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Assignment on:

Case Study: Orange County

Assigned by:
Mr. Ashek Ishtiaq Haq
Course Instructor
FIN 508: Financial Engineering

Submitted by:
A. F. M. Jobayer Islam Bhuiyan
MBA Program
19th Batch

Institute of Business Administration


Jahangirnagar University
Savar, Dhaka-1342

June 28, 2014

Problem faced by Orange County:


Being bankrupted after suffering the losses of around $1.6 billion.

Reasons behind the Bankruptcy:


Wrong way betting on interest rates.
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Conservative approaches towards risk and returns.

Gambling that medium-term securities would maintain or increase their value.

High betting on outliers like inverse floaters notes whose coupon falls as interest rates
rises.

Robert Citrons Wrong Strategies:


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Highly dependence on short-term interest rates expecting to be lower than mediumterm interest rates which can be said misallocation of risk and return.

Besides, he was not able to identify the problems and its effects.

Being over-confident about making decisions:


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Over-confidence about unusual rate of returns by being high risk takers.

Believing in the formula Cash would grow before spending, from their prior experience
of offsetting the eventual loss.

Lack of Financial Sophistication:


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No application of informed & independent risk oversight, risk-averse investment

guidelines, detailed reporting.


Liquidity Trap:
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Reverse REPO agreements cyclical effect that calling for more collateral on declining
market value of original collateral.

Shifting policy of Federal Bank of raising interest rates had made the liquidity crisis
higher.

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Counterparts backing out:


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Seizing and liquidating collaterals, spooking by local government investors accelerated


the bankruptcy. Failing to communicate properly with them was also a reason there.

What made the Solution:


Cutting back on spending and social service Provision.
Taking Long-term recovery bonds to recover the losses.
Increasing tax rates as it saw a buoyant (good) local economy. That helped to had high
revenues to exit from bankruptcy in only 18 months.
Institution of reforming and government structuring included by:
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Oversight committees

Internal auditing

Making a long-range financial planning

Stricter written investment policy containing:


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Safety of principal and liquidity as primary objectives.

Prohibiting borrowing for investment purposes like reverse REPOs, structured notes
and options.

Submission of monthly reports to investors and key county officers containing sufficient
information.
Settlement with Merrill Lynch by litigation. Merrill Lynch was respectful to laws and acted
properly and professionally regarding the settlement taken place.

Learnings:
One have to have knowledge about financial sophistication irrelevance of his/her long track
record.
Same strategy is not applicable always as market can change anytime.
Not to believe blindly The more the risk, the more the return.
Not to borrow short and invest in long-term at the same time, which create liquidity risk.
Financial Framework must be followed in every financial decisions.
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