Global derivative debacles : from theory to malpractice / Laurent L Jacque.

Format:

Book

Author/Creator:

Jacque, Laurent L., author.

Language:

English

Subjects (All):

Derivative securities.

Finance.

Physical Description:

xxvii, 338 pages ; 24 cm

Edition:

Second Edition.

Place of Publication:

Singapore ; Hackensack, NJ : World Scientific, [2015]

Summary:

This book analyzes in depth all major derivatives debacles of the last half century including the multi-billion losses and/or bankruptcy of Metallgesellschaft (1994), Barings Bank (1995), Long Term Capital Management (1998), Amaranth (2006), Société Générate (2008), AIG (2008) and JP Morgan-Chase (2012). It unlocks the secrets of derivatives by telling the stories of institutions which played in the derivative market and lost big. For some of these unfortunate organizations it was daring but flawed financial engineering which brought them havoc. For others it was unbridled speculation perpetrated by rogue traders whose unchecked fraud brought their house down. Should derivatives be feared "as financial weapons of mass destruction" or hailed as financial innovations which through efficient risk transfer are truly adding to the Wealth of Nations? By presenting a factual analysis of how the malpractice of derivatives played havoc with derivative end-user and dealer institutions, a case is made for vigilance not only to market and counter-party risk but also operational risk in their use for risk management and proprietary trading. Clear and recurring lessons across the different stories call not only for a tighter but also "smarter" control system of derivatives trading and should be of immediate interest to financial managers, bankers, traders, auditors and regulators who are directly or indirectly exposed to financial derivatives. The book groups cases by derivative category, starting with the simplest and building up to the most complex - namely, Forwards, Futures, Options and Swaps in that order, with applications in commodities, foreign exchange, stock indices and interest rates. Each chapter deals with one derivative debacle, providing a rigorous and comprehensive but non-technical elucidation of what happened. What is New in the Second Edition? A new chapter on JP Morgan-Chase's London Whale, an in-depth discussion of credit-default swaps, and an update of the revamped regulatory framework with Basel 2.5 and Basel 111 against the backdrop of the Euro crisis, along with a revised and expanded discussion of the AIG debacle. Book jacket.

Contents:

Chapter 1 Derivatives and the Wealth of Nations 1

What are Derivatives? 2

A Brief History of Derivatives 4

Derivatives and the Wealth of Nations 8

Organization of the Book 9

Bibliography 11

Part I Forwards 13

Chapter 2 Showa Shell Sekiyu K.K. 15

"Shell-Shocked By Shell Games": The Showa Shell Debacle 15

Hedging Currency Risk at Oil Companies 16

The Mechanics of Hedging Dollar Exchange Rate Risk and Oil Price Risk 19

Was Showa Shell Hedging or Speculating? 21

Concealing Currency Losses 22

The Story Unfolds 23

Forecasting Exchange Rates: Treacherous at Best 23

The Moral of the Story 25

Chapter 3 Citibank's Forex Losses 29

Currency Trading in the Tranquil Days of Bretton Woods 30

Gambling on Currencies with Forward Contracts 32

How Do Banks Keep a Lid on Their Foreign Exchange Trading Operations? 33

Speculating from a Commercial Bank's Trading Desk: When Citibank is Not Quite a Hedge Fund a La Georges Soros 35

