Risk, Return, and Market efficiency

Article 1

Extending the Capital Asset Pricing Model: the Reward Beta Approach

Topic: to know is reward beta approach better than CAPM and the three-factor model.

Theory:

- Fama And French (1992), doubt about the validity of the CAPM.

- Fama and French (2004) conclude that the CAPM’s empirical problems invalidate most of its current applications.

-  Fama and French (1992) provide strong evidence for size and book to market effects.

-  Bornholt (2006) extends these case by deriving a board class of mean risk asset pricing models that includes the CPAM as a special case.

-  Fama and French (1993) typically show increasing average excess returns and decreasing CPAM betas as book to market equity increases.

-  Fama and French (1992,1993,1995,1996) argue that if stocks are priced rationally, then size and book-to-market equity must proxy for underlying risk factors.

-  Fama and French (1993) use the three-factor model to explain the cross-sectional variation in the returns of 25 portfolios of stocks sorted on size and book-to-market equity comprising New York Stock Exchange (NYSE), American Stock exchange (AMEX) and National Association of Securities dealers Automated Quotation System (NASDAQ) stocks.

-  Fama and French (1992, 1993, 1995, 1996) argue that size and book-to-market equity must proxy for two underlying risk factors if stocks are priced rationally.

Hypothesis:
Reward Beta Approach perform better than the CAPM and the three-factor model.

Variables:

The reward beta approach

Rf=the risk free rate

Ri and Rm=random returns of security I and the market

Βi= CAPM beta

A version of the market model

J= portfolio j

Εj= a random error term

Empirical evaluation

Method of Analysis

• The reward beta approach
• A version of the market model.
• Empirical evaluation
  • Within sample estimates of betas and factor sensitivities
  • Out-of-sample test
  • Robustness

Analysis:
Both the CAPM and the Fama French three factors model are known to have deficiencies.The empirical evidence does not support the CAPM, whereas the three factor model lacks theoretical asset pricing justification and its appeal is limited in practice by estimation problems.

The reward beta approach is based on asset pricing theory and is strongly supported by the empirical evidence reported.

These advantages make this approach a better choice across a range of applications.

Article 2

A Historical Analysis of Market Efficiency: Do Historical Returns Follow a Random Walk?

Main Topic: Market Efficiency

Main problem: try to find that historical returns follow a random walk or not

Theory:

Market efficiency is directly or implicitly tested any time a study is performed to identify stock price reactions to certain events such as dividend announcements (Bajaj and Vijh 1995, 1990), earnings announcements (Bamber 1987), stock splits (Copeland 1979), large block transactions (Holthausen, Leftwich, and Mayers 1987; Kraus and Stoll 1972), repurchase tender offers (Lakonishok and Vermaelen 1990), and other public announcements (Kim and Verrecchia 1991a,b).

Hypothesis: Historical Returns Follow a Random Walk

Method of Analysis

The Box-Jenkins method of forecasting is different from other methods in that it does not assume any particular pattern in the historical data of the series to be forecast. Instead, it uses an iterative approach to identify the underlying pattern. The model is deemed to fit the series well if the residuals between the forecasting model and the historical data points are small, randomly distributed (as white noise), and independent. If the specified model is not satisfactory, the process is repeated by using another model designed to improve upon the original one.

Variable:

YT = dependent variable,

YT-1,YT-2,YT-p = lagged variables,

B1,B2,Bp = regression coefficients,

eT = residual term.

W1,W2,Wq = weights,

eT-1,eT-2,eT-q = previous values or residuals.

Conclusion

Historical stock returns are analyzed to test the efficiency of the NYSE from 1885 through 1962, the period before the CRSP tapes were available. The Box-Jenkins methodology was employed in an attempt to identify patterns which could be used to predict stock returns.

The confidence intervals associated with each of the three tables are consistently and significantly widened with each successive forecasting period indicating that changes in historical stock prices are completely random. Although monthly and weekly return patterns were found to be significant, they were still unsuccessful in predicting future stock price movements. Since changes in stock prices are random, we can do no better than to predict that the next period’s price will be somewhere around where it was the last time we knew it. This conclusion is not surprising, and moreover, is consistent with modern efficient market studies.

Ownership, Control, and Compensation

ARTICLE 1

TITLE

OWNERSHIP STRUCTURE, INVESTMENT, AND THE CORPORATE VALUE: AN EMPIRICAL ANALYSIS

TOPIC

Ownership, Control, and Compensation

THEORY USED BY ARTICLE RESEARCH

Morck et al (1988) and Mc Connell (1990) about non linear relation between ownership structure and corporate value.

1. Exploring how ownership structure affects corporate value.
2. Testing whether it is appropriate to treat ownership structure as exogenous.

Demsetz and Lehn (1985) about OLS (Ordinary Least Square) will generate inconsistent parameter estimates which can lead to misinterpretation of regression results and incorrect management decisions.

Morck et al.(1988) significant relation between insider ownership and corporate value. A similar non monotonic relation between insider ownership and investment, where investment is measured by both capital expenditures and research and development expenditures.

Theoretical predictions focusing whether ownership structure affects investment.

Jensen and Meckling (1976) and Stulz (1988) ownership structure affects corporate value.

