...on the Nikkei 225 as the underlying. The Nikkei 225 was traded as a future on both the SIMEX and the Osaka markets. There were always known to be differences between the two markets which could be arbitraged. The idea was to exploit the differences between the 2 markets , and execute in the cheaper market on client orders. This would then allow Barings to net a profit as they execute in the cheaper market but quote the client the price in the more expensive market. The underlying idea was of course to always be long one and short the other. Leeson was long Nikkei 225 futures, short Japanese government bond futures, and short both put and call options on the Nikkei Index. He was betting that the Nikkei index would rise, but instead, it fell, causing him to lose $1.39 billion. 2. What went wrong that caused his strategy to fail? Nick Leeson’s strategy failed because the Nikkei 225 index kept falling while he continued to bet that it would rise. On the 17th of January 1995 a huge earthquake struck Kobe in Japan. The Nikkei plummeted putting Leeson’s positions under a lot of stress. The Nikkei plunged to 17950 by the end of that week and Leeson started recording big losses. Leeson’s solution was however to ask for extra funds from London to meet his margin calls and continue trading. His view was that the move down on the Nikkei was temporary and he could ride it out. In the weeks that followed he almost doubled his futures position to 55,000 contracts. However the Nikkei did not...
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...established in the name of the bank. | |When it went into receivership on February 27, 1995, Barings, via Leeson, had outstanding notional futures positions on Japanese | |equities and interest rates of US$27 billion: US$7 billion on the Nikkei 225 equity contract and US$20 billion on Japanese | |government bond (JGB) and Euroyen contracts. Leeson also sold 70, 892 Nikkei put and call options with a nominal value of $6.68 | |billion. The nominal size of these positions is magnificent; their enormity is all the more astounding when compared with the | |banks reported capital of about $615 million. | |The size of the positions can also be underlined by the fact that in January and February 1995, Barings Tokyo and London | |transferred US$835 million to its Singapore office to enable the latter the meet its margin obligations on the Singapore | |International Monetary Exchange (SIMEX). | |Reported activities (Fantasy) | |The build-up of the Nikkei positions took off after the Kobe earthquake of January 17. This is...
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...Barings Bank and Nick Leeson Introduction I would like to present the case of Barings Bank, one of the most famous histories in the world when one man led to the bankruptcy the oldest British bank. Barings collapsed on February 26, 1995, due to the activities of one trader, Nick Leeson, who lost almost $1.4 billion. The loss was caused by a large exposure to the Japanese stock market, which was achieved through the futures market. Leeson, the chief trader for Barings Futures in Singapore, had been accumulating positions in stock index futures on the Nikkei 225, a portfolio of Japanese stocks. As the market fell more than 15 percent in the first two months of 1995, Barings Futures suffered huge losses, which were made even higher due to the sale of options, which implied a bet on a stable market. As losses mounted, Leeson increased the size of the position, in a stubborn belief he was right. Finally, on 25 February 1995 he walked away, when he realized that bank was unable to make the cash payments required by the exchanges. Later, he sent a fax to his superiors, offering “sincere apologies for the predicament that I have left you in.” Nick Leeson had totally wiped out the venerable 233-year-old Baring Investment Bank, which proudly counted Queen Elizabeth as a client. He left behind huge liabilities totaling $1.4 billion, more than the entire capital and reserves of the British institution. This situation - and a similar scam at the New York branch of Japan's Daiwa Bank in October...
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...Topic: The biggest scams in the banking history Course: Banking Students: Nino Vepkhvadze, Gohar Trchunyan, Giorgi Menteshashvili & Giorgi Paksashvili Date: 04.06.2012 A fraud, by definition, is the act of deliberate deception of people to secure an unlawful gain. These are mainly for the purpose of defrauding money as well as prestige rather than immediate financial gain. A study by BBC has revealed that the average woman lies twice a day while a man tells three lies a day. However, the lies they tell differ from each other a lot, both in essence and the results yielded. This is why we decided that the frauds and scams of the banking industry as well as their influence on other financial institutions would be quite interesting and intriguing. Let us together investigate how far a human mind can go to earn as much money and glory as we desire. Jerome Kerviel’s case-Societe Generale on the edge In January 2008, A French court sentenced former Société Générale trader Jérôme Kerviel to three years in prison for his role in one of the world's biggest-ever trading scandals and ordered him to repay his former employer €4.9 billion—a sum it would take him 180,000 years to pay at his current salary. In convicting Mr. Kerviel of breach of trust, forgery, and unauthorized computer use, the judge also handed Mr. Kerviel a lifetime trading ban. The prison sentence handed to Mr Kerviel is for five years, of which two years were suspended. Throughout the trial, Mr. Kerviel and...
