THE USE OF FINANCIAL HEDGING TOOLS IN ASSET- LIABILITY MANAGEMENT TO MANAGE INTEREST RATE
RISKS FACED BY BANKS AND ITS EFFECT TO PROFIT.
(Study Case: PT Bank Danamon Indonesia Tbk)
By Stephanus
A Bachelor’s Thesis Submitted to the Faculty of BUSINESS ADMINISTRATION
in partial fulfillment of the requirements for the Degree of
BACHELOR OF BUSINESS ADMINISTRATION
SWISS GERMAN UNIVERSITY Campus German Centre Bumi Serpong Damai – 15321
Island of Java, Indonesia www.sgu.ac.id
STATEMENT BY THE AUTHOR
I hereby declare that this submission is my own work and to the best of my knowledge, it contains no material previously published or written by another person, nor material which to a substantial extent has been accepted for the award of any other degree or diploma at any educational institution, except where due acknowledgement is made in the thesis.
_______________________________________ ________________
Stephanus Date
Approved by:
________________________________________ __________________
Ir. Yosman Bustaman, MBA. Date
______________________________________ _________________
Chairman of the Examination Steering Committee Date
ABSTRACT
THE USE OF FINANCIAL HEDGING TOOLS IN ASSET-LIABILITY MANAGEMENT TO MANAGE INTEREST RATE RISKS FACED BY BANKS AND ITS EFFECT TO PROFIT. (Study Case: PT Bank Danamon Indonesia Tbk)
By
Stephanus
SWISS GERMAN UNIVERSITY Bumi Serpong Damai
Ir. Yosman Bustaman, MBA. , Major Lecturer
Interest rate risk is one of the risks that financial institutions must face in their daily operations. Being exposed to interest rate risk could be prove fatal as no one can control its movement and business participants can only act as a price taker. The movement of interest rate can affect the firm’s profit in terms of its interest income and expense as a potential decrease in income can result from an unfavorable movement of interest. Due to its importance, the research will elaborate the effect of interest rate movements to the firm’s income and expense. Asset Liability management in terms of sensitivity gap and duration gap analysis will be applied to analyze the firm’s exposure to interest rate risk and derivatives contract, in this case, a future and option contract will be used to mitigate the exposure. The research will be using PT Bank Danamon Indonesia Tbk 5 year financial statements. Throughout the research, a simulation analysis of interest rate movement (increase or decrease) will
DEDICATION
I dedicate this thesis to my beloved mother:
Ang Hie Ling And
to Mr. Ir. Yosman Bustaman MBA as my thesis advisor
ACKNOWLEDGMENTS
The author wishes to firstly express his gratitude to Jesus Christ for blessing the author with the strength and health to be able to complete the thesis on time.
The author also wanted to express his gratitude to Ir. Yosman Bustaman MBA as the thesis advisor, for the patience in listening and answering so many questions regarding the thesis.
Many thanks dedicated to the author’s family: Monica, Pauldy, Veronica, Stephanie, Adam and Christine for their support and encouragement. The author also wanted to mention Kiki, Shiro, Luna, Floyd, Leelo and Lily for their affection as to keep the author in good spirit.
Thank you to Ms. Mina Arsita for being very helpful and supportive in organizing the administrative issues associated to the thesis and to Ms. Ane for her time and advice.
Last but not least, an acknowledgement is dedicated to Benedicte Olivia Febe. The author is grateful for her assistance and companionship during the thesis working period.
Stephanus
Jakarta, July 2009
TABLE OF CONTENTS
STATEMENT BY THE AUTHOR ... 2
ABSTRACT…….. ... 3
DEDICATION…. ... 4
ACKNOWLEDGMENTS ... 5
CHAPTER 1- INTRODUCTION ... 13
1.1. Background… ... 13
1.2. Problem Statement….. ... 15
1.3. Research Objective…. ... 16
1.4. Significance of Study…. ... 17
1.5. Scope and Limitation… ... 18
1.6. Systematic Format…. ... 19
CHAPTER 2 – LITERATURE REVIEW ... 20
2.1. What is a Bank?… ... 20
2.2. Risks……….. ... 24
2.3. Interest Rate….. ... 26
2.3.1. Interest Rates in Monetary Policies…. ... 28
2.3.2. Forces Determining Interest Rate in the Market…. ... 29
2.3.3. Interest Rate Risk ... 30
2.4. Asset Liability Management (ALM) ... 33
2.4.1. Interest Sensitivity Gap Management ... 34
2.4.2. Duration ... 38
2.4.2.1. Duration to Hedge Interest Rate Risk ... 41
2.4.3. Derivative Contracts ... 42
2.4.3.1. Futures... 42
2.4.3.2. Options ... 44
2.4.3.5. Interest Rate Floor... 48
2.4.3.6. Interest Rate Collar ... 49
2.4.4. Interest Rate Parity (IRP) ... 49
2.5. Empirical Analysis ... 50
CHAPTER 3 - METHODOLOGY ... 51
3.1. Research Design... 51
3.2. Research Questions ... 53
3.3. Types and Source of Data.. ... 54
CHAPTER 4 – Discussion and Analysis…….. ... 55
4.1. Company Overview – PT Bank Danamon Indonesia Tbk... 55
4.1.1. Corporate Strategy ... 56
4.1.2. Organizational Structure ... 57
4.2. Sensitivity Gap Analysis ... 58
4.3. Net Interest Income Hedging Process ... 95
4.3.1. Hedge with Futures ... 96
4.3.2. Hedge with Options ... 107
4.3.3. Summary NII Hedging Process ... 118
4.4. Duration Gap Analysis ... 119
4.5. Net Worth Hedging Process... 137
4.5.1. Hedge with Futures ... 137
4.5.2. Hedge with Options ... 149
4.5.3. Summary NW Hedging Process ... 159
CHAPTER 5- CONCLUSION AND RECOMENDATION ... 160
5.1. Conclusion…. ... 160
APPENDICES…. ... 168 CURRICULUM VITAE ... 172