AAT L4 Cash & Treasury Management 4 — Questions and Answers
Question 1: A cash pooling arrangement in a group context:
- Requires every subsidiary to hold minimum cash balances at all times
- Allows surplus cash from one entity to fund deficits in another within the group, reducing overall external borrowing and optimising interest (Correct answer)
- Merges all group bank accounts permanently into one
- Transfers cash permanently between group companies with no record
Correct answer: Allows surplus cash from one entity to fund deficits in another within the group, reducing overall external borrowing and optimising interest
Cash pooling (notional or physical) allows group treasury to offset surplus cash balances against deficit balances — reducing gross borrowing, improving interest received on surpluses, and reducing interest paid on overdrafts.
Question 2: The Bank of England base rate is relevant to treasury management because:
- It determines the UK corporation tax rate
- It is the benchmark for many variable rate loans, deposits, and financial instruments — changes in base rate directly affect borrowing costs and deposit returns (Correct answer)
- It sets the rate for all UK consumer price inflation
- It is used to calculate capital allowances
Correct answer: It is the benchmark for many variable rate loans, deposits, and financial instruments — changes in base rate directly affect borrowing costs and deposit returns
The Bank of England base rate is the benchmark rate against which many floating rate instruments are priced (e.g., SONIA, which replaced LIBOR). Changes in the base rate directly affect the cost of floating rate debt and the return on deposits.
Question 3: Which of the following is a key risk in treasury operations?
- The risk of selling too many products
- Counterparty risk — the risk that a bank, financial counterparty, or deposit-taker defaults on its obligation (Correct answer)
- The risk of making too large a profit
- The risk that customers order too frequently
Correct answer: Counterparty risk — the risk that a bank, financial counterparty, or deposit-taker defaults on its obligation
Counterparty risk in treasury is the risk that the other party to a financial instrument or deposit (e.g., a bank holding funds, a swap counterparty) defaults — managed through counterparty limits, diversification, and credit ratings.
Question 4: A money market fund (MMF) is suitable for investing short-term surplus cash because:
- It offers guaranteed high returns with no risk
- It provides diversified, highly liquid investment in short-term, high-quality instruments with immediate access to funds (Correct answer)
- It invests in corporate equities to maximise return
- It is only available to companies with turnover over £500 million
Correct answer: It provides diversified, highly liquid investment in short-term, high-quality instruments with immediate access to funds
MMFs invest in diversified portfolios of short-term, high-quality instruments (government securities, bank deposits, commercial paper) — providing safety, liquidity (daily access), and a return above bank deposits for short-term cash parking.
Question 5: The treasury function should operate within board-approved limits for which of the following?
- The number of invoices processed per day
- Counterparty exposure limits, maximum permitted debt levels, permissible hedging instruments, and currency exposure limits (Correct answer)
- The number of customers in each market segment
- The marketing budget for the financial year
Correct answer: Counterparty exposure limits, maximum permitted debt levels, permissible hedging instruments, and currency exposure limits
The board approves a treasury policy setting maximum limits: how much can be placed with any single counterparty, maximum debt gearing levels, what hedging instruments are permitted, and maximum open currency exposure — ensuring treasury operates within controlled parameters.
Question 6: When a company has a surplus of foreign currency received from exports, it can manage this by:
- Leaving the currency in a foreign account indefinitely
- Converting to sterling using a spot transaction, using the funds to pay foreign currency suppliers (natural hedge), or entering a forward contract (Correct answer)
- Refusing to accept payment in foreign currency
- Converting immediately at whatever rate is available regardless of timing
Correct answer: Converting to sterling using a spot transaction, using the funds to pay foreign currency suppliers (natural hedge), or entering a forward contract
Options include: converting to sterling at spot rate; retaining to pay matching foreign currency costs (natural hedge); or using a forward contract to lock in the conversion rate — the choice depends on the timing of matching outflows and risk appetite.
AAT L4 Cash & Treasury Management 4
A cash pooling arrangement in a group context: