Derivative Disastors

8/8/2019 Derivative Disastors

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PRESENTED BY:

DEBJYOTI SARKARPARAG C DHAKATE

RASHMI ROJA SAHU

SUBHASREE SAHOO

DERIVATIVES DISASTERS

(ORANGE COUNTY)


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Introduction

Joseph Jetts trading for kidder Peaboy lost$350 million.

Barrings 1995- Nick Leeson responsible for aloss of $1billion in making big bets on thefuture direction of the NIKKEI 225 using

futures and options.

Chemical Bank lost $33million due to usage ofa incorrect model to view interest rate caps.


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Daiwa a Japanese bank in New York lost

$1billion in 1990s.

Long Term Capital Management- This hedge

fund lost about $4billion by followingconvergence-arbitrage model,due to

widening credit spreads from default of

Russian bonds.

Orange County- Bob Citrons trading led this

municipality in California losing $1.6billion


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The loss must not be regarded as loss for the

Derivative industry rather a small fraction of

it which can be avoided.

Derivative is multi trillion dollar industry andhas been outstandingly successful.


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ORANGE COUNTY

InDecember 1994, Orange County stunned

the markets by announcing that its

investment pool had suffered a loss of $1.6billion.

This loss was the result of unsupervisedinvestment activity of Bob Citron, the County

Treasurer, who was entrusted with a $7.5

billion portfolio.


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Citron delivered returns about 2% higherthan the comparable State pool before the

disaster.

Citron invested in derivatives securities and

thereby leveraging the portfolio.

Repeated public warning came from John

Moorlach, who ran for Treasurer in 1994, thatthe pool was too risky.


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The county declared bankruptcy when the

Fed started a series of interest rate hikes (six

consecutive times) that caused severe lossesto the pool.

Citron's main purpose was to increase current

income by exploiting the fact that medium-

term maturities had higher yields than short-term investments.


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FINDINGS

Lack of control

Risk limit

Investor Overconfidence

Yield curve

Value at risk Opportunity loss

diversification


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Lessons For Financial

institutions

1) Monitor Trader Carefully-Particularly high

profit making traders trades must be fully

accountable,to know whether the highprofits are made by taking unreasonable risk.

1) Separate Front, Middle and Back office-So

that any disastrous nature of the trade is not

concealed.


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3)Do not blindly trust models- Followingincorrect models can ruin the company as in

the case of kidder peaboy and chemical

banks.

4)Beware when everyone is following the

same strategy-Give rise to unstable market

and large losses for the market participants.


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Learning For All Users Of

Derivatives.

Define Risk Limits.

Taking the risk limits seriously- Sticking to thepre-decided risk limit. e.g. Orange County

Do not assume you can outguess the market

Do not underestimate the benefit ofdiversification.

Carry out scenario analysis and stress test.


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CONCLUSION

Derivative provide treasures with very

efficient ways to manage risks.

Derivative should be appropriately used i.e.

either for hedging or speculation.

Importance of internal control.

Derivative Disastors

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