Jensen and Meckling (1976) Find ownership structure affects corporate value by its affect on investment.

Morck et al.(1988) and Mc Connell (1990) and Servaes (1990) empirically explore the overall relation between ownership structure and corporate value using Tobin’s Q as a proxy for corporate value. Tobin’s Q may serve as a proxy for other things such as corporate quality or corporate opportunities.

Morck et al (1988) and Mc Connell (1990) treat ownership structure as exogenous in exploring the relation between ownership structure and corporate value.

Demsetz and Lehn (1985) ownership structure is endogenously determined in equilibrium.

Kole (1994) reversal of causality in ownership corporate value relation, suggesting that corporate value could be a determinant of the ownership structure rather than being determined by ownership structure.

HYPOTHESIS OF RESEARCH

1. Hypothyze Ownership structure affects investment which, in turn, affects corporate value.
   1. The possibility that ownership structure, investment, and corporate value are endogenously determined rather than assuming that ownership structure is exogenous.

VARIABLE USED

• Insider ownership (INS1,INS2, INS3)
• Replacement cost of assets
• Tobin’s Q (1990, 1991)
• Capital expenditure
• R&D expenditure
• Cash flow

METHOD OF ANALYSIS

OLS regression analysis

1. Fix this level, then search for the second ownership level that yields the most significant slope coefficient on the second and third insider ownership variables in the regression.
2. Using an iterated search technique around the two initial point, seek to find the two levels of ownership that provide the most significant slope coefficients on the three insider ownership variables simultaneously.

Simulatneous equation regression analysis

to address the potential endogencity effect, a simultaneous equations system of ownership structure, investment, and corporate value using the two stage least squares (2SLS)

RESULT OF THE ANALYSIS RESEACRH

Investment regression result a significant non monotonic relation between the level of investment and insider ownership. The relation between insider ownership and investment is significant for ownership levels between 0% and 38%, but is insignificant for level above 38%.

Simultaneous equation regression analysis a higher level of insider ownership are expected at firm with high corporate value. A higher level of investment may lead to a greater corporate value which induces a higher level of insider ownership.

Simultaneous equation regression result a investment affects corporate value, affects ownership structure.

Robustness test a relation between corporate value and debt is negative for high growth firms and positive for low growth firms.

This paper shows that endogencity significantly affects the inferences one can draw regarding the relation among ownership structure, investment, and corporate value. OLS regression suggests that ownership structure affects investment and therefore corporate value. However. Simultaneous regression reveals that investment affects corporate value which, in turn, affects ownership structure, but not vice versa. The finding also brings into question the result in previous studies, such as Morck et al. (1988) that treat ownership structure as exogenous.This also offers an important managerial implication. In particular, the main finding that investment affects corporate value which, in turn, affects ownership structure, but not reverse suggests that ownership may not be an effective incentive mechanism to induce managers to make value maximizing investment decisions.

ARTICLE 2

TITLE

How Do Family Ownership, Control, and Management Affect Firm Value?

TOPIC

Ownership, Control, Management and Firm Value

THEORY USED BY ARTICLE RESEARCH

family firms are at least as common among public corporations around the world as are widely held and other nonfamily firms (Shleifer and Vishny, 1986; La Porta et al., 1999; Claessens et al., 2000; Faccio and Lang, 2002; Anderson and Reeb, 2003).

Holderness and Sheehan (1988) find that family firms have a lower Tobin’s q than nonfamily firms, while Anderson and Reeb (2003) find the opposite. In other economies, the evidence is scarce but also mixed (Morck et al., 2000; Claessens et al, 2002; Cronqvist and Nilsson, 2003; Bertrand et al., 2004).

Berle and Means (1932)

suggest that ownership concentration should have a positive effect on value because it alleviates

the conflict of interests between owners and managers

Demsetz (1983)

argues that ownership concentration is the endogenous outcome of profit-maximizing decisions by current and potential shareholders, so that as a result, it should have no effect on firm value.

Three recent studies focus more narrowly

on the effect of ownership in the hands of families and other large shareholders: Claessens et al. (2002), Anderson and Reeb (2003), and Cronqvist and Nilsson (2003)

Individual- and family-controlled firms are the foremost example of the corporation modeled by Shleifer and Vishny (1986), one with a large shareholder and a fringe of small shareholders. In such a corporation, the classic

owner-manager conflict described by Berle and Means (1932) or Jensen and Meckling (1976) (to which we shall refer as “Agency Problem I”) is mitigated due to the large shareholder’s greater incentives to monitor the manager. However, a second type of conflict appears (“Agency Problem II”): The large shareholder may use its controlling position in the firm to extract private benefits at the expense of the small shareholders.

Claessens et al. (2002) and Lins (2003) show that in East Asian economies, the excess of large shareholders’ voting rights over cash flow rights reduces the overall value of the firm, albeit not enough to offset the benefits of ownership concentration.

Cronqvist and Nilsson (2003) find that in Sweden it is cash flow ownership, not

excess voting rights, that has a negative impact on value.

Morck et al. (1988), Palia and Ravid (2002), Adams et al. (2003), and Fahlenbrach (2004) find that founder-CEO firms trade at a premium relative to other firms.

