LECTURE (2)LECTURE (2)

Program Magister ManajemenProgram Magister Manajemen

Fakultas Ekonomi Fakultas Ekonomi

Universitas IndonesiaUniversitas Indonesia

Edgar Ekaputra SE, MM.Edgar Ekaputra SE, MM.

Feb 9, 2010Feb 9, 2010

Questions for 2Questions for 2ndnd Lecture Lecture

1.1. What is the price of What is the price of funds?funds?

2.2. Why is interest rate risk Why is interest rate risk important to a financial important to a financial institution?institution?

3.3. What is Gap Analysis?What is Gap Analysis?4.4. How is gap analysis How is gap analysis

different from Duration different from Duration Match Strategy?Match Strategy?

5.5. What are the basic forms What are the basic forms of derivatives?of derivatives?

The Bank Balance SheetThe Bank Balance Sheet

1.Cash1.Cash 1.Deposit1.DepositCashCash Giro, DepositGiro, Deposit

Marketable SecuritiesMarketable Securities TabunganTabungan

2.Earning Assets2.Earning Assets 2. Purchase Funds2. Purchase FundsLoansLoans BanksBanks

Non Banks FINon Banks FI

3. Non Earning Assets3. Non Earning Assets 3. Capital3. Capital

TREASURY MANAGEMENT (2) 15-16TREASURY MANAGEMENT (2) 15-16

MANAGING MANAGING INTEREST RATE RISKINTEREST RATE RISK

GAP ANALYSISGAP ANALYSISDURATION MATCH STRATEGYDURATION MATCH STRATEGY

INTEREST RATE SWAPINTEREST RATE SWAPDERIVATIVESDERIVATIVES

TRADES & 25 TRADING RULESTRADES & 25 TRADING RULES

What is the Definition of What is the Definition of Business ?Business ?

What is the Price of Funds?What is the Price of Funds?

PROFIT PRINCIPLEPROFIT PRINCIPLEBuy Low – Sell HighBuy Low – Sell High

The Interest RateThe Interest Rate

INTEREST RATEINTEREST RATE

THE POSSIBILITY OF THE POSSIBILITY OF LOSSLOSS

INCURRED BY AN INCURRED BY AN FI FI

WHEN THE PRICE, AMOUNTS, AND WHEN THE PRICE, AMOUNTS, AND MATURITIES OF MATURITIES OF

THE EARNING ASSETS AND LIABILITIES THE EARNING ASSETS AND LIABILITIES

ARE ARE MISMATCHEDMISMATCHED

ANDAND

INTERESTINTEREST RATES RATES ARE ARE VOLATILEVOLATILE

CALCULATION EXAMPLECALCULATION EXAMPLEAssetAsset LiabilitiesLiabilities V = 10 bioV = 10 bio V = 10 bioV = 10 bio t = 2 yrt = 2 yr t = 1 yrt = 1 yr i = 10%i = 10% i = 9 %i = 9 % profit 1profit 1stst yr = …………….? yr = …………….? Profit 1Profit 1stst yr = 0.01 * 10 bio = 100 mio yr = 0.01 * 10 bio = 100 mio

profit 2profit 2ndnd Yr = ……………? Yr = ……………? What if the rates went up/down by more than 1 % ?What if the rates went up/down by more than 1 % ?

Prudently we would try to match tenors between assets Prudently we would try to match tenors between assets and liabilities. and liabilities.

Furthermore you must identify Risk Sensitive Assets (RSA) Furthermore you must identify Risk Sensitive Assets (RSA) and Risk Sensitive Liabilities (RSL)and Risk Sensitive Liabilities (RSL)

Risk Sensitive Assets & Risk Sensitive Assets & LiabilitiesLiabilities

AssetAsset LiabilitiesLiabilities Cash 0/N Cash 0/N 7.3 %7.3 % Giro Giro 0%0% 1 mos 1 mos 7.67%7.67% Deposito 1 mos Deposito 1 mos 4.5 %4.5 % 3 mos 3 mos 7.81%7.81% 3 mos 3 mos 4.75%4.75% 6 mos 6 mos 7.98%7.98% 6 mos 6 mos 4.85%4.85% 1 yr 1 yr 8.19%8.19% 1 yr 1 yr 5.0 %5.0 %Markt.Sec: Markt.Sec: 11.5% (t:?)11.5% (t:?) Purchased Fund….Purchased Fund….Loan Loan 12.5 %12.5 %NPL: 0%NPL: 0% Capital (ROE ?)Capital (ROE ?)NEA: 0%NEA: 0%

GAP ANALYSISGAP ANALYSIS An An NIINII Projection given Interest Movements Projection given Interest Movements

The analysis of RSA and RSL to project the The analysis of RSA and RSL to project the Net Interest Income given a movement of Net Interest Income given a movement of

Interest RateInterest Rate

cNII = (Gap)*cRt = (RSAt-RSLt)*cRtcNII = (Gap)*cRt = (RSAt-RSLt)*cRtC: ChangeC: Change

