Beruflich Dokumente
Kultur Dokumente
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Financial Disasters
Misleading Reporting Cases
Drysdale Securities and Chase Manhattan Bank
Kidder Peabody
Barings
Allied Irish Bank
Union Bank of Switzerland
Daiwa
SocitGnrale
Sumitomo
Askin Capital Management and Granite Capital
Merrill Lynch
National Westminster Bank
Large Market Movement Cases
Metallgesellschaft
Long-Term Capital Management
Customer Conduct Cases
Bankers trust
JPMorgan, Citigroup, and Enron
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Lessons Learned
Need for more precise methods for computing the value of collateral.
Need for better process control.
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instantly profit by purchasing a bond for cash and delivering the forward
contract.
The system failed to realize that this profit would disappear once financing
costs for the cash bond were taken into account.
Lessons to be learned
Always investigate a stream of large unexpected profits thoroughly and
make sure you completely understand the source.
Periodically review models and systems to see if changes in the way they
are being used require changes in simplifying assumptions.
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Incident
Nick Leeson, a British Barings junior trader in Singapore, took speculative
derivative positions in an effort to recoup prior trading losses that he was able to
hide fraudulently. The loss of roughly $1.25 billion went undetected due to
inadequate control systems.
Nick Leesons strategy
Leesons trading involved two strategies Selling Straddles on the Nikkei 225
and arbitraging price differences on Nikkei 225 futures contracts that were trading
on different.
A short straddle strategy is profitable when the underlying index
remains relatively unchanged over the life of the straddle.
A short straddle involves selling calls and puts.
The calls and puts expire worthless, leaving the option writer with
the option premium.
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B
Short futures
With high price
A
Time
Long futures
With low price
In order to recover the losses, Leeson abandoned the hedged posture in the long-short futures
arbitrage strategy and initiated a speculative long-long futures positions on both exchanges
in hope of profiting from an increase in the Nikkei225 which finally led to much more loss.
The Nikkei 225 plunged because the earthquake in Japan, then the huge losses were created.
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Results
The size of the losses relative to Barings capital along with potential additional
losses on outstanding trades forced Barings into bankruptcy in February 1995.
Main Reasons result in failing to find the misreport
Allowing Leeson to function as a head of trading and the back office at an isolated
branch.
Leeson was able to decide the trade strategy as the floor manager .
Leeson was able to use the back-office influence to hide the losses, and book
the profitable trade to the standard trading accounts, while booking the
unprofitable trade to the old error account (Account 88888) to escape reporting
to senior management.
Lessons to be learned
Absolute necessity of an independent trading back office.
The need to make thorough inquiries about unexpected sources of profit (loss)
and/or cash movements
The need to establish information, reporting, and control systems.
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Daiwa
This misleading reporting went undetected due to Iguchis dual role as the
head of both trading and the back-office support function.
Iguchi was able to not only hide these losses, but also forge customer
trading slips, which actually made his actions appear profitable to Daiwa
Banks management.
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Lessons to be learned
This case is similar to Barings. But Rusnak had not dual role.
Proprietary trading is a high-risk activity .
Risk management architecture is crucial .
Relationship between parent and overseas units needs to be clarified .
Strong and enforceable back-office controls are essential .
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60% exposure to written options on the fund. By taking these two positions, UBS
was hoping to delta-hedge their exposure to LTCM; however, LTCM's lack of
transparency
positions. It was believed that UBS failed to properly analyze and stress test its
positions.
Lessons to be learned
The incident emphasizes the need for independent risk oversight.
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SocitGnrale
Incident
In January 2008, it was discovered that one of Socit
Gnrale's junior traders, Jrme Kerviel, was involved in
unauthorized trading activity that resulted in losses of $7.1
billion.
Result
The incident damaged the reputation of SocitGnrale and
required the bank to raise additional funds to meet capital
needs.
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ultimately created close to 1,000 fictitious trades before the fraud was
finally discovered.
