 Interest expense 25 Net Income before tax 922 Tax @ 30 % 277 Net income 645 Div 55 Retained earnings 590

Interest = 553,000,000 x .045 = 24,885,000 30,000,000 x .015 = 450,000 25,335,000 rounded to 25

GBP Millions Assets Liabilities Cash 1,230 Payables 382 7 % of sales Receivables 819 15 % of

sales Short term loans

33 Cost 1.5 %pa

Inventory 546 10 % of sales

Long Term Loans

550 Average interest cost 4.5 %

Net Fixed Assets 695 800-145+40

Equity 2,325 1,735 +590

Total Assets 3,290 Total Liabilities

3,290

Retained earnings 589 Plus depreciation 145 Plus decrease Recs 6 Plus decrease in Inv 4 Plus increase in Payables 217 Plus increase in ST Debt 60 Minus Capex (40) Cash flow for year 981 Opening Balance 278 Closing Cash Balance 1,259

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Reconciliation:

ii) The company looks to be highly cash generative, helped by the increase in payables and so the cash manager will need to plan ahead as to what to do with the funds depending on when in the year they are generated and any plans for investment not shown. Choices are to repay some debt if the surplus is perceived to be long term. If short term only, then may be more cost effective to keep debt. If it is not possible or desired to repay debt then plan an investment strategy. Given the cash generation, may need to question why they plan to drawdown 30 million. Do they need to look at their forecasting or can they not go ahead with debt drawdown? Maybe pay some of the trade payments if good discounts available. Consider wisdom of increasing payables. Required: c) i) Chapter reference 14

Co Payer UK GBP USD Canada Australia Total Receiver GBP - - 1,256,913 1,256,913 USD 4,250,000 2,450,820 6,700,820 Canada 2,075,211 2,075,211 Australia 1,131,222 1,131,222 Totals 4,250,000 2,075,211 2,388,135 2,450,820 11,164,166

Co Pays Receives Net GBP 4,250,000 1,256,913 (2,993,087) USD 2,075,211 6,700,820 4,625,609 Canada 2,388,135 2,075,211 (312,924) Australia 2,450,820 1,131,222 (1,319,598) 11,164,155 11,164,16 0

Netting Diagram below

Retained earnings 590 Plus depreciation 145 Plus decrease Recs 6 Plus decrease in Inv 4 Plus increase in Payables 217 Plus increase in ST Debt 30 Minus Capex (40) Cash flow for year 952 Opening Balance 278 Closing Cash Balance 1,259

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c) ii) Chapter 14.26 The most obvious course of action would be to lag the payment due from Australia to the USA thus saving the bank borrowing rate plus spread however the company in the USA would need to be compensated for the ‘loss ‘ of funds for a month and this would be added the next month. We would need to know if the USA would be in surplus after the netting although it is a net receiver. We would also need to know of any other knock on effects in the netting but given the USA can still pay, the rest should settle, including the Canadian payment to the UK. We would want to know if lagging the payment to the USA would be considered inter-company lending and if so, what the tax consequences would be. Would leading a payment from another country (if we know a payment is due in say the next netting) be viewed differently and would it have a different more beneficial tax effect? Finally, consider FX consequences.

GBP

Netting Centre

GBP 2,993,100

USD AUD AUD 2,019,117

USD 7,355,643

CAD 497,904

CAD

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QUESTION 4 a) Chapter reference 12.3

Operating cash is the cash that is needed in the short term for daily operating

needs. This cash requires preservation of capital, instant access and same day liquidity

Liquidity reserve. This is cash that is not needed immediately but needs to remain liquid in case of unforeseen circumstances. This cash can be invested for between 3 to 12 months

Strategic balance. Cash for which there is no immediate use forecasted. It is cash that has remained on the balance sheet unused. This cash may also be invested for between 3 to 12 months.