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...1) Suppose you are a portfolio manager for the MBA Advisor Nikkei 225 index fund, which has Y100 billion in assets linked to the Nikkei 225 index. What should you do when you hear news of the index redefinition? In your preparation, you should consider: a) The construction of the Nikkei index and the portfolio weights it gives rise to. In order to minimize risk, they would like to sell stocks to be deleted and buy stocks to be added to rebalance the portfolios and swap the deletions and additions at the closing price. Upon announcement of the composite change, they can go long the stocks newly adopted and short sell deletions. For short sales, they go the securities lending market and borrow the stocks. They have to act fast since borrowing demand in the securities lending market shoots up upon announcements. This long position in additions and short position in deletions will be held until one day prior to the change date. And then unwind the position as close as possible to the closing of the change date. For the price-weight average, since the index substituted 30 large capitalization stocks for 30 small capitalization stocks, down weighting the 195 stocks that remained in the index and most of the additions were technology companies which experienced high returns, the index divisor would be adjusted for this redefinition. The additions would drive the price up and have a higher weight in the portfolio. b) The effect of your trading on the prices of the index constituents...
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...Dow Jones Industrial AverageTM Stated Objective To represent large and well-known U.S. companies. Covers all industries with the exception of Transportation and Utilities. Key Features — The index is maintained by the Averages Committee. — Components are added and deleted on an as-needed basis. For the sake of continuity, such changes are rare, and typically occur following corporate acquisitions or other significant changes in a component company's core business. When one component is replaced, all of them are reviewed. — While stock selection is not governed by quantitative rules, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth and is of interest to a large number of investors. Maintaining adequate sector representation within the index is also a consideration in the selection process. — The index is price weighted. — The Dow Jones Industrial AverageTM was first calculated on May 26, 1896. Descriptive Statistics Market Capitalization (Billions) ComponentCurrency Number | Float-Full Adjusted Mean Median Largest Smallest | USD 30 | 5,016.6 4,769.7 159.0 137.8 412.4 34.2 | Data calculated as of end of October, 2014. Mean, median, largest component and smallest component values are based on float-adjusted market capitalization. Performance ...
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...NIKKEI 225 RECONSTITUTION 1) As a portfolio manager for the HEC-UNIL Advisors Nikkei 225 Index Fund, which has ¥100 billion of assets linked to Nikkei 225 index, what would you do when you hear the news of index reconstitution? The Nikkei 225 is a price-weighted average of the stocks it incorporates. It simply adds the prices of the 225 stocks and divides this sum by a divisor. When the announcement about index change takes place, the index is calculated as the above-mentioned method until the new composition of stocks becomes effective. The announcement date and the date of “effectiveness” are different – there is a time period between them. After the effectiveness date the shares of new member companies are added and divided by the new divisor. The price sequence has to be maintained by the index. Therefore, the new divisor is calculated to guarantee the sequence before and after the effectiveness date. The equation below must be satisfied: Σ 225 stocks before changeDivisor before change= Σ 225 stocks after changeNew divisor From the point of view of one who does not like a lot of risk and wants to minimize it. So, I would like to sell stocks that will be deleted and then will be stocks that will be added one day before the effectiveness date. In this case, if I would be able to swap the deletions and additions at the date, I would bear no risk. 2) What would you do if, instead, you were at the proprietary trading desk of Goldman Sachs? There are two possible...
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...The Nikkei 225 Reconstitution by Romain Boulanger ; 30 Apr 2015 ; HBR business case Because the Nikkei 225 reshuffling is thought to induce inefficient prices, the arbitrageur Taka Haneda believes he could squeeze profit opportunities out of it. Conversely, buy-andhold investors will probably encounter losses. Both will interact to make the nicest move. Following the index reconstitution announcement, economics 101 state that the to-be-added large cap stocks will face an upward price pressure whereas deleted and remaining stocks will suffer from downside risk. However, shareholders of an index do enjoy zero tracking errors and will certainly wait until the effective day to rebalance. Therefore, as a trader at Goldman Sachs, I would play the arbitrage game. I would provide liquidity to index investors by shorting freshly added stocks and buying excluded ones. Via this move, I would hope a forthcoming favorable reversal impact as I expect (perhaps wrongly) prices to return to normality. After all, at the announcement date, prices already reflected the health of the underlying company. Even more so, the Nikkei 225 is a closely monitored index. Bid-ask spreads are getting lower. Prices and volumes effects should then be more pronounced. But this is not a foregone conclusion. Prices might not go back to normal. Indeed, the information theory suggests that index changes convey information about the affected stocks, causing “permanent” price movements. More specifically...
