Cash flows and Liquidity management – Securities Products
Each security has by its structure a set of associated cashflows. Most common products are cash securities.
These typically have a set of cashflows that are created during the product life cycle. Some examples are:
- Foreign Exchange (FX) – where there is a promise to exchange foreign currency cashflows
- Fixed Income / Bonds – the issuance of a bond and receiving cash, payment of periodical cashflows (coupon interest) and the repayment of the bond at maturity (just like a loan)
- Equities – Issuance of equities by subscription and payment of cash and then the optional distribution of dividends. In case of buyback, payment of cash. Buy/Sale of equities result in cashflows (net of commissions, fees, exchange taxes, brokerage, etc.)
- Loans – Lending / borrowing of a principal amount and payment of periodical interest and finally the repayment of the loan amount
Cashflows in derivative contracts are determined by the specific type and the underlying assets and are linked to events. There is a difference in the nature of Exchange Traded and OTC derivatives.
- Forward Rate Agreemnet (FRA) – usually the cashflow will be settled based on the difference between the fixed rate and the floating rate that is determined on the specified date.
- Futures – cashflows in exchange traded futures are typically the posting of initial margin and then the daily variation margin (based on mark-to-market MTM). Closing of the contract will also result in the cashflow in or out.
- Options – The main cashflows are the premium cashflows at the start of the contract. On exercise there can be a cashflow, if cash settled, for the difference between strike price and market price
- Swaps – fixed cashflows and floating cashflows (which are determined when the rates are fixed for each period). Swaps are derivatives and hence the notional face values do not result in cashflows. However, there could be collateral cashflows
What this means is that for every trade or contract the bank enters into, it can generate the future projected cashflows for the securitiy or contract – hence projected cashflows.
Let take a look at a few examples related to Cash Securities
A bond is a borrowing and is a promise to repay it at maturity. In a simple bond, the interest payments are paid regularly (e.g. Six montly payments).
So once there is a bond contract, the projected cashflows are the remaining coupon interest cashflows (interest rate X principal amount) and the maturity amount cashflows (principal amount).
So at given time, all the open bond contract have associated future cashflows and all these can be stored and can be aggregated. The dates of these cashflows are know and hence can be aggregated by dates and currency.
- Fx Spot
An FX spot contract is a contract for the exchange of two foreign currency cashflows at settlement date. A spot contract settles in T+2 days (trade date + 2 business days)
Lets have the bank enter into a spot contract to buy USD vs GBP. Let say the spot rate is 1.41. The bank will receive 1.41 USD and deliver 1 GBP. If the total contract is for 1 million GBP, then on T+2 the bank will receive $1.41 million and delivery GBP 1 million
The projected cashflows will then be
– 1,000,000 GBP
These entries are the actual cashflows that will happen in the future. In this case in T+2 days
These cashflows are usually stored in a cashflow database.
All Fx spot contracts done on T will all be generating projected cashflows and the cashflow database can provide a collective view of all the cashflows that are to be paid / received on T+2 after netting.