b) Chapter reference 13.19

Negative covenants require the borrower to refrain from certain actions in order to protect the lender’s position. Typically these would include: There must be no material adverse change in the business during the term of

the loan Restriction on the sale of assets and /or that the sales proceeds must be used

to repay drawings under the facility Restrictions on capital purchases, mergers and acquisitions Restrictions on obtaining other borrowings or on securing assets with more

favourable terms for other lenders (negative pledge) An event of default under another facility causes a default in this one. (cross

default)

c) Chapter Reference 15.2.5

Interest apportionment, also known as interest offset reallocation, refers to the way participant accounts are compensated in a pool. Debit and credit balances are offset and the bank pays or charges a rate of interest agreed with the Treasurer on the net position. This is reallocated to participants based on their balances and possibly adjusted so that the net benefit is shared amongst borrowers, lenders and the treasury. Most tax authorities require this to be done on an arms-length basis. Banks may do this as part of a pooling service. d) Chapter Reference 17.5

Systemic risk is the risk that the failure of one participant in meeting its required obligations in a transfer system or in financial markets generally, will cause other participants or financial institutions to be unable to meet their obligations when due e.g. including settlement obligations in a transfer system. This risk can be as broad

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as the collapse of a financial system, e.g. stock markets or as narrow as the failure of one system used by a company or its bankers. The Cash Manager must be aware of these risks as if the systems that support a transaction fail, this may result in loss to the company. Diversification does not protect against this risk in its broadest definition.

e) Chapter Reference 20.16

In most developed countries banks are now expected to identify, query and potentially report to the police, transactions that appear to be out of the normal business area of their customers. In some countries central banks may require documentary evidence of transactions to be lodged by companies trading with overseas counterparties.

f) Chapter Reference 21.16

An RFI is a request for information, often a letter, designed so that banks can respond with service details that will enable a company to assess the product offerings and the strengths and weaknesses of potential providers. It should help produce a shortlist of banks who will be asked for a full proposal. An RFI should include: A brief overview of the company’s business e.g. turnover, locations, currencies Future plans for cash management Specific product requirements Products and services on offer in what areas does the bank think it has a

leading edge and why Pricing guidelines Service levels Request for products and services brochures. Question 5 a) i chapter reference 22.35 b) ii chapter reference 23.24 c) v chapter reference 23.7 d) ii chapter reference 23.4 e) iii chapter reference 19.19 f) iii chapter reference 9.30 g) iv chapter reference 19.29 h) v chapter reference 7.9 i) iv chapter reference 6.5

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April 2014 ICM Chief Examiner’s Report Summary The pass rate was 54%, and increase on October 2013. 10 distinctions were awarded. Overall, 11% passed Question 1 but failed overall.

Question 1 Average mark 18.14 Standard Deviation (SD) 5.9. a) Overall this part was well answered with only a few students managing to avoid

giving the definition of cash management. Candidates who made their answers specific to Fleurel scored well, it is not enough to just say ‘Fleurel…’ and give the generic points already made with regards to the definition.

b) i) Most candidates calculated this correctly. A few used 360 for the days, so do remember that the 360/365 day issue refers to accruing interest.

ii) The question referred specifically to comments on Fleurel’s cash position but many candidates extended this to general working capital comments. The question also referred to the issue of shareholders and this was often ignored.

iii) Fluctuations in cash flows. This part was not answered well.

c) Students were asked to describe and illustrate a structure of accounts for

Fleurel’s central treasury. Common errors were:

Giving account structures for Asia or Europe. It was quite legitimate to show the connection between the regional and central treasuries but this level of detail was not required

Many did not specify the currency of the account or even say that an account is opened e.g. stating simply ‘central treasury in Atlanta’. The description and the diagram must be complete and complement each other even if it is ‘obvious’.

Fleurel is not really a retail operation so justification was needed for lockboxes either retail or wholesale.

Not giving a full description. If on the diagram it shows an overnight sweep then the reason for this and how it fits should be in the description.

Many had accounts in the diagram which were not referenced in the description.

d) Supply Chain Finance. Some excellent and very full answers were given, however others lacked detail.

e) Repos. This question specifically asked about Repos in relation to being an investment instrument for Fleurel. A lot of answers were from the perspective of using it as a borrowing instrument by Fleurel. It is important to read the question carefully.

f) VAR and sensitivity. Weak answers did not define sensitivity or VAR or describe how Fleurel might use them in their risk management processes.