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...year later, BFS began to trade using its own account, attempting to take advantage of the difference between futures on the Japanese and Singaporean exchanges to make a profit. Such arbitrage, referred to inside Barings as “switching”, was seen as “essentially risk-free and very profitable” by management in London, including its chairman Peter Baring. Table from slideshare.net Leeson, however, set up a secret account, number 88888, which he used to invest in the Japanese stocks, specifically in the Nikkei 225. Luck was not on Leeson’s side because by the end of 1994, account 88888 had lost about £200 million, but Barings’ London management were not aware. Leeson, as head of both front and back offices of the company, was able to disguise his losses as debts owed by Barings clients. However, on the morning of January 17, 1995, the devastating Kobe earthquake caused $100 billion in damage and shook its bond and stock markets. Leeson continued to invest in Nikkei 225 thinking that the country’s economy will recover fast from the earthquake, but it did not. Leeson’s losses rose to more than £800 million and he was no longer able to disguise them from Barings...
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...Japan’s Nikkei 255 stock average Public launch depends on the price of NPWs (Nikkei put warrants) 1987, BS issued currency warrants by GECC, heavily subscribed. Selling echange-listed currency warrants made three important impressions on GS team. 1. while investors were interested in puts on the yen, puts on the Nikkei would be much more widely demanded. 2. Profits to be made from buying options (sourcing volatility) in institutional markets and resell to retail customers 3. New markets could quickly become satiated. The prices of the currency warrants fell quickly from the initial deal levels Exhibit 1 daily implied volatilities of exchange-listed yen currency warrants 1988, IFR reported the first of a series of recent Eurobonds whose redemption values at maturity were tied to the level of the Nikkei 225 stock average. Exhibit 2 Representative Nikkei-Linked Euro-Yen offerings, Dec 1989 Exhibit 3 Hypothetical Nikkei-Linked Euro-Yen Transactions Through a set of swaps, the issuer transformed its annual fixed-rate yen payments in to dollar-dominated LIBOR-based payments. At maturity, the issuer would redeem the bonds from the investor a price tied to the Nikkei. If Nikkei fell since the bonds were issued, the issuer would pay less than par to redeem the bonds. Thus, it would be as if the issuer sold bonds with final principal payments at par but also bought a put option on the Nikkei maturing in the same years as the bond. If the Nikkei fell, the...
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...The number of international stock market indexes is . quite large. For many of us, the level of the Dow or . the S&P 500 is known. How about the Nikkei 225? Or . the FTSE 100? Do you know what countries these . represent? ------------------------------------------------- Types of indices Stock market indices may be classed in many ways. A 'world' or 'global' stock market index includes (typically large) companies without regard for where they are domiciled or traded. Two examples are and S&P Global 100. A 'national' index represents the performance of the stock market of a given nation—and by proxy, reflects investor sentiment on the state of its economy. The most regularly quoted market indices are national indices composed of the stocks of large companies listed on a nation's largest stock exchanges, such as the American S&P 500, the Japanese Nikkei 225, and the British FTSE 100. Other indices may be regional, such as the FTSE Developed Europe Index or the FTSE Developed Asia Pacific Index. The concept may be extended well beyond an exchange. The Wilshire 5000 Index, the original total market index, represents the stocks of nearly every publicly traded company in the United States, including all U.S. stocks traded on the New York Stock Exchange (but not ADRs or limited partnerships), NASDAQ and American Stock Exchange. Russell Investment Group added to the family of indices by launching the Russel Global Index. More specialized indices...
