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Joseph Jettǯs trading for kidder Peaboy lost

$350 million.

Barrings 1995- Nick Leeson responsible for a

loss of $1billion in making big bets on the
future direction of the NIKKEI 225 using
futures and options.

Chemical Bank lost $33million due to usage of

a incorrect model to view interest rate caps.

§aiwa a Japanese bank in New York lost
$1billion in 1990ǯs.

Long Term Capital Management- This hedge

fund lost about $4billion by following
convergence-arbitrage model,due to
widening credit spreads from default of
Russian bonds.

Orange County- Bob Citronǯs trading led this

municipality in California losing $1.6billion

The loss must not be regarded as loss for the
§erivative industry rather a small fraction of
it which can be avoided.

§erivative is multi trillion dollar industry and

has been outstandingly successful.
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In §ecember 1994, Orange County stunned

the markets by announcing that its
investment pool had suffered a loss of $1.6
billion.

This loss was the result of unsupervised

investment activity of Bob Citron, the County
Treasurer, who was entrusted with a $7.5
billion portfolio.

Citron delivered returns about 2% higher
than 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, that
the pool was too risky.

The county declared bankruptcy when the
Fed started a series of interest rate hikes (six
consecutive times) that caused severe losses
to 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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Lack of control

Risk limit

Investor

Overconfidence

Yield curve

Value at risk

Opportunity loss

diversification
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1) Monitor Trader Carefully-Particularly high

profit making traders trades must be fully
accountable,to know whether the high
profits are made by taking unreasonable risk.

1) Separate Front, Middle and Back office-So

that any disastrous nature of the trade is not
concealed.

3) §o not blindly trust models- Following
incorrect 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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§efine Risk Limits.

Taking the risk limits seriously- Sticking to the

pre-decided risk limit. e.g. Orange County

§o not assume you can outguess the market

§o not underestimate the benefit of

diversification.

Carry out scenario analysis and stress test.

mmŒY

§erivative provide treasures with very

efficient ways to manage risks.

§erivative should be appropriately used i.e.

either for hedging or speculation.
Importance of internal control.