Cash & Treasury Management Flashcards

Interest rate risk arises when:

Answer: Changes in interest rates affect the cost of borrowing or the return on investments

Interest rate risk is the exposure to changes in interest rates that affect the cost of variable-rate borrowings or the return on variable-rate investments; it can affect both the income statement (interest charges) and cash flow.

An interest rate swap allows a company to:

Answer: Convert a variable-rate loan to a fixed rate (or vice versa) by exchanging interest payments with a counterparty, while the principal is unchanged

An interest rate swap exchanges interest payment obligations — typically swapping a floating rate payment (e.g., SONIA + margin) for a fixed rate with a counterparty, effectively locking in a fixed interest cost without changing the underlying loan principal.

Surplus short-term cash in a treasury function is typically invested in:

Answer: Short-term, highly liquid, low-risk instruments such as money market funds, treasury bills, or short-term bank deposits

Surplus short-term cash must be readily accessible and safe; treasury invests in liquid, low-risk instruments (money market funds, bank deposits, treasury bills) to earn a return without putting capital at risk or sacrificing liquidity.

The 'matching principle' in working capital management means:

Answer: Long-term assets are funded with long-term finance; short-term assets are funded with short-term finance

The matching principle aligns the nature of the funding with the nature of the asset: long-term (non-current) assets should be financed with long-term capital; current assets may be funded by current liabilities — avoiding liquidity mismatches.

A foreign currency transaction exposure arises when:

Answer: A business has a transaction denominated in a foreign currency — the sterling value will change if exchange rates move before settlement

Transaction exposure is the risk that exchange rate movements between the transaction date and the settlement date change the sterling value of a foreign currency receivable, payable, or commitment.

Which of the following is an example of a natural hedge?

Answer: Matching revenues in euros with costs/purchases also denominated in euros — so exchange rate movements affect both sides equally

A natural hedge exists when a business naturally offsets foreign currency revenues against foreign currency costs in the same currency — exchange rate movements affect both sides, reducing net currency exposure without the need for financial instruments.