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...Question 1 What was the motivation to issue Nikkei-linked Eurobonds? The motivation for the European bank issuers of the Eurobonds, wasthe possibility to get U.S. dollar finance for a lower interest rate. Toachieve this, the issuer could sell the embedded put to Goldman Sachs. The profits from the put offset the difference between the 7%coupon they paid on the bonds and the desired LIBOR floating rate. The payment from the put covered the cost paid to the swapcounterparty for hedging the exposure to the Yen-Dollar exchangerate and swapping the LIBOR for a higher coupon rate. The European financial institution was left with a fully hedged U.S. dollar financing with a lower than normal coupon rate.Furthermore, due to some specific administrative regulation in Japan, the demand for these kind of coupons was high. In Japan,companies where not allowed to pay dividend out of capital gains. Moreover, dividend payments where an important factor in gaining an competitive advantage. Therefore, this bond construction allowed the Japanese life insurers (investors) to use the coupon rateto pay out dividend while still maintaining an exposure to the Nikkei. How are the puts embedded in the Nikkei-linked Eurobonds? A normal bond to Japanese institutions would pay a coupon rate lessthan 7%. The amount by which the 7% exceeded the normal couponrate can be seen as the put premium paid by the issuer. If, atmaturity, the Nikkei dropped below a pre-determined value (hencethe theoretical strike...
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...CHAPTER 9 – CHARACTERIZING RISK AND RETURN Questions LG1 1. Why is the percentage return a more useful measure than the dollar return? The dollar return is most important relative to the amount invested. Thus, a $100 return is more impressive from a $1,000 investment than a $5,000 investment. The percentage return incorporates both the dollar return and the amount invested. Therefore, it is easier to compare percentage return across different investments. LG2 2. Characterize the historical return, risk, and risk-return relationship of the stock, bond and cash markets. Examining Table 9.2, it is clear that the stock market has earned about double the return since 1950 than bonds. Bonds have earned about 50% higher return than the cash markets. The risk in the stock market is also higher than the bond and cash markets according to the standard deviation measurement (Table 9.4). Another illustration of the high risk is that the stock market frequently losses money and sometimes does not earn more than the bond and cash markets over short periods of time (Table 9.2). The risk-return relationship tells us that we should expect higher returns for the riskier market. We do see higher realized returns over the long term to the higher risk asset classes. LG3 3. How do we define risk in this chapter and how do we measure it? Risk is defined as the volatility of an asset’s returns over time. Specifically, the standard deviation of returns is used to measure...
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...CHAPTER 9 – CHARACTERIZING RISK AND RETURN Questions LG1 1. Why is the percentage return a more useful measure than the dollar return? The dollar return is most important relative to the amount invested. Thus, a $100 return is more impressive from a $1,000 investment than a $5,000 investment. The percentage return incorporates both the dollar return and the amount invested. Therefore, it is easier to compare percentage return across different investments. LG2 2. Characterize the historical return, risk, and risk-return relationship of the stock, bond and cash markets. Examining Table 9.2, it is clear that the stock market has earned about double the return since 1950 than bonds. Bonds have earned about 50% higher return than the cash markets. The risk in the stock market is also higher than the bond and cash markets according to the standard deviation measurement (Table 9.4). Another illustration of the high risk is that the stock market frequently losses money and sometimes does not earn more than the bond and cash markets over short periods of time (Table 9.2). The risk-return relationship tells us that we should expect higher returns for the riskier market. We do see higher realized returns over the long term to the higher risk asset classes. LG3 3. How do we define risk in this chapter and how do we measure it? Risk is defined as the volatility of an asset’s returns over time. Specifically, the standard deviation of returns is used to measure...
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...prevent such fraud from occurring. He had authority to deal in futures and options order for clients or other firms within Barings and arbitraging price differences between Nikkei futures traded on the SIMEX and Osaka exchange, it was a low risk strategy meant to make small profits. Where Leeson went astray was when he began unauthorized speculation in futures on Nikkei 225 stock index and Japanese government bonds. These trades where highly risky due to the fact that they involved a highly leveraged strategy and depended solely on the markets movement upwards. This strategy is a double edged sword because even though it provided devastating results for Leeson it could of also provided incredible gains if the market would have gone up. Leeson essentially bet that the Nikkei was going to rise. Once the loses started coming in Leeson opened up a secret trading account, account 88888. The account was initially set up to cover a mistake done by one Leeson’s traders in which she mistakenly submitted a purchase order instead of a sell order. Leeson traded his way out of her mistake but found himself in the red once again due to his strategy and bullish sentiment on the Nikkei. As 1995 came along Leeson’s approach remained the same, on January 17th 1995 a 7.2 earthquake hit the Japanese city of Kobe, causing the Nikkei to plummet, one would think this would change Leeson’s approach but his loses where...
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