NII: Net Interest Income (Interest Income-Interest Expense)NII: Net Interest Income (Interest Income-Interest Expense)

RSA: Risk Sensitive AssetsRSA: Risk Sensitive Assets

RSA: Risk Sensitive LiabilitiesRSA: Risk Sensitive Liabilities

R: Interest RateR: Interest Rate

t: Timet: Time

GAP ANALYSISGAP ANALYSIS(in Billions)(in Billions)

AssetAsset LiabilityLiability GapGap1 day1 day 2020 3030 -10-101day-3mos1day-3mos 3030 4040 -10-103-6 mos3-6 mos 7070 8585 -15-156-12 mos6-12 mos 9090 7070 +20+201-5 yr1-5 yr 4040 3030 +10+10 5 yr5 yr 1010 5 5 + 5+ 5

260260 260260 0 0

cNII = (Gap)*cRt = (RSAt-RSLt)*cRtcNII = (Gap)*cRt = (RSAt-RSLt)*cRtCommon repricing gap is 1 year, Gap = -15, Common repricing gap is 1 year, Gap = -15, if change of rate is average 1% (0.01) then if change of rate is average 1% (0.01) then

cNII = -15 * 0.01 = -0.015cNII = -15 * 0.01 = -0.015

DURATION MATCH DURATION MATCH STRATEGYSTRATEGY

An An EquityEquity Projection given Interest Projection given Interest MovementsMovements

cE = -(DA – kDL) * A * cR/(1+R)cE = -(DA – kDL) * A * cR/(1+R)

c: Changec: ChangeE: EquityE: EquityDA : Tenor of AssetsDA : Tenor of Assetsk = L/A, Measures the amount of Leveragek = L/A, Measures the amount of LeverageDL: Tenor of LiabilitiesDL: Tenor of Liabilities(DA – kDL) :The Leverage Adjusted Duration Gap(DA – kDL) :The Leverage Adjusted Duration GapA: Tot Fin AssetsA: Tot Fin AssetsL: Tot Fin LiabilitiesL: Tot Fin LiabilitiescR/(1+r): The Size of Interest Rate ShockcR/(1+r): The Size of Interest Rate Shock

DURATION MATCH DURATION MATCH STRATEGYSTRATEGY

DA = 5 yrDA = 5 yr DL= 3 yrDL= 3 yrEconomic forecast of rates will increase from 10% to 11%Economic forecast of rates will increase from 10% to 11%Total asset = 100 bio, Total Liability = 90 bio, Total asset = 100 bio, Total Liability = 90 bio, Equity = 10 bioEquity = 10 bioWhat is the potential impact to equity holders if the forecast What is the potential impact to equity holders if the forecast

is true?is true?

cE = -(DcE = -(DA A – kD– kDLL) * A * cR/(1+R)) * A * cR/(1+R)cE = -(5 – (0.9)(3)) * 100 * 0.01/1.1cE = -(5 – (0.9)(3)) * 100 * 0.01/1.1

cE = - 2.09 biocE = - 2.09 bio

WHAT ARE WHAT ARE DERIVATIVES ?DERIVATIVES ?

Derivatives is an extension or credit Derivatives is an extension or credit enhancement enhancement

of a conventional financial product of a conventional financial product

with the intention of increasing yields or with the intention of increasing yields or reducing risks reducing risks

of the original financial transaction. of the original financial transaction.

THE FOUR NOTES OF THE FOUR NOTES OF DERIVATIVESDERIVATIVES

SPOT : SPOT : A transaction done based on two working days.A transaction done based on two working days.

FORWARD: FORWARD: A transaction done on a predetermined date after the A transaction done on a predetermined date after the spot datespot date

SWAP: SWAP: Two transactions (buy & sell) done on two consecutive Two transactions (buy & sell) done on two consecutive dates simultaneously.dates simultaneously.

OPTION: OPTION: A transaction done based on an option (not an A transaction done based on an option (not an obligation) to sell or buy on a certain predetermined dateobligation) to sell or buy on a certain predetermined date

Bid – Offer PricesBid – Offer PricesBuy – SellBuy – SellLong – ShortLong – ShortCaps – Floors & CollarsCaps – Floors & CollarsSupport – CeilingSupport – Ceiling

SIMPLE CALCULATION SIMPLE CALCULATION EXAMPLEEXAMPLE

US$ Rate US$ Rate 9.1509.150

Interest rate Rp: 8%Interest rate Rp: 8%

Interest rate US$ 4%Interest rate US$ 4%

What is the 3 months forward Rate?What is the 3 months forward Rate?

3 mos fw = 3 mos fw = 9.150 (1+0.08*3/12)9.150 (1+0.08*3/12)

1 (1+0.04 *3/12)1 (1+0.04 *3/12)

= 9.333/1.01 = = 9.333/1.01 = 9.24059.2405

TYPES OF TRADESTYPES OF TRADES

TECHNICAL TRADING VS. TECHNICAL TRADING VS.

