1. LECTURE (2) Program Magister Manajemen Fakultas Ekonomi Universitas Indonesia Edgar Ekaputra SE, MM. Feb 9, 2010

2. Questions for 2 nd Lecture 1.What is the price of funds? 2.Why is interest rate risk important to a financial institution? 3.What is Gap Analysis? 4.How is gap analysis different from Duration Match Strategy? 5.What are the basic forms of derivatives?

3. The Bank Balance Sheet 1.Cash1.Deposit CashGiro, Deposit Marketable SecuritiesTabungan 2.Earning Assets2. Purchase Funds LoansBanks Non Banks FI 3. Non Earning Assets3. Capital

4. TREASURY MANAGEMENT (2) 15-16 MANAGING INTEREST RATE RISK GAP ANALYSIS DURATION MATCH STRATEGY INTEREST RATE SWAP DERIVATIVES TRADES & 25 TRADING RULES

5. What is the Definition of Business ? What is the Price of Funds? PROFIT PRINCIPLE Buy Low – Sell High The Interest Rate

6. INTEREST RATE THE POSSIBILITY OF LOSS INCURRED BY AN FI WHEN THE PRICE, AMOUNTS, AND MATURITIES OF THE EARNING ASSETS AND LIABILITIES ARE MISMATCHED AND INTEREST RATES ARE VOLATILE

7. CALCULATION EXAMPLE AssetLiabilities V = 10 bioV = 10 bio V = 10 bioV = 10 bio t = 2 yrt = 1 yr t = 2 yrt = 1 yr i = 10%i = 9 % i = 10%i = 9 % profit 1 st yr = …………….? profit 1 st yr = …………….? Profit 1 st yr = 0.01 * 10 bio = 100 mio Profit 1 st yr = 0.01 * 10 bio = 100 mio profit 2 nd Yr = ……………? profit 2 nd 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 and liabilities. Furthermore you must identify Risk Sensitive Assets (RSA) and Risk Sensitive Liabilities (RSL)

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

9. GAP ANALYSIS An NII Projection given Interest Movements The analysis of RSA and RSL to project the Net Interest Income given a movement of Interest Rate cNII = (Gap)*cRt = (RSAt-RSLt)*cRt C: Change NII: Net Interest Income (Interest Income-Interest Expense) RSA: Risk Sensitive Assets RSA: Risk Sensitive Liabilities R: Interest Rate t: Time

10. GAP ANALYSIS (in Billions) AssetLiabilityGap 1 day2030-10 1day-3mos3040-10 3-6 mos7085-15 6-12 mos9070+20 1-5 yr4030+10  5 yr10 5+ 5 260260 0 cNII = (Gap)*cRt = (RSAt-RSLt)*cRt Common repricing gap is 1 year, Gap = -15, if change of rate is average 1% (0.01) then cNII = -15 * 0.01 = -0.015

11. DURATION MATCH STRATEGY An Equity Projection given Interest Movements cE = -(DA – kDL) * A * cR/(1+R) c: Change E: Equity DA : Tenor of Assets k = L/A, Measures the amount of Leverage DL: Tenor of Liabilities (DA – kDL) :The Leverage Adjusted Duration Gap A: Tot Fin Assets L: Tot Fin Liabilities cR/(1+r): The Size of Interest Rate Shock

12. DURATION MATCH STRATEGY DA = 5 yrDL= 3 yr Economic forecast of rates will increase from 10% to 11% Total asset = 100 bio, Total Liability = 90 bio, Equity = 10 bio What is the potential impact to equity holders if the forecast is true? cE = -(D A – kD L ) * A * cR/(1+R) cE = -(5 – (0.9)(3)) * 100 * 0.01/1.1 cE = - 2.09 bio

13. WHAT ARE DERIVATIVES ? Derivatives is an extension or credit enhancement of a conventional financial product with the intention of increasing yields or reducing risks of the original financial transaction.

14. THE FOUR NOTES OF DERIVATIVES SPOT : A transaction done based on two working days. FORWARD: A transaction done on a predetermined date after the spot date SWAP: Two transactions (buy & sell) done on two consecutive dates simultaneously. OPTION: A transaction done based on an option (not an obligation) to sell or buy on a certain predetermined date Bid – Offer Prices Buy – Sell Long – Short Caps – Floors & Collars Support – Ceiling

15. SIMPLE CALCULATION EXAMPLE US$ Rate 9.150 Interest rate Rp: 8% Interest rate US$ 4% What is the 3 months forward Rate? 3 mos fw = 9.150 (1+0.08*3/12) 1 (1+0.04 *3/12) = 9.333/1.01 = 9.2405

16. TYPES OF TRADES TECHNICAL TRADING VS. FUNDAMENTAL TRADING - PRINCIPAL DIFFFERENCE - WHICH ONE DOES THE WORLD FOLLOW?

17. 25 TRADING RULES 1.Trade with the Trend (no trend-no trade) 2.Buy Strength and sell Weakness 3.Have a plan for Your Trade (do your homework) 4.Predetermine Maximum losses in Every Potential Trade (manage your losses) 5.Don’t Chase the Market 6.Give a Trade Time to Work 7.Keep Losses Small 8.Do Not Add to Losses 9.When the Reason for the Trade is No Longer There. Get Out. 10.Use Volume to Help You Trade 11.Make Sure the Technical Confirm the Fundamentals 12.Don’t Trade Illiquid Markets 13.Take A Break When loosing Big 14.When Trading Well Push It a Little

18. 25 TRADING RULES - CONTD 1.Never risk more than 5% of your account equity on a trade 2.Trade Your Personality (Risk Preference) 3.Prices Have Memory (Cycles) 4.Trade What You Trade Best (Knowledge) 5.Monitor Yourself (Moods & Behavior) 6.Know Your Markets (Don’t trade blindly) 7.Don’t Be Greedy (isn't everybody ?) 8.Don’t Trade Scared 9.“Hope” is Not A Trading Strategy 10.Keep It Simple 11.Take A Part of the Profit to Reward Yourself

19. INTEREST RATE SWAP A financial derivative instrument with the Ability to exchange Fixed to floating interest rates, And vice versa, with the purpose to reduce Financial loss due to a movement of interest rates. Floating Rate vs Fixed Rate Swap In reality no Principle Exchange but Netting off payments

20. INTEREST RATE SWAPS Bank ABank B Asset : Com Loan $100Fixed Rate Mortg $100 i: Libor+2.5%i: Fixed at 10% i: Libor+2.5%i: Fixed at 10% Liab: MTN $100 @10%ST CD (Lib+2%) $100 Bank A Floating Rate Bank B Fixed Rate

21. END OF LECTURE (2)

22. The GAME – Week 2

23. OIL PRICE $71.89/Barrel

24. BOND PRICE 113.92

25. SBI RATE 6.44%

26. JSX INDEX 2.476

27. USD/Rp RATE 9.405

28. THE FINANCIAL CRISIS Please 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 PROBLEM d.IDENTIFYING TRIGGERS FOR A FINANCIAL CRISIS Minimum 10 pages, 1.5 spacing, font 12 arial. Complete with conclusions & recommendations