Smith and Amoako-Adu (1999) and Pérez-González (2001) find that the stock market reacts negatively to the appointment of family heirs as managers.

For firms with multiple classes of tradable shares, the procedure is the same for each class of stock and only requires adding the market value of all classes (Zingales, 1995, Nenova, 2003).

Palia and Ravid (2002), Adams et al. (2003), and Fahlenbrach (2004) find the founder-CEO premium to be robust to a variety of self-selection tests.

The Governance Index is the measure of corporate governance developed by Gompers,

Ishii, and Metrick (2003) based on the Investor Responsibility Research Center (IRRC) data.

Both dividends and debt can play a role in limiting minority shareholder expropriation by removing corporate wealth from family control (Jensen, 1986; Faccio, Lang, and Young, 2001).

The theoretical debate about the relative importance of each agency problem (see, e.g., Burkart et al., 2003).

HYPOTHESIS OF RESEARCH

Family Ownership, Control, and Management Affect Firm Value

VARIABLE USED

1 Family firm

Firm whose founder or a member of the family by either blood or marriage is an officer, a

director, or the owner of at least 5% of the firm’s equity, individually or as a group. Table 10

considers alternative definitions. Source: Proxies.

2 Founder

Individual responsible for the firm’s early growth and development. Founders have to be

identified as such in at least two public data sources and have no other source mention a

different person as the founder. Sources: Proxies and other SEC documents, Hoover’s,

corporate websites, and web searches about company histories and family relationships.

3 Firm age

Number of years since the founding of the firm or the oldest of its predecessor companies.

Sources: Same as for founder.

4 Family ownership stake

Ratio of the number of shares of all classes held by the family to total shares outstanding. The

numerator includes all shares held by family representatives (e.g., cotrustees, and familydesignated

directors). It includes all shares over which any family member has shared

investment or voting power with a family member (which are only counted once), but none of

the shares over which the investment or voting power is shared with a nonmember of the

family. Source: Proxies.

5 Controlenhancing mechanisms

Voting or control structures that enable the family’s voting rights to exceed its cash flow

rights. These structures include: multiple share classes, pyramids, cross-holdings, and voting

agreements. Multiple share classes are voting structures where the firm has issued two or more

classes of stock with differential voting rights. Pyramids are control structures where the

family holds shares in the firm through one or more intermediate entities such as trusts, funds,

foundations, limited partnerships, holdings or any other form of corporation of which the

family owns less than 100%. Cross-holdings are control structures where the firm owns shares

in a corporation that belongs to the family’s chain of control in the firm. Voting agreements are

pacts among shareholders that result in the family’s holding voting power over a larger number

of shares than what it owns with investment power. Source: Proxies.

6 Family voteholdings in excess of shares owned

Difference between the percentage of all votes outstanding held by the family and the

percentage of all shares outstanding owned by the family. The family’s holdings include all

shares and votes held by family representatives (see [4]). The number of votes held by each

family member/representative is the product of the number of shares with voting power of each

class, times the number of votes per share of that class. Source: Proxies.

7 Governance index

Number of governance provisions in the firm’s charter, bylaws, or SEC filings that reduce

shareholder rights (Gompers-Ishii-Metrick (2003) measure). Source: IRRC.

8 Nonfamily blockholder ownership

Ratio of the number of shares (of all classes) held by all nonfamily blockholders to the total

shares outstanding. Blockholders are individuals or institutions listed in the proxy as beneficial

owners of at least 5% of the firm. Source: Proxies.

9 Nonfamily outside directors

Number of nonfamily outside directors (i.e., directors that are not managers as well, either

active or retired), divided by the total number of directors on the Board. Source: Proxies.

10 Tobin’s q

Ratio of the firm’s market value to total assets. For firms with nontradable share classes, the

nontradable shares are valued at the same price as the publicly traded shares. Sources:

Compustat and Proxies.

11 Industryadjusted q

Difference between the firm’s Tobin’s q and the asset-weighted average of the imputed qs of

its segments, where a segment’s imputed q is the industry average q. Industry averages are

computed at the most precise SIC level for which there is a minimum of five single-segment

firms in the industry-year. Sources: Compustat and Proxies.

12 ROA

Ratio of operating income after depreciation to total assets. Source: Compustat.

13 Market risk (beta)

Estimate from market model in which the firm’s monthly returns over the past five years are

regressed on the S&P 500 monthly returns. Source: CRSP.

14 Idiosyncratic risk

Standard error of estimate from market model in which the firm’s monthly returns over the

past five years are regressed on the S&P 500 monthly returns. Source: CRSP.

15 Diversification

Equals one if the firm has two or more segments in Compustat, zero otherwise.

METHOD OF ANALYSIS

The results are generally robust to the use of alternative specifications and econometric techniques, including multivariate OLS regressions of q and industry-adjusted q on continuous and categorical measures of family ownership and control, fixed and random-effects panel data models, and treatment effect models to control for endogeneity.