FUNDAMENTAL TRADINGFUNDAMENTAL TRADING

- PRINCIPAL DIFFFERENCE- PRINCIPAL DIFFFERENCE

- WHICH ONE DOES THE WORLD - WHICH ONE DOES THE WORLD FOLLOW?FOLLOW?

25 TRADING RULES25 TRADING RULES1.1. Trade with the Trend (no trend-no trade)Trade with the Trend (no trend-no trade)2.2. Buy Strength and sell WeaknessBuy Strength and sell Weakness3.3. Have a plan for Your Trade (do your homework)Have a plan for Your Trade (do your homework)4.4. Predetermine Maximum losses in Every Potential Predetermine Maximum losses in Every Potential

Trade (manage your losses)Trade (manage your losses)5.5. Don’t Chase the MarketDon’t Chase the Market6.6. Give a Trade Time to WorkGive a Trade Time to Work7.7. Keep Losses SmallKeep Losses Small8.8. Do Not Add to LossesDo Not Add to Losses9.9. When the Reason for the Trade is No Longer There. When the Reason for the Trade is No Longer There.

Get Out.Get Out.10.10. Use Volume to Help You TradeUse Volume to Help You Trade11.11. Make Sure the Technical Confirm the FundamentalsMake Sure the Technical Confirm the Fundamentals12.12. Don’t Trade Illiquid MarketsDon’t Trade Illiquid Markets13.13. Take A Break When loosing BigTake A Break When loosing Big14.14. When Trading Well Push It a LittleWhen Trading Well Push It a Little

25 TRADING RULES - CONTD25 TRADING RULES - CONTD

1.1. Never risk more than 5% of your account Never risk more than 5% of your account equity on a tradeequity on a trade

2.2. Trade Your Personality (Risk Preference)Trade Your Personality (Risk Preference)3.3. Prices Have Memory (Cycles)Prices Have Memory (Cycles)4.4. Trade What You Trade Best (Knowledge)Trade What You Trade Best (Knowledge)5.5. Monitor Yourself (Moods & Behavior)Monitor Yourself (Moods & Behavior)6.6. Know Your Markets (Don’t trade blindly)Know Your Markets (Don’t trade blindly)7.7. Don’t Be Greedy (isn't everybody ?)Don’t Be Greedy (isn't everybody ?)8.8. Don’t Trade Scared Don’t Trade Scared 9.9. ““Hope” is Not A Trading StrategyHope” is Not A Trading Strategy10.10. Keep It Simple Keep It Simple 11.11. Take A Part of the Profit to Reward YourselfTake A Part of the Profit to Reward Yourself

INTEREST RATE SWAPINTEREST RATE SWAPA financial derivative instrument with theA financial derivative instrument with the

Ability to Ability to exchangeexchange Fixed to floating interest rates, Fixed to floating interest rates,

And vice versa, with the purpose to And vice versa, with the purpose to reducereduce

Financial lossFinancial loss due to a due to a movementmovement of interest ratesof interest rates..

Floating Rate vs Fixed Rate SwapFloating Rate vs Fixed Rate Swap

In reality no Principle Exchange butIn reality no Principle Exchange but

Netting off paymentsNetting off payments

INTEREST RATE SWAPSINTEREST RATE SWAPS

Bank ABank A Bank BBank B

Asset : Com Loan $100Asset : Com Loan $100 Fixed Rate Mortg $100Fixed Rate Mortg $100

i: Libor+2.5%i: Libor+2.5% i: Fixed at 10%i: Fixed at 10%

Liab: MTN $100 @10%Liab: MTN $100 @10% ST CD (Lib+2%) $100ST CD (Lib+2%) $100

Bank AFloating Rate

Bank BFixed Rate

END OF LECTURE END OF LECTURE (2)(2)

The GAME – Week 2The GAME – Week 2

OIL PRICE $71.89/BarrelGlobal Oil Price (WTI)

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110.00

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08

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US$/barrel

BOND PRICE 113.92

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YTD Capital Gain (Right)

Price Index (Left)

(%)

SBI RATE 6.44%SBI 1mo Rate

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%

JSX INDEX 2.476Global Stock Market

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Indonesia (J CI) Singapore (STI) Dow J ones (DJ IA), Right

USD/Rp RATE 9.405USD/IDR

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THE FINANCIAL CRISISPlease Choose 1 Topic

a. SHOULD THE GOVERNMENT BAIL OUT BANK CENTURY?

b. THE CRISIS DIFFERENCE BETWEEN 1998 AND 2008 IN INDONESIA

c. THE CURRENT US FINANCIAL PROBLEMd. IDENTIFYING TRIGGERS FOR A FINANCIAL

CRISIS

Minimum 10 pages, 1.5 spacing, font 12 arial. Complete with conclusions &

recommendations