Foundation Case Study by Edu Pristine

Author of lecture Foundation Case Study

Edu Pristine

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... and gasoline at a fixed price over a 5yr or 10yr period ie., sale of 5yr or 10yr forward contracts => a short position for MG in long term forward con tracts
Hedging Strategy MG hedged this ...

... Why? Mismatch between MG’s short positions and long positions?Capacity to withstand interim cash ...

... out losses in long term futures positions. Wait for 5/10yrs to realize gains in short forward positions. The periodic cash settlements resulted in Cash Flow crunch Basis Risk Petroleum Futures Markets -> Normal Backwardation Price of futures < ...

... access to credit. Hence compounding. MG’s Cash Flow problems. Trading Liquidity Risk Size of MG’s position -> enormous. Would have taken 10 days to liquidate Would have taken 20 to ...

... of Chase Manhattan Bank $20m in capital. Unsecured Borrowing of about $300m. Exploited a flaw in market practices for computing the value of US govt. bond collateral. The firm took systematic advantage of ...

... Failed to recognize that Chase is taking full responsibility for payments due
Lessons Learned Securities Industry.T o make methods for computing collateral value on bond borrowings more precise. Chase & Other firms Need ...

... into a merger on unfavorable terms with Swiss Bank Corporation (SBC). Less is known – The size of losses has never been fully disclosed. Considerable controversy existed on whether it was due to poor decision making or unlucky outcomes or ...

... violations of fundamental principles of independent oversight. Primary reasons for losses in Equity Derivatives business. 1. A change in British tax laws impacted the value of some long dated stock options. 2. A large portion in Japanese bank warrants was inadequately hedged against a significant drop in the underlying stocks ...

... the UBS CEO => certainly an authorized position. Accusation: Trades were approved without adequate review by risk control and were never properly represented in the firm’s risk management systems. LTCM Position details40 % represented a direct ...

... short position in futures would find little physical copper available for delivery and would be forced to pay heavy premium for physic al copper or unwind its short position by taking an offsetting long futures position.Risk in the ...

... Positions unrelated to legitimate commercial needs of Sumitomo. Resulted in Hamanaka reassigned to another position in May, 1996. This in turn sparked suspicion among other copper traders who began to sell their ...

... Relative Value Based on arbitrage price differences between similar securities. Profit when prices converge. Spreads Based on yield differences between risky and riskless FI securities and risk premiums tending to revert ...

... debt Russian interest rates soared to 200 %. Value of the Ruble crushed. This economic shock triggered investor concern about already faltering economies in the Pacific rim. Yields on developing nations’ debt increased. Yields on ...

... risked the possibility of insolvency before convergence could occur. Model Risk Flawed valuation and trading models. Models assumed historical relationships were useful predictors of future relations. True in the absence of economic shocks. But external shocks often cause correlations that are historically low to increase. Models did not adequately capture the spike in ...

... enabled it to assume extremely large and high-profile positions. This attracted the attention of imitators who initiated similar or identical trades. Added to the size of LTCM’s positions in ...

... Profitable if the underlying index remains relatively unchanged over the life of straddle, in which case the calls and puts expire worthless, leaving the option writer with the option premiums. Arbitraging price differences on Nikkei 225 futures contracts that were trading on different exchanges Involves taking long futures ...

... long-short futures arbitrage strategy and initiated a speculative long-long futures position on both exchanges in the hope of profiting from an increase in the Nikkei 225.
The move exposed Barings to enormous market risk and event risk.
On January 17, 1995 an ...

... on the SIMEX in which the same firm buys and sells a security at the current market price. Using his back-office influence, he directed settlement employees to modify the execution price, making one side of the trade profitable and other unprofit able ...

... BT to help them reduce their funding costs.
BT used derivatives; promised a high-probability small reduction in funding costs in exchange for a low-probability, large loss.
The derivatives trades only resulted in significant losses for ...

... the prices given to P&G and GG were manipulated.
Result.
The scandal severely damaged BT’s reputation and forced its CEO to resign.
BT was eventually acquired by Deutsche Bank and was dismantled.
Lessons
Prompted tighter controls ...

... incorrectly reported in firm’s accounting system, artificially inflating reported profits.
When this was corrected in April 1994, $350m in previously reported gains had to be reversed.
Result.
Though no actual loss of cash, the massive misreporting of earnings triggered a substantial loss of confidence in the competence of the firm’s management ...

... to offset his real trades.
Reported only modest gains so as not raise any red flags.
Sold deep-in-the-money options, with high premiums, to cover some of his losses.
Entered false positions in the firm’s system for calculating risk measures.
Bullied back-office ...

... Expected Return and Standard Deviation. ...

... Portfolio possibility curve can be drawn by calculating the expected return and volatility of various weight combinations of two assets. ...

... The most left point on the portfolio possibilities curve is known as the minimum variance portfolio. ...

... Return possible for the given amount of risk 9. ...

... Short sales are allowed. ... 

... Risk (standard deviation) for a particular portfolio. Represents all possible combinations of the market portfolio (P) and risk free asset. ...