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Question 2 Average mark 8.7/17. Standard Deviation 3.1. a) Smart cards. It appeared to the examiners overseas candidates were more

familiar with smart cards with Octopus (and oyster) cards being used as illustrations. Some excellent answers were given but others lacked appropriate detail.

b) i) Value, availability and Finality. This was a straightforward ‘define’ question which was answered well however some responses lacked full definitions. Candidates should note that it is insufficient to state that ‘availability is when the funds are available…’ as this does not add much to understanding – in what sense are the funds available?

ii) Use a diagram to show the C&CCC clearing process. Candidates spent additional time describing the process which was not required if their diagram was also properly labelled. The labelling should also include value and finality dates, Drs and Crs etc. Some answers did not show the settlement across the Bank of England accounts. The second part of this question asked about the risks for all the parties involved and this was ignored by many candidates. Simply repeating the 2-4-6 timing does not in itself highlight the risks to the parties involved. Given the marks available, the risks that follow from this should be briefly described.

c) How to make the payments and from where and which account. Overall this question was answered, but weaknesses identified were:

Sketchy reasoning was given behind the suggested solution Not reading the question. In part i) many answered as if there were

receivables in Switzerland and domestic receipts in the USA although the question clearly states that ‘no sales are made in the USA’.

Not realising that a swap is a buy and sell of a currency rather than a one way flow. Candidates should be careful to use the term only when it fits

Not stating what currency the account is in and where

d) International payments. This question was poorly answered by the majority.

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Question 3 Average mark 11.3/21. Standard Deviation 4. a) i) The swap. Overall, this was well answered question but some common errors

were: Not realising that AUD is on a 365 day basis and not 360 and that the

rates are banded for AUD and stepped for USD. Marks were lost by many for ignoring these two factors.

Not adding the amount swapped to the existing AUD amount Taking the forward amount as the spot amount Only working on the difference in interest amounts. Note that this answer

ignores the effect of the difference between the forward and the spot rate on the principal amount.

ii) Usually too few factors were taken into account but some very full and excellent answers were given.

b) i) The ‘pro forma’ forecast. Very few calculated this correctly and some ignored this question altogether. Common errors/omissions were: Forgetting to add back depreciation Forgetting the opening balance Getting the sign wrong on the increase /decrease in the working capital

items (payables, receivables and inventory) Forgetting the dividend payout Miscalculating the fixed assets

ii) For those that completed the calculations, some gave reasonable comments but others were too brief.

c) i) Most candidates calculated the netting correctly although some multiplied the

amounts by the rate rather than divide. The most common mistake or omission was not to do what the question asked for i.e. show the net flows into and out of the netting centre on a diagram. One of the points about netting is that each company will pay or receive in its own currency so showing the net flows in sterling terms was not the answer.

ii) Funding the AUD through the netting. Good answers leading and lagging

and the resulting issues, but other answers were too brief.

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Question 4 Average mark 7.7/18 Standard Deviation 3.4. a) Define operating cash, liquidity reserve and strategic balance. Overall this was

answered well however:

Terms were not defined and some candidates launched straight into the investment

Very generic answers were offered, eg ‘active’ or ‘passive’ but better responses gave more detail as to liquidity and risk and tenor.

b) Negative covenants. Some answers dwelt on the financial covenants such as

debt equity levels and some credit was given for these but negative covenants are things that the borrower should not do e.g. should not sell assets etc and those that covered these issues scored well.

c) Interest Apportionment. This question was answered well. d) Systemic risk. Most candidates knew what systematic risk was, however as

this question was worth 4 marks more detail was needed to score well. e) Anti-money laundering. This question was answered well, although few

candidates remembered to state that the customer should not be informed of the Bank’s suspicions.

f) RFI. Usually reasonably well answered but some candidates did not offer a

definition of RFI and their answers lacked detail. Question 5 Average mark 3.4/9. Standard Deviation 1.8 Surprisingly few candidates scored well for this question. Candidates should remember that there is no negative marking, and so should avoid leaving a blank response.