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Main Reasons
A number of reasons were cited that explained how Kerviel's unauthorized
trading activity went undetected, including:
the
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Incidence
In 1991, Metallgesellschaft Refining and Marketing (MGRM), an American
subsidiary ofMetallgesellschaft (MG), an international trading, engineering, and
chemicals conglomerate, implemented a marketing strategy designed to insulate
customers from price volatility in the petroleum markets for a fee.
The Strategy
MGRM offered customers contracts to buy fixed amounts of heating oil and gasoline at
a fixed price over a 5-year or 10-year period. And the contracts gave MGRM a short
position in long-term forward contracts.
MGRM hedged the exposure with long positions in near-term futures using a stackand-roll hedging strategy ().
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Results
In December of 1993, MGRM cashed out its positions and reported losses of
approximately $1.5 billion.
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The Strategies
Most of LTCMs investments strategies could be classified as relative value, credit
spreads, and equity volatility.
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Relative value strategies involved arbitraging price differences, among similar securities
and profiting when the prices converged.
LTCM Noticed that credit spread were high, they entered into mortgage spreads and
international high-yield bond spreads intending to profit when the spreads shrank to
more typical average historical levels.
LTCMs equity volatility strategy assumed that volatility on equity options tended to
revert to long-term average levels. When volatility implied by equity options was
abnormally high, LTCM sold volatility until it regressed to normal levels.
FRMFinancial Risk Manager
The flight to quality increased, rather the decreased, credit spreads, causing
huge losses for LTCM.
Brazil devalued its currency, thereby further increasing interest rates and risk
premiums.
The general increase in volatility also generated losses in LTCMs equity volatility
strategies.
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The Results
The Federal Reserve Bank of New York orchestrated a bailout in which 14 leading
banks and investment houses invested $3.65 billion for a 90% stake in LTCM.
Lessons to be Learned
One suggestion is to ensure that an initial margin is provided.
Another suggestion is to incorporate potential liquidation costs into prices in the
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Citigroup Inc. and JP Morgan Chase & Co., the largest and second largest US
banks respectively, reached an agreement July 28 2003 with the Securities
and Exchange Commission (SEC) to pay a combined $286 million in fines in
connection with their involvement in the fraud perpetrated by Enron.
The SEC charged that the two banks aided defunct energy trading giant Enron
in disguising loans as cash in order to defraud investors.
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Examples
1.
B.
C.
D.
Using short-term futures contracts with a larger notional value than the
long-term risk they are meant to hedge.
Answer: C
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Examples
2.
Past financial disasters have resulted when a firm allows a trader to have dual
roles as both the head of trading and the head of the back-office support
function. Which of the following case studies did not involve this particular
operational risk oversight?
I.
Drysdale Securities
II.
Daiwa
III.
Allied Irish Bank
IV.
Barings
A.
B.
C.
D.
I only
II and IV
I and III
I, II, and IV
Answer: C
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Examples
3.
B.
High Leverage.
C.
Fraud.
D.
Answer : A
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Examples
4.
In the case of Barings Bank (Barings), Nick Leeson incurred huge trading
losses. Which of the following statements correctly describes one of the
B.
C.
Leeson held speculative double short positions in the market for Nikkei
225 futures contracts.
D.
Answer : D
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45. Studying previous financial disasters provides lessons learned that can help improve
processes and controls in order to help prevent future disasters. Which of the
following case studies correctly identifies a lesson learned from the given financial
disaster?
A.
The Metallgesellschaft case shows the necessity of procedures that may lead to
the detection of fictitious trade entries.
B.
The Societe Generale case highlights the importance of correctly measuring the
correlation between large positions.
C.
The Barings Bank case demonstrates why firms should restrict the use of
leverage in trading Derivatives.
D.
The Long-Term Capital Management case shows the importance of taking into
account that correlations can increase sharply during crises.
Answer : D
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FRM
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