RESULT OF THE ANALYSIS RESEACRH

Although family firms play a vital role in the world economy, this sector has received relatively little attention, partly because of the difficulty of obtaining reliable data on these firms. Using this data, we examine the impact of family ownership, control, and management on firm value. Our results highlight the differential contribution to value of each of these elements, individually and in combination with one another. The overall conclusion is that whether family firms are on average more or less valuable than non family firms depends on how these three elements enter the definition of a family firm.

We find that family ownership creates value only when it is combined with certain forms of family control and management. Family control in excess of ownership is often manifested in the form of multiple share classes, pyramids, cross-holdings, or voting agreements. These mechanisms reduce shareholder value, with the reduction in value being proportional to the excess of voting over cash-flow rights. Family management adds value when the founder serves as the CEO of the family firm or as its Chairman with a nonfamily CEO, but destroys value when descendants serve as Chairman or CEO. The interaction between family control and management also generates significant value differences across firms.

Moreover, as Jensen and Meckling (1976) note, agency problems may not impose agency costs on minority shareholders if they were already capitalized into their purchase prices. In descendant-CEO firms, control-enhancing mechanisms have a mildly positive impact on value. This positive impact suggests that the mechanisms play a different role in these firms or at least send a weaker signal to the market: If control-enhancing mechanisms are put in place by descendants, it may be perceived as a defensive move on their part to counter the dilution of their ownership stake that comes with firm or family growth. Nevertheless, nonfamily shareholders in descendant-CEO firms are worse off than they would have been in a nonfamily firm.

Finally, we note that our estimates of the relative importance of family firms are likely be conservative because the firms in our sample are among the largest in the world, are listed on an exchange in a country with a high degree of shareholder protection, are frequent investment targets for index funds, and are generally old and thus more difficult to maintain under family control.

Analysis of KAEF company stock and business portfolio

Company Profile

History

Kimia Farma is a pioneer in the pharmaceutical industry of Indonesia. On August 16, 1971 changed its legal form into Limited Liability Company, a PT Kimia Farma (Persero). Since the date of July 4, 2001 Kimia Farma as a public company listed on the Jakarta Stock Exchange and Surabaya Stock Exchange.

Armed with a long industrial tradition for over 187 years and the name synonymous with quality, today Kimia Farma has grown into a major healthcare company in Indonesia is increasingly playing an important role in development and nation building and community.

Vision: Commitment to improving the quality of life, health and the environment.

Mission: Develop chemical and pharmaceutical industries to perform research and development of innovative products.

Develop an integrated health service businesses (health care providers) based distribution network and a network pharmacy.

Improving the quality of human resources and developing enterprise information systems.

Holding

PT. Kimia Farma Tbk.

Formed: August 16, 1971

Line of Business: Health Services

As well as state-owned public companies, Kimia Farma fully committed to implementing corporate governance both as a necessity and obligation as mandated by Law No.. 19/2003 on State Enterprises.

PT. Kimia Farma Tbk. Is a privately owned integrated health services, moving from upstream to downstream, namely: industry, marketing, distribution, retail, clinical laboratories and health clinics.

The production is made by both companies Pharmaceutical Factory products of chemical drugs, and herbal formulations, divided into 6 (six) lines of ethical production, free drugs, generic drugs, licensing and raw materials.

Almost all therapeutic classes accommodated by the company’s products consist of more than 260 items and products are marketed throughout Indonesia as well as exported to several countries through distribution companies or networks that have agreements with the company.

Subsidiaries

PT. Kimia Farma Trading and Distribution

Line of Business: Distribution of Drugs and Medical Devices

PT. Kimia Farma Trading & Distribution, which has 40 branches that distributes drugs and medical devices that are manufactured or produced by third parties with perpegang in principle to meet customer needs and satisfaction.

PT. Kimia Farma Apotek (Kimia Farma pharmacy)

Line of Business: Pharmacy

PT. Kimia Farma Apotek Apotek manage as many as 340 scattered throughout the country, which led the market with the acquisition field perapotekan market for 19% of total pharmacy sales in Indonesia.

Analysis of company stock risk and market risk

1. a. Analysis of average and standard deviation of stock return, market return and beta of company stock.

IHSG

average return	-0,0002%
standard deviation	0,02184241	2,1842%

KAEF

Average return	-0,0780%
std. Dev.	0,04353864	4,3539%

Market risk and stock risk

Basically, stocks are subject to two types of risk – market  risk and nonmarket risk. Nonmarket risk, also called specific risk, is the risk that events specific to a company or its industry will adversely affect the stock’s price. For instance, an increase in the cost of oil would be expected to adversely affect the stock prices of the entire oil industry, while a major management change would only affect that company. Market risk, on the other hand, is the risk that a particular stock’s price will be affected by overall stock market movements.

Nonmarket risk can be reduced through diversification. By owning several different stocks in different industries whose stock prices have shown little correlation to each other, you reduce the risk that nonmarket factors will adversely affect your total portfolio.

No matter how many stocks we own, you can’t totally eliminate market risk. However, we can measure a stock’s historical response to market movements and select those with a level of volatility you are comfortable with. Beta and standard deviation are two tools commonly used to measure stock risk

Standard Deviation

Standard deviation, which can also be found in a number of published services, measures a stock’s volatility, regardless of the cause. It basically tells you how much a stock’s short-term returns have moved around its long-term average return.. Higher standard deviations represent more volatility. In this case the standard deviation of KAEF is  4,3539% and standard deviation of ihsg is 2,1842%. So KAEF stock is more volatile than its indices.

