A Study on Financial Derivatives for Hedging Risk Management and Profit Maximization

Abstract

The derivatives market is gaining recognition around the world as a response to the stock market. The importance of derivatives markets is recognized even by developing countries. The impact of derivatives has also been a source of worry among policymakers, practitioners, and regulators. Derivatives are being developed as more advanced, novel risk management strategies. Banks serve two purposes: maximizing profitability while ensuring sufficient liquidity. To achieve this goal, banks must systematically monitor, maintain, and manage their asset and liability portfolios, taking into account the varied risks that these sectors provide. Liquidity and interest rate risks are the two main categories of substantial risks on the balance sheet (IRR). Interest rate risk refers to the danger that interest rate changes pose to your earnings or investments. To this purpose, size, asset quality, capitalization, profitability, and interest rate risk profile of banks are regressed against the assumed principle of interest rate swaps stated in hedging operations. Large banks (defined as total assets divided by pre-tax profit) and Profitable Banks (defined as pre-tax profit divided by total assets) doesn’t seem to have any significant advantage in using more interest rate swaps for the purpose of hedging. Small banks are also more likely to use interest rate swaps if they have a higher share of loans to high net worth assets and a higher exposure to interest rate risk.