Barings [LOS] - answer-1. Describe how massive losses were incurred
2. Describe why true position was not noticed earlier
3. Describe role of External Auditors
4. Describe supervision done by Bank of England
5. Describe role of Financial Services Authority
6. Describe lessons learnt
7. Discus...
PRMIA: Exam IV - Case Studies
Barings [LOS] - answer-1. Describe how massive losses were incurred
2. Describe why true position was not noticed earlier
3. Describe role of External Auditors
4. Describe supervision done by Bank of England
5. Describe role of Financial Services Authority
6. Describe lessons learnt
7. Discuss events leading up to the losses, risks incurred & mitigating processes described
Barings [Background] - answer-Collapsed in Feb 95.
unauthorized trades in derivatives by Leeson
Losses of £827m wiped out bank's capital of £200m
Barings [What Happened] - answer-Jan 94, Leeson used Nikkei options to go "short volatility"
Kobe earthquake in Jan 95.
Leeson then bought Nikkei futures. Doubled down, bad idea.
Barings [Operational Risk Lessons 1] - answer-1. Failure of internal controls (Leeson in charge of
both front & back office)
2. Management failed to heed warnings from internal auditors on internal controls (although
C&L concluded these were satisfactory, treasury report of 94, ignored)
Barings [Operational Risk Lessons 2] - answer-3. Unauthorized trades concealed, account
"88888" & unreconciled suspense accounts & falsified reports & transactions
4. Leeson's remuneration encouraged risk taking, & management did not restrain their "star"
trader
5. Confusion between risk control & risk monitoring
6. Lack of understanding of Leeson's trading activities by management
Barings [Mitigation] - answer-1. Management team needs to fully understand business
2. Responsibility for each business activity to be clearly established & communicated
3. Clear segregation of duties (front & back office)
4. Internal controls, including independent risk management, to be established
5. Management & audit committee to ensure significant weaknesses are identified & resolved
Bankers Trust [LOS] - answer-1. Describe the timeline of events
2. Describe the lessons learnt
3. Discuss the events leading up to the losses, the risks inccurred & the mitigating processes
described
, 2. Sued by P&G ($195m) & others for misleading risk of (intentionally) complex derivatives
transactions
Bankers Trust [What Happened] - answer-1. P&G entered into complex interest-rate derivative.
2. Betting US interest rates would remain stable, or decline (its position aggressively leveraged
20:1).
3. Fed raised rates repeatedly in 1994 & P&G lost substantial sums
Bankers Trust [Lessons 1] - answer-1. Balance "hard side" (policies, limits, systems) with "soft"
(people, culture & incentives)
2. Honesty best policy. Focus on integrity & openness in dealing with customers. BT lost its
reputation due to sales practices
Bankers Trust [Lessons 2] - answer-3. Align incentives properly
4. Practice good stakeholder management. In rush to create profits, attention should be given
to clients who are integral to the business
Metallgesellschaft [LOS] - answer-1. Describe trading strategies employed by conglomerate
2. Describe how proper supervision could have averted disaster
3. Discribe how similar financial crises may be avoided in future
4. Discuss the events leading up to the losses, the risks incurred & mitigating processes
described
Metallgesellschaft (MG) [Background] - answer-1. MG entered long-term fixed-price forward
contracts to supply customers with gas & oil.
2. MG hedged its position in the futures market (with more liquid stacked-hedge) & OTC swaps
to receive float & pay fixed energy prices.
3. Decline in oil prices that led to MG's collapse
Metallgesellschaft (MG) [What Happened] - answer-1. Size of exposure - futures position was
significant % of total open interest in NYMEX (liquidation problematic)
2. Although MG hedged market risk, timing of cash flows to maintain hedge (margin calls) &
funding risk/costs were not considered
3. Swap positions introduced credit (counterparty) risk
Metallgesellschaft (MG) [What Happened 2] - answer-4. Oil markets moved from
backwardation to contango as spot prices tumbled due to OPEC deadlock
5. Contango market (i.e. full carry) compounded MG's cash flow crunch (losses on rollover of
futures)
6. MG was profitable under US standards (hedge losses offsets by gains on forward positions)
but recorded losses under German standards (no hedge accounting)
Metallgesellschaft (MG) [Mitigation] - answer-1. Implement recommendations of G30
derivatives study
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