These two measures can provide important information about a stock’s volatility. If your portfolio is riskier than you realized, you might want to take steps to reduce that risk. When investing, you might want to take a look at a stock’s risk first.

Beta

	Coefficients	Standard Error
Intercept	3,50141E-05	0,001059493
X Variable 1	0,05504994	0,024359543

Beta, which can be found in a number of published services, is a statistical measure of the impact stock market movements have historically had on a stock’s price. By comparing the returns of IHSG to a particular stock’s returns, a pattern develops that indicates the stock’sexposure to stock market risk.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security’s returns to respond to swings in the market. A beta of 1 indicates that the security’s price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security’s price will be more volatile than the market. For example, if a stock’s beta is 1.2, it’s theoretically 20% more volatile than the market.

The IHSG is an index generally considered representative of the Indonesia stock market and has a beta of 1. A stock with a beta of 1 means that, onaverage, it moves parallel with the IHSG – the stock should rise 10% when the IHSG rises 10% and decline 10% when the IHSG declines 10%. A beta greater than 1 indicates the stock should rise or fall to a greater extent than stock market movements, while a beta less than 1 means the stock should rise or fall to a lesser extent than the IHSG. Since beta measures movements on average, you cannot expect an exact correlation with each market movement.

In this case the beta of KAEF is 0,05504994 or 5,5049 %. It shows that this stock is almost risk free. means that, although all listed stocks average price change (up or down) the stock has a beta of 0 is no change  in price at all. Because the beta of thsi stock is almost zero if IHSG change the stock will has a very little change. so the stock has a beta of 0 is not affected by the stock market situation in general.

This Kimia Farma shares viewed from the beta of its shares belong to the income shares of stock, the stock tends to has a beta of less than one. These stocks are usually able to pay higher dividends than dividends paid in previous years. investors who own shares of this type are usually not thinking about the potential growth of stock market prices.

The risk inherent to the entire market or entire market segment. Risk which is common to an entire class of assets or liabilities. The value of investments may decline over a given time period simply because of economic changes or other events that impact large portions of the market. Asset allocation and diversification can protect against market risk because different portions of the market tend to underperform at different times. also called systematic risk.

First i think that the holding company is on the cash cows position. Cash cows are units with high market share in a slow-growing industry. These units typically generate cash in excess of the amount of cash needed to maintain the business. They are regarded as staid and boring, in a “mature” market, and every corporation would be thrilled to own as many as possible. They are to be “milked” continuously with as little investment as possible, since such investment would be wasted in an industry with low growth. The holding company has the largest profit but with low growth.

The second i analyze about the PT. Kimia farma apotek, the SBU of PT kimia farma.it should be include in star matrix. Stars are units with a high market share in a fast-growing industry. The hope is that stars become the next cash cows. Sustaining the business unit’s market leadership may require extra cash, but this is worthwhile if that’s what it takes for the unit to remain a leader. When growth slows, stars become cash cows if they have been able to maintain their category leadership, or they move from brief stardom to dogdom. In this case they growth fastly in profit and market share. We can look in the annual report that the profit is increase year by year.

The third matrix is question mark. Question marks (also known as problem child) are growing rapidly and thus consume large amounts of cash, but because they have low market shares they do not generate much cash. The result is a large net cash consumption. A question mark has the potential to gain market share and become a star, and eventually a cash cow when the market growth slows. If the question mark does not succeed in becoming the market leader, then after perhaps years of cash consumption it will degenerate into a dog when the market growth declines. Question marks must be analyzed carefully in order to determine whether they are worth the investment required to grow market share. I think that PT. KFTD include in this matrix. They dont generate much cash, and need large net cash consumption. We can look on the annual report that they suffer some losses in 2009.

BRI Risk Management

Corporate Profile

PT Bank Rakyat Indonesia (Persero) Tbk. is the oldest bank in Indonesia. Its history was started back on 16 December 1895, when Raden Bei Aria Wiraatmaja founded a small financial institution with the name of De Poerwokertosche Hulp en Spaarbank der Inlandsche Hoofden. The institution managed the mosque’s fund, which was then made available for the people in the vicinity with an easy repayment scheme. Over the years, the institution went through name changes and evolve with the surrounding condition. In 1912, it’s name changed to Centrale Kas Voor Volkscredietwezen, and in 1942 – by Japanese ruling it was changed again to Syomin Ginko. In the independence era, Syomin Ginko was replaced by the name of Bank Rakyat Indonesia. Still going through some name changes, finally in 1992 the official name of the institution was PT Bank Rakyat Indonesia (Persero), being one of the state owned enterprises. In 2003, the Government of Indonesia decided to sell off 30% of its share in the Bank and the Bank became public with the current name.

