ib ppt - group 7

8/4/2019 Ib Ppt - Group 7

1/18

G r o u p 7 | s e c t i o n A | P G D M 2 0 1 0 - 1 2

A n k i t a a br ol

H i t e s h g u p t a

M a n i s h s o n i

P r i ya m g u pt a

S h i v a m e h r a

Va ru n a ho oj a

Barings Bank


2/18

Case Brief

y Barings Bank was brought to its knees by Nick Leeson in

Singapore office in 1995

y

Employed by Barings to profit from arbitrage opportunitybetween derivative contracts on the SIMEX and Japans Osaka

Exchange

y Leeson left a $ 1.4 billion hole in Barings' balance sheet due to

his unauthorized derivatives speculation, causing the 233yr old

Bank to collapse


3/18

Barings Bank

y Founded in 1762 as the John and Francis Baring Company by

Francis Baring, with his older brother John as a mostly silent

partner

y Barings gradually diversified from wool into many other

commodities, providing financial services necessary for the rapid

growth of international trade

y Despite surviving the Great Depression and both World Wars,

Barings was brought down in 1995 due to unauthorized trading

by its head derivatives trader in Singapore, Nick Leeson


4/18

Nick Leeson

y Grew up in Londons Watford suburb and worked for Morgan

Stanley after graduating

y

Leeson then joined Barings(Jakarta) to sort through back officemess involving 100 million pounds of share certificate

y Successfully rectified the situation in 10 months

y Was then transferred to Singapore and worked with more power

& freedom


5/18

Barings official strategy

y Official trading strategy was switching i.e. taking advantage

of temporary price differences b/w the SIMEX and OSE

Nikkei 225 contracts

y Buying cheaper contracts and selling at the same time the

more expensive ones, reversing the trade when the price

difference had narrowed or disappeared.


6/18

Rationale for Barings strategy

y OSE and SIMEX have different market conditions

y OSE has local business whereas SIMEX has mostly off-

shore business

y OSE conducts business more slowly than SIMEX.


7/18

Leeson`s Trading Strategy

y Leeson's trading strategy was supposed to take advantage oftemporary price differences between the SIMEX and OSE Nikkei225 contracts

y But Leeson was not short on SIMEX, infact he was long

approximately the number of contracts he was supposed to beshort

y Instead of hedging, gambled on the future direction of theJapanese market

y He was betting that the Nikkei would rise in future from currentlevels of 19350

y He hid these unauthorised trades in an account named ErrorAccount 88888


8/18

Leeson`s Trading Strategy

y However, the price of Nikkei 225 fellon the exchanges to 18950, futureswere incurring losses

y He thought that the prices would

remain in the range of 19000-20000y So he took short straddle positions

in Nikkei 225 contracts, gain frompremiums

y Nikkei dropped 1000 points to

17,950 on Monday January 23, 1995y Leeson found himself showing

losses on his long futures positionand facing unlimited damage fromselling put options


9/18

Kobes Aftermath

y Nikkei dropped 1000 points

y Leeson tried to reverse negative sentiment himself

Long position of 27000 March Contracts on 27th Jan

Long position of 55000 March Contracts on 22nd February

y Started placing bets on direction of price movement

y Expected Nikkei to rebound->wouldve resulted in

Increased stock value Increase in interest rates


10/18

Leesons Positions


11/18

Deceptive Tactics

y Cross Trade

y London Euro Yen arbitrage

y In charge of both front and back office

y Used clients to bail them

y Account 88888


12/18

Account 88888

y Setup as an error account

Unknown to senior management

y High volume cross trading

y Instructed settlement staff to breakdown total contractsinto multiple trades

y Change Trade prices

Profits get credited to switching accounts

Losses charged to 88888 account

y Speculation disguised as Arbitrage


13/18

Where did it go wrong?

y Mostly gambled on direction of markets

y A major part of Leesons trading strategy

involved the purchase of futures on Nikkei-225

future contracts

y His only hedge was in holding a short position in

JGB

y

He only made a one sided bet


14/18

Leeson`s Positions in February 1995


15/18

The Failure of Internal Control

y No segregation of front office and back office

y No comprehensive review of Leesons funding requirements

y Bank of England allowed more than 25% of share capital

y Lack of internal checks and balancesy Financing the trading margins of low-value customers

y Improper segmentation of client funds and financial

requirements

y Poor supervision of employeesy Lack of a clear reporting line

y Lack of understanding of the business


16/18

Other Significant Collapses

y MGS

Lost $660 million on derivative hedges and long term oil

contracts

y Kidder Peabody (

KP)

Fired Joseph Jett on the charges recording enormous profits of

$350 million by stripping the interest and principle

y Orange County

Reported $1.5 billion loss because of investments inderivatives

y Daiwa

Lost $1.1 billion because of Toshihide Ingushi.


17/18

Lessons From the Case

y Segregation of duties as suggested by audit

Role of trader

Role of back office

y Role of main office

y Concentration of power

y Knowledge of business

y Control and Risk management


18/18

Thank You

ib ppt - group 7

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