CUSTOMER BUSINESS DISASTER DUE TO MISLEADING REPORTING DISASTER DUE TO LARGE MARKET MOVES IMAGINARY TRADES Trust VALUATION ISSUES HOARDING JDNKJN Bankers 1. Chase Manhattan vs 1.Barings Bank Sumitomo 1.LTCM Drysdale Securities INCIDENT- INCIDENT- INCIDENT- INCIDENT- INCIDENT- - For Interexchange S+,F+ -On being approached by -Hedge Fund developed by Scholes & -Drysdale borrowed T- arbitrage using Nikkei -Bought all P&G & Gibson for a Merton securities from sec dealer Futures,used Short physical derivative trade that would -Indulged in relative value trades-sold through Chase Manhattan, Straddle i.e.(P-,C-) & commodities reduce their funding cost, D the run & bought off the run on indulged in arbitrage by short Long Futures on both along with their Bankers Trust presented securities due to contrarian view. selling US Treasuries for Mkt the Index( 2F+). futures. their strategy in such a Price+ Acc Int in Govt sec Mkt -Due to Kobe -Heavy losses due C - onvergence strategies- complex manner that & borrowing US treasuries at earthquake, Nikke to liquidity Went long on Russian sovereign P&G & Gibson could not MkT Price In Repo Mkt. futures fell & risk.Impact loss securities,had a view that their risk understand. high. Collateral valuation volatility increased has been overestimated,which on -No competitive quote –A - resulting in huge correction will result in lower feeling of tailor-made was made without Acc losses. yield.But Ruble crisis resulted in flight strategy. interest. Mkt rallied,brought -Changed software to to quality,widening the spread . -Tapped phone huge losses & Chase had to not report trades,since Sold options expecting mean conversations showed how bear coupon payments on head of front & back reversion of volatility,BUT it shot up. Bankers Trust STAFF office same. FOOLED THEIR CLIENTS. behalf of Drysdale. LESSONS LEARNT- -Warning signals like M - odel Risk-Based on historical -Lost customers’ data & lot of assumptions Trust.Reputational Loss. Rules for collateral valuation unexpected profits in & Risk Control Functions. imaginary trades(changed T - ail Risk not captured .
2. Kidder Peabody software) & margin
call outflow bcoz of -Liquidity –Did not have liquidity LESSONS LEARNT- INCIDENT- when margin calls trigerred. -Complex strategies are rt exchange trade possible but should be -Value of Fwd Contract=Se -S IGNORED feature. communicated LESSONS LEARNT- understanding the PRICING OF LESSONS LEARNT- WRONG Independent trading Better use of stress tests in assessing sophistication level of office & inquire credit risks,need for initial margin if client. FORWARDS. INSTANT PROFIT RECORDED unexpected profits & counterparty’s principal business is -Customers should be able -S/Holders lost confidence in sources of cash. trading,need to incorporate to obtain price quotes company; no cash loss. endogenous & exogenous liquidity from an area independent LESSONS LEARNT- Investigate unexpected profits I 2.Allied rish Bank risks. of front office. -Firms should be cautious & review models. INCIDENT- 2 Metallgesellschaft of communications . -For arbitrage using FX
3.UNION BANK OF options,indulged in
speculation. INCIDENT- SDFSDF Entered into a 5 yr Fwd contract to SWITZERLAND (UBS) -VAR under-reported. sell heating oil to customers.Ran the INCIDENT- -Bullied back office risk of price going up,due to which it -Concentration Risk ( LARGE employees. entered into short dated futures & STAKE IN LCM). -Sold options to show decided to roll them over-[This -Unusual Independence to high cash flows in the resulted into huge losses.] Derivatives Division. OTC Market & only Reasons- -Low realization while selling modest gains Oil prices fell-Loss in futures reported. Basket of Equity position & gain in F/w Long Dated position. options,but not apparent due Market for oil changed from to usage of Marked to Model backwardation to contango. feature. Futures loss resulted in cash -Inappropriate hedging of outflow on futures position
Bank Warrants but no cash inflow in fwd
gain leading to liquidty problem. -British Tax Law Changes LESSONS LEARNT- Separate risk mgmt department & correct model for valuations. Page 45