Vision and Mission

The vision of the Bank is being the leading commercial bank that always prioritize customer satisfaction. To accomplish its vision, the Bank has set itself three missions. First, to conduct the best banking practice with a priority given to services for the Micro, Small and Medium Enterprises (MSMEs) in order to support the economy of the people. Second, to provide its customers with excellent services delivered through its vast network and supported by professional human resources, while adhering to the practices of Good Corporate Governance. Third, to create optimal values and benefits for its stakeholders. Business Focus One characteristic of the Bank that has remained unchanged since its conception is its commitment to provide assistance to micro, small and medium enterprises (MSMEs). The commitment is reflected in the allocation of loans for the sectors that affect the livelihood of the population and other financial services that the Bank offers to the community.

Line of Services

Full Range of Deposits Account

• Saving Deposits (Simpedes, Simaskot, Britama) • Demand deposits • Time Deposits • Special purpose saving deposits (Haj Deposits, Sharia Deposits) Full Range of Lending Accounts • Micro Loans – “Kupedes” ( loans up to Rp 50,- million) • Small Loans (loans from Rp 50,- million up to Rp 5,- billion), including • Consumer Loans • Commercial Loans • Medium Loans (commercial loans from Rp 5,- billion up to Rp 50 billion) • Corporate loans (commercial loans above Rp 50,- billion) Full Range of Banking Services • Money Transfer • Domestic Traveler’s Cheque • Trade Finance and Remittances • Treasury Product Services • Investment Banking Services : – Trust Services – Custodian – Defined contribution pension fund services • Bancassurance • Point of sales services Networks • 1 Head Office • 13 Regional Offices • 11 Inspectorate Offices • 325 Branches (including 1 Special Branch Office) • 148 Sub Branch Offices • 4.049 Micro Units (BRI Units) • 2 Overseas Representative Offices • 612 ATMs owned and more than 6.000 ATMS shared among member banks (“Link”, “ATM Bersama”)) All Branches, Sub Branches and 164 BRI Unit offices are connected online by BRINETS. The rest of BRI Units are computerized but off line systems. BRI’s ATM cards are able to access “Cirrus” worldwide.Employees Due to the extensive networks spread out through the archipelago of Indonesia, the Bank has huge man power. Currently it employs more than 36.000 people with various level and competence. Customers The Bank currently has more than 33 million accounts that represent about 25 million customers, (either depositors or borrowers)

The Risks Faced by Banks

When discussing the challenges faced by financial institutions in managing risk, it is important to have a consistent definition of the term ‘risk’. For the purposes of this paper, risk is defined as the volatility of a corporation’s market value. What is of interest is all decisions that may impact on a change in market value. This is consistent with the view that risk management is about optimising the risk-reward tradeoff – not about minimising the absolute level of risk. In practice, banks’ exposures are asymmetric. This is particularly true for credit risk, where the upside consists of a small positive yield, and the downside consists of a loss that could range from zero to more than 100 per cent of the exposure. Given the importance of this downside risk, banks tend to focus their energies on understanding and managing the key drivers that determine financial loss. In doing this, they generally distinguish between three main types of risk:

i. credit risk – the potential financial loss resulting from the failure of customers to honour fully the terms of a loan or contract. Increasingly, this definition is being expanded to include the risk of loss in portfolio value as a result of migration from a higher risk grade to a lower one;

ii. market risk – the risk to earnings arising from changes in interest rates or exchange rates, or from fluctuations in bond, equity or commodity prices. Banks are subject to market risk in both the management of their balance sheets and in their trading operations; and

iii. operational risk – the potential financial loss as a result of a breakdown in day-to-day operational processes. Operational risk can arise from failure to comply with policies, laws and regulations, from fraud or forgery, or from a breakdown in the availability or integrity of services, systems or information.

Risk Management

BRI’s business activities are always facing risk relating to its function as a financial intermediary institution. The rapid business development in the external and internal bank industry also caused the risk on the bank’s business activities to become more complex. BRI is demanded to implement good risk management to adapt in the bank’s business environment. In this case, risk management principles applied will support BRI to operate more carefully within a rapidly developing banking business and operational activities. Considering the above matters, BRI has prepared the risk management general policy (KUMR) which represent the highest rule in the risk management implementation in BRI’s entire business activities/ either the conventional or based on sharia principles, including general policy, risk management strategy, risk management organization, risk management process, risk management information system, risk management implementation. Internal control system and risk management implementation in using information technology and integrated risk management (Enterprise Risk Management) which include managing risk profile, business continuity management (BCM) implementation, management of new product and activities. BRI’s KUMR was established in accordance with BRI’s Directors Decision Letter to change the organizational structure of the operational working units which initially was only one group of risk taking unit that became the core risk taking unit and supporting risk taking unit. Based on the above KUMR, BRI has applied some policies in risk management sector, such us policies in Market Risk Management (MRP), Credit Risk Management (MRK), and operaional Risk Management (MRO), in order to make the implementation more easier, which were made into one book entitled Guidance on the application and implementation of Risk Management (PPPMR), which is a series of technical guidelines that determine the stages in risk management process that has been determined in KUMR, such as risk identification, risk measurement, risk monitoring and risk control. BRI PPPMR consist of gudance on the application and implementation of credit risk management (PPPMRO), and Gudance on the application and implementation of market Risk Management (PPPMRP). BRI has prepared the Implementation Strategy of Risk Management (SIMR) as the step-by-step guidelines in implementing a consistent risk management for every BRI’s employee, especially senior managers and other executive positions in order to obtain the same understanding of the aims and implementation strategy of risk management in BRI.

