Barings Bank Case Analysis

Description
This is a PPT about case analysis of "Whatever happened at Barings Bank case".

Whatever happened at Barings? Part 2

Presented by:

Outline
? Background

? What happened
? Strategies adopted – Leeson ? Where did it go wrong? ? Why did it happen? ? Fraudulent activities ? Strategies could have been adopted? ? Signals Overlooked

Background
? Unauthorized trading began from the time he took

his appointment ? Leeson took up long and short positions in futures-not matched by the corresponding offset positions ? Open positions were concealed by accounting and reporting techniques ? 1992-activity was quite small, in Feb 95-losses grew three fold

What Happened
High Bonus

More Profit
More Risk High Loss

Fraudulent Activity
Management negligence What Happened to Barings

Strategies adopted
? Leeson?s Strategy:
? Long positions in Nikkei futures – bullish view ? Short positions in JGB futures – bonds were over valued ? Short volatility position in Nikkei exchange traded

options ? Used short straddle – limited profit on limited risk ? Intra day unhedged trades ? Open short position in Euroyen futures
? Profitable if:
? The positions futures prices on the Nikkei Index

increased ? Japanese bond prices fall ? Volatility in the Nikkei Index remained low

Where did it go wrong?
? January, Nikkei fell sharply – Kobe earthquake

? Led to suffer positions both in Nikkei futures and

options positions. ? Fall in Japanese interest rates saw losses incurred from the short JGB futures positions ? Bets were not hedged
Price Movement (predicted) Movement (happened)

Share Price
Interest rate Bond Price

Why did it happen?
? Failure of risk management systems ? Leeson was in charge of both the front office and back ? ? ? ?

?

office: he could conceal all fraudulent information Barings internal audit failed to act on the warnings raised by the members No reconciliation was done by BSL on request for funding by BFS Loans were classified as “loans to clients” but never subject to check Bank of England allowed for under-reporting by Leeson, margins deposited with Far East Exchanges 25% of capital base large exposures limit SIMEX fall in the category of complacency

Leeson?s poor judgment
? Net positions were in the opposite direction of the

market
? Nikkei – net long in the falling market ? JGB – net short position in the rising market

? Recession in the Tokyo Stock Exchange, financial

sector suffering from low profitability ? No potential for rising share price – still Leeson invested

Fraudulent Trading
? Transfer trading
? Secret error account 88888 ? Transferring losses to 88888 and profit to BSJ &

BSL ? 88888 is funded by margin payments of Baring group ? Fictitious trades between 88888 and BSL & BSJ.
? Not disclosed unhedged positions in BSL & BSJ

account ? Understatement of margin calls
? Long Nikkei positions in 88888 by short positions in

BSJ/JGB arbitrage account ? Short JGB positions in 88888 by long positions in the BSJ/JGB arbitrage account

Funding Manipulation
Losses posted to 88888 BSL BSLL BSJ Total Barings group Borrowed from Japanese bank 857 317 110 284 701 156

• Misrepresented margin requirements to BSL
• Used the surplus funds to finance losses in account 88888

Strategies Could Have been Adopted
? Long Butterfly ? Put Ratio Spread ? Delta Neutral Spread

Long Butterfly

• Long 1 call at time Xa • Short 2 call at time X • Long 1 call at time X+a

Put Ratio Spread
• Buy 1 put at higher strike price • Sell 2 put at lower strike price

Delta Neutral Spread
? Delta – rate of change of options price relative to

one unit change in underlying asset ? Delta neutral – Net delta 0.
- Buy X call options with delta „2d? and buy 2X put options with delta „d? - Net delta = X*2d – 2X*d = 0

? Low risk

THANK YOU



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