| Summary: | Master of Agribusiness === Department of Agricultural Economics === Allen M. Featherstone === Cash management practices for corporate treasurers are in a state of instability in
recent years. Events during the credit crisis of 2008 have had an impact on how
organization’s cash positions are managed. This has led corporate treasurers to juggle
unprecedented amounts of cash across multiple bank counterparties and invest these funds
based on previous investment policies with potentially inflexible limits. Many regulations
have been passed to strengthen domestic and global financial systems, yet the risk of
default is not completely removed and there are many uncertain ties that corporates face.
To succeed in the uncertain financial environment, counterparty risk tools must be
put in place to improve the visibility of potential operational risk, along with a higher
frequency of reviewing and updating investment policies. It is crucial for corporates to look
beyond the traditional market perceptions and bank credit ratings to evaluate counterparty
risk. Although these continue to be a valuable metric, they should be incorporated with
other forward looking market risk metrics such as credit default swaps, capital and asset
resiliency metrics, and growth and profitability metrics to their current investment
guidelines review. By integrating risk metrics to help formulate an investment policy,
corporates can adapt to the changing financial environment.
This thesis examined methodologies to develop a more accurate and immediate
viewpoint of counterparty creditworthiness. This was done through the creation of models
using market information to set values to view the strength of counterparties and the
likelihood of default. Models were created for both financial institutions and countries
where cash or investments are placed. Depending on the models, this restricts the
permissible investment options that an institution or country has. This approach allows the
company to invest more with higher rated counterparties, and sets a maximum to those who
are deemed high risk of default.
The findings of this thesis identified that it is crucial to classify the right metrics and
look beyond traditional market perceptions and bank credit ratings. By implementing a
balanced process that regularly monitors current market indicators of counterparty risk, an
organization will be in a stronger position to define and determine the potential risk. This
creates a balanced view of both backward looking and forward looking metrics such as
long term debt ratings and credit default swaps. These metrics were useful indicators of a
counterparty’s strength. Because of the wide range of information available and cost, it
went beyond the resources of the company to perform detailed ongoing analysis.
It was also identified that a risk-adjusted approach to setting counterparty limits is
crucial for managing counterparty exposure and the risk of default. To optimize liquidity, it
is in the company’s best interest to place higher balances in institutions with the lowest risk
of default. Grouping banks into tiers and assigning a percentage of total balance to each tier
allows for financial institutions to have a specific limit capacity. Incorporating these tools
on a frequent basis allows for real-time analysis of counterparty exposure and risk.
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