Credit Risk Management

The implementation of credit risk management is not only intended to position BRI as a bank that has comlied with the regulation, but as an obligation for management to implement a good credit risk management system and appropriate with best practice in banking industry, which in turn is expected to support BRI’s business activities. In order to maintain and manage credit risk, BRI has established some principles, such as segregation of credit officers according to their task (Relationship management and Credit Risk Management), the implementation of four eyes principle, the implementation of risk scoring system, and also segregation of credit default management. Furthermore, in the credit granting process prudent credit procedures should be followed. BRI has established the guidance on the application and implementation of credit risk management (PPPMRK), consisting the framework and Governance of credit risk management, Loan Portfolio guidelines, Credit Risk Limit Determination Procedures for activities (credit, trade finance, treasury and financing) and credit risk measurement guidance based on Basel II (standardized approach and Internal Rating Based Approach). In the Credit Risk Management Framework, a Credit Risk Management Framework, a Credit Risk Management Comittee/CRMC is required, which is a Sub Risk Management Committee (RMC) to discuss problems regarding the credit riskexpoosure and the implementationof credit riskmanagement. The measurement of credit risk with internal rating based Approach (IRBA) was started by performing the Redisgn Credit Risk Rating (CRR) and Credit Risk Scoring (CRS). BRI has redesign the CRR for middle and retail businesses, and also CRS for Briguna Kretap Loans, Kresun, KPR, automobile KKB, Motorcycle KKB and kupedes non Golbertap loan. To support the implementation of credit risk measurement based on Basel II (Standardized Approach and Internal Rating Based Approach) as stated above, currently the Loan Approval System (LAS) is implemented for kupedes loans and a part of retail loans (consumer loans and co0mmercial loans up to Tp 500 million and Public Credit Activities). The following step, LAS development for loans above Rp 500 million will be implemented. In addition, BRI has performed credit risk stress testing analysis by using indicators and methods in line with internal and macro economic conditions. Stress testing analysis is conducted in a routine way a minimum of once in a year or if a worst case has occured.

Liquidity and Market Risk Management

BRI monitors the optimum liquidity level by maintaing an adequate amount of liquid assets to pay the deposits from customers and matured liabilities and provide funds for asset growth when needed. BRI has established the liquidity risk analysis called the liquidity Gap Analysis which is information that becomes BRI’s consideration in planning and managing its liquidity containing information about surplus or deficit projection of liquidity pursuant to maturity profile including BRI business expansion needs. BRI performs market risk management by monitoring the trading activities conducted by the dealers from treasury division and setting the transaction limit such as dealer nominal limit and cut loss lomit through standardized method approach established by Bank Indonesia. In preparing the application of market risk calculation with internal model, BRI has performed a simulation of the calculation of capital expense with internal model VaR Variance Covariance in 10 Days Holding Period for Interest rate risk and exchange rate risk. To support the process of capital alloocation calculation to cover market risk to ease the monitoring of market risk and providing an updated information for management, BRI is the process of developing Up Grade Treasury System and Market Risk Applications. With the above applications onhand, it is expected that the calculation of market risk can be more accurate and reflect the real risk rate.

Operational Risk Management

Management of operational risk is an integral part of BRI’s risk management. The nature of operational risk differs from credit risk and market risk. Generally, the important process in managing operational risk is the mitigation of risk. The above management of risk is to minimize the possibility and effect of loss, including permanen threat of BRI’s reputation. Some important matters that have been preformed in connection with the implementation of operational risk management are:

1. Primary tools of Operational Risk Management The primary tools of such operational risk management are Risk and Control Self Assessment (RCSA), key Risk Indicators (IRU) and Incident Managemnt (MI).

2. Application System of Operational Risk Management To support the smooth implementation of the three operational risk management tools mentioned above, BRI currently has reached the final step of management development process of operational Risk Management application software and process of preparing the Guidance on the implementation of Operational Risk Management (PPPMRO). This application system will include RCSA, IRU,MI and the calculation of reserve capital of operational risk with advanced Measurement Approach (AMA) method. The target completion of procurement and development of MRO application system by June 2009. Furthermore, Operational Risk Management has mapped the business line as required by Basel Capital Accord II so that the risk measurement tools can be performed in a more sensitive approach

3. Risk Management Function The risk Management function found in all BRI operation units (UKO) is used to improve risk awareness culture in every employee and in applying the identification, measurement control and monitoring processes in their respective units. This function is directly responsible to the head of UKO and in directly reports of risk management and monitoring to the risk management Division (DMR).

4. Risk Management Forum (RM FORUM) RM forum facilities the employee and worker communication with each other on every matter in connection with risk management involved in operationa and business activities in BRI working units. The purpose is to improve awareness and care to all BRI employees in the operational and business activities,disseminationof knowledge and understanding of risk to BRI employees also to improves BRI’s employees skills in performing control and risk mitigation.