Hasty and Costly Conclusion 38

The Moral of the Story 39

Chapter 4 Bank Negara Malaysia 41

What is Central Banking All About? 42

Bank Negara as a Macro-Hedge Fund 43

How Did Bank Negara Speculate? 44

Part II Futures 47

Chapter 5 Amaranth Advisors LLC 49

The Rise and Fall of Amaranth Advisors LLC 50

Genesis of Natural Gas Derivatives 52

A Primer on Speculating in Natural Gas Derivatives 53

The Alchemy of Speculation Through Natural Gas Futures 58

The Story Unfolds: Amaranth Speculative Assault on Nymex 60

Risk Management at Amaranth 68

The Moral of the Story 70

Postscript 72

Chapter 6 Metaligesellschaft 73

The Metallgesellschaft Debacle 74

The "Long and Short" of Hedging in the Oil Market 77

Numerical Illustration of "Ebbs & Flows" Under a "Stack & Roll" Hedge 83

The "Message is in the Entrails": Empirics of the Oil Market (1983-2002) 85

If Only MGRM had been Allowed to Roll the Dice 89

When a Hedge is a Gamble: Was MGRM Hedging or Speculating? 92

MGRM as a Market Maker 93

The Moral of the Story 94

Bibliography 96

Chapter 7 Sumitomo 97

Was Sumitomo Manipulating Copper Prices? 98

Alarm Bells 100

Debacle 101

Postscript 101

Part III Options 103

Chapter 8 Allied Lyons 105

A New Mission for Allied Lyons Treasury Department 106

A Primer on Currency Options: Was Allied Lyons Hedging or Speculating? 109

Selling Volatility: Allied-Lyons "Deadly Game" 115

Alarm Bells are Ignored as the Story Unfolds 121

The Moral of the Story 122

Appendix: Pricing Currency Options 123

Chapter 9 Allied Irish Banks 125

Rusnak and Currency Trading at Allfirst 125

Gambling on Currencies with Forward Contracts 127

Arbitraging the Forward and Option Market: The International Put-Call Parity Theorem 129

The Art of Concealment 133

When Alarm Bells are Ignored 137

The Moral of the Story 139

Epilogue 140

Bibliography 140

Chapter 10 Barings 143

The Rise and Fall of the House of Barings 144

Rogue Trader 146

Arbitrage 148

From Harmless Arbitrage to Lethal Speculation 151

A Primer on How to Speculate with Options 156

Financing Margin Calls by Selling Volatility 161

Warning Bells 168

The Art of Concealment 169

The Moral of the Story: Leeson's Seven Lessons 174

Epilogue 177

Bibliography 177

Chapter 11 Soriété Géenérale 179

The Making of a Rogue Trader 179

From Arbitrage to Directional Trades 182

Hasty Conclusion 188

When Alarm Bells are Ignored 190

The Art of Concealment 192

The Moral of the Story 192

Postscript 195

Bibliography 196

Part IV Swaps 197

Chapter 12 Procter & Gamble 199

How to Reduce Financing Costs with Levered Interest Rate Swaps 200

Embedded Options and Hidden Risks 206

Landmark Lawsuit 210

The Moral of the Story 213

Bibliography 214

Chapter 13 Gibson Greeting Cards 217

Chapter 14 Orange County 221

Municipal Finance in Orange County 222

A Primer on Fixed Income Securities 224

Anatomy of Orange County Asset Portfolio 227

OCIP as a Hedge Fund 232

Double Jeopardy: How Orange County Collapsed 236

Was Filing for Bankruptcy Warranted? 237

The Moral of the Story 239

Epilogue 242

Bibliography 244

Chapter 15 Long-Term Capital Management 245

What are Hedge Funds? 246

The Rise of Long-Term Capital Management 247

The Alchemy of Finance 249

Relative Value or Convergence Trades 252

The Central Bank of Volatility 257

Straying Away from the Master Plan 263

The Fall of LTCM 264

The Rescue of LTCM 267

The Moral of the Story 270

Epilogue 272

Bibliography 273

Chapter 16 AIG 275

Securitization and Credit Default Swaps 275

What are Credit Default Swaps (CDSs)? 278

A Stealth Hedge Fund at AIG 279

The Moral of the Story 281

Postscript 283

Chapter 17 JP Morgan Chase London Whale 285

The JP Morgan Chase Fortress 286

A Primer on Credit Default Swaps and Their Extended Family 288

The London Whale: The Story Unfolds 291

Hedge Funds Harpoon the London Whale 296

A Stealth Hedge Fund? 298

The Art of Concealment 300

The Moral of the Story 304

Postscript 306

Chapter 18 From Theory to Malpractice: Lessons Learned 309

Some First Principles 309

Policy Recommendations for Non-Financial Firms 310

Policy Recommendations for Financial Institutions 314

Policy Recommendations for Investors 320

Policy Recommendations for Regulators 322.

Notes:

Includes bibliographical references and index.

ISBN:

9789814663243

9814663247

9814663263

9789814663267

OCLC:

904335814