Cashflows and Liquidity Management

Cash flows and Liquidity management – Securities Products

Each security has by its structure a set of associated cashflows. Most common products are cash securities.

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


  1. Bonds

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.

  1. 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


+1,410,000 USD

– 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.



MCX (Multi-commodity exchange of India) – A snapshot

The Multi Commodity Exchange of India Limited (MCX), is a commodity derivatives exchange that facilitates online trading, and clearing and settlement of commodity futures transactions. The Exchange, which started operations in November 2003. It is listed on the BSE. Currently with a market capitalization of ~Rs 5448 crores.

Most active products are

  • Crude oil
  • Zinc
  • Silver
  • Copper
  • Natural Gas
  • Lead
  • Crude Palm Oil
  • Cotton

Key commodities futures product are as below. Options on these are expected to be introduced soon.mcx products


Options on Commodities Futures

Sebi has allowed Derivative Exchanges to allow Options on Commodity Futures as per a circular on their website (13 June 2017).  See link  Sebi circular

In India there are four exchanges were commodity derivatives are traded.

Most contracts are futures (or forwards but since on exchange are futures 🙂 ).

Sebi now allows Options on the futures contracts. This allows for hedging. Also speculation.

Basic criteria is that the futures should have been in the top 5 in trading value over the past 12 months. Basically only liquid futures contracts are eligible.

There is also average daily turnover criteria for the futures over the past 12 months (agricultural Rs 200 crore, other 1000 crore)

Key features

European style exercise

Settlement will be to take the underlying long or short position.


Long call will result in a long position in the future; Long put will result in short position in the future

Short call will result in a short position in the future; Short put will result in the a long position in the future

Position limits for options are separate from futures limits. Margining will be separate.

Due to exercise, the position limits of futures maybe breached. Two working days are allowed to bring these under the limit threshold levels

More on this.

Introduction to Financial Derivatives

A derivative is a financial instrument whose value is derived from another underlying asset. The underlying asset could be

  • Stock
  • Interest rate or foreign exchange rate
  • Index value such as a stock index value
  • Commodity price or index

Value of a derivative is ‘derived’ from another variable

The four basic derivatives types are

  • Forwards
  • Futures
  • Options
  • Swaps

A. Forwards

A forward contract gives the owner the right and obligation to buy a specified asset on a specified date at a specified price. On the specified date, the underlying asset will be received or delivered at this price.

  • The seller of the forward contract has the right and obligation to sell the asset on the date for the price
  • At the end of the forward contract, at “delivery,” ownership of the good is transferred and payment is made from the purchaser to the seller
  • Generally, no money changes hands on the origination date of the forward contract
  • However, collateral may be demanded

Delivery options may exist concerning the

  • quality of the asset
  • quantity of the asset
  • delivery date
  • delivery location

If your position has value, you face the risk that your counterparty will default.

B. Futures

This is a financial contract

  • obligating the buyer
  • to purchase an asset (or the seller to sell an asset),
  • such as a physical commodity (crude oil, wheat, corn) or a financial instrument (debt instruments, stock index, currencies)
  • at a predetermined future date
  • at a predetermined future price

Futures contracts are standardised and are be traded on exchanges. Default risk is lower as they are cleared on exchanges.

Futures and Forwards are identical in structure. The key difference is

  • Futures are exchange traded and hence have no counterparty risk, Forwards are OTC (Over the Counter) products
  • Futures are standardized contracts (done by the Exchange), Forwards are customized by the parties.

C. Options

These are derivatives with the following features

The buyer of an option

  • Has the right
  • but not the obligation
  • to buy (or sell) a particular product
  • on a particular date (Exercise Date)
  • at a particular price (Strike or Exercise Price)

The seller of the option

  • Receives a premium for selling the right
  • Has the obligation to deliver the product when the buyer exercises the option
  • An option seller is also called a ‘WRITER’

Listed Options are standardised and are traded on exchanges

OTC Options are customized and not traded on exchanges

Call Options

  • A call option is a contract that gives the owner of the call option the right, but not the obligation, to buy an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
  • The seller of a call option, the call writer, is obligated to deliver, or sell, the underlying asset at a fixed price, on (or sometimes before) expiration day
  • The fixed price is called the strike price, or the exercise price.


Put Options

  • A put option is a contract that gives the owner of the put option the right, but not the obligation, to sell an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
  • The seller of a put option, the put writer, is obligated to take delivery, or buy, the underlying asset at a fixed price, on (or sometimes before) expiration day.
  • The fixed price is called the strike price, or the exercise price.

Options that can only be exercised at expiration are called “European” options.

Options that can be exercised any time until expiration are called “American” options

D. Swaps

  • A swap is an agreement between counter-parties to exchange cash flows at specified future times according to pre-specified conditions
  • Involves the exchange of cash flows arising from specific
  • Assets
  • Liabilities
  • To exchange one set of cash flows for another without involving the transfer of the asset or liability itself
  • A swap is like a portfolio of forwards. Each forward in a swap has a different delivery date, and the same forward price