5. Risk Management Socialization In order to improve risk culture, awareness and the paradigm that the most responsible to the application of risk mitigation on every activity conducted are UKO, BRI keeps socializing risk management through education and training progrrame also thorugh socialization held by DMR such as risk management socialization in some communication forum or trainig both formal or informal.

Enterprise Risk Management

BRI has implemented enterprise risk management that integrates 8 kinds of risk (credit risk, market risk, operational risk, liquidity risk, strategic risk, legal risk, reputation risk and compliance risk) through the implementation of Risk Profile. In order to monitor BRI’s Risk Profile in the tolerable risk limit, BRI applies the business continuity Management (BCM), therefore the continuance of business and operational activities are maintained. In addition, BRI always perform testing on new products and or activities to ensure that the 8 integrated kinds of risk can be managed through effective controls and implementation procedures on new products and activities proposed by working units. Briefly, the three matters steted above could be explained as follows: a. Implementation of Risk Profile BRI has revised the risk profile ordering guidelines with the linking of risk profile with MRO tools which is RCSA, IRU and MI. The purpose of harmonizing Risk Profile with MRO tools is that operational risk valuation on all business and operational activities in the valuation of risk profile doesnt depend only on audit valuation results, but also based on self assessment made by operational working units in the branch offices, Regional Offices and Head Office.

Indonesia Economic Indicators

Indonesia Economic Indicator
Economic indicator
Economic indicator is a piece of economic data or statistic data about the economy. It is usually of macroeconomic scale, that is used by investors to interpret current or future investment possibilities and judge the overall health of an economy. Economic indicators allow analysis of economic performance and predictions of future performance.
Economic indicators include various indices, earnings reports, and economic summaries, such as unemployment, housing starts, Consumer Price Index (a measure for inflation), industrial production, bankruptcies, Gross Domestic Product, broadband internet penetration, retail sales, stock market prices, crude oil price and money supply changes. Economic indicators are primarily studied in a branch of macroeconomics called “business cycles”.
An economic indicator is only useful if one interprets it correctly. History has shown strong correlations between economic growth (as measured by GDP) and corporate profit growth. However, determining whether a specific company will grow its earnings based on one indicator is nearly impossible. Indicators give us signs along the road, but the best investors will utilize many economic indicators, looking for patterns and verifications within different sets of data.

Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. The term “inflation” once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation. Inflation can also be described as a decline in the real value of money—a loss of purchasing power in the medium of exchange which is also the monetary unit of account. When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate, which is the percentage change in a price index over time.
Inflation can cause adverse effects on the economy. For example, uncertainty about future inflation may discourage investment and saving. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future.

Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused when money supply increases faster than the rate of economic growth.

In indonesia the authority to control the money supply is in Bank indonesia. They always try to keep and maintain the stability in rupiah because unstable inflation will adversely impact socio-economic conditions among the population. First, high inflation will steadily erode real incomes and thus bring about reduced living standards, thus making everyone and especially the poor all the poorer. Second, unstable inflation will create uncertainty for economic players in their decision making. Empirical experience indicates that unstable inflation will increase the difficulties for people in making decisions in the areas of consumption, investment, and production, and this will ultimately reduce economic growth. Third, a higher rate of domestic inflation compared to inflation in neighboring countries will cause real domestic interest rates to lose competitiveness, and this could put pressure on the rupiah.

Unemployment
Unemployment occurs when a person is available to work and currently seeking work, but the person is without work. The prevalence of unemployment is usually measured using the unemployment rate, which is defined as the percentage of those in the labor force who are unemployed. The unemployment rate is also used in economic studies
There are a variety of different causes of unemployment, and disagreement on which causes are most important. Different schools of economic thought suggest different policies to address unemployment. Monetarists for example, believe that controlling inflation to facilitate growth and investment is more important, and will lead to increased employment in the long run. Keynesians on the other hand emphasize the smoothing out of business cycles by manipulating aggregate demand. There is also disagreement on how exactly to measure unemployment. Different countries experience different levels of unemployment. According to the BPS (Badan pusat statistic) the unemployment in indonesia is 9.394.515 people (Aug 2008).
The impact of un employment:
An economy with high unemployment is not using all of the resources, i.e. labour, available to it. Since it is operating below its production possibility frontier, it could have higher output if all the workforce were usefully employed. However, there is a trade off between economic efficiency and unemployment: if the frictionally unemployed accepted the first job they were offered, they would be likely to be operating at below their skill level, reducing the economy’s efficiency.
Gross Domestic Product

The gross domestic product (GDP) is one of the measures of national income and output for a given country’s economy. GDP can be defined in three ways, all of which are conceptually identical. First, it is equal to the total expenditures for all final goods and services produced within the country in a stipulated period of time (usually a 365-day year). Second, it is equal to the sum of the value added at every stage of production (the intermediate stages) by all the industries within a country, plus taxes less subsidies on products, in the period. Third, it is equal to the sum of the income generated by production in the country in the period—that is, compensation of employees, taxes on production and imports less subsidies, and gross operating surplus (or profits).

GDP is a good measure of economic well-being because people prefer higher to lower income. But it is not a perfect measures of well-being. For example, GDP excludes the value of leisure and the value of a clean environment.

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