Since the margins are so low it requires a large

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- Since the margins are so low, it requires a large volume of trading to make a profit, but it is not a risky strategy because the short position in one market is offset by the long position in the other. Exchange arbitrage: trying to profit from difference in Nikkei futures contracts listed in Japan (OSE) and Singapore (SIMEX) OR Cash-and-Carry arbitrage: a market neutral strategy combining the purchase of a long position in an asset such as a stock or commodity, and the sale (short) of a position in a futures contract on that same underlying asset ii. Explain the strategy he actually pursued (the “straddle”). Instead of hedging his positions, Leeson gambled on the future direction of the Japanese market. He had unhedged his positions and bought $7 billion-worth of stock-index futures and sold $20 billion-worth of bond and interest-rate futures contracts. - Most losses came from the stock-index futures. Saddles are deals where one simultaneously sells put options (conferring the right to sell) and call options (conferring the right to buy) on Nikkei-225 futures. - The seller of saddles profits if the market is less volatile than the options prices predict. - By selling 40,000 of these, Leeson made the bank $150 million. A “straddle” = An options strategy where the investor holds a position in both a call and put with the same strike price and expiration date, but with different exercise prices significant profits if price changes significantly but a loss occurs if it barely changes simultaneously sold put options (right to sell) and call options (right to buy) on Nikkei futures profit when market proves less volatile than options predict he gambled in the future direction of the Japanese market iii. Why did this go wrong, what did Leeson do about it, and how did this result in massive losses? The Kobe earthquake caused the Nikkei-225 to wobble - Leeson needed it to stay in the 18500-19500 range, but it fell to under 17800 when the Tokyo stock market plunged in January. - Leeson attempted to buy futures on a huge scale to push the prices back up, as bonuses were due out in February. Bought futures hoping to single handedly drive the market back up but when stock market plunged he took a huge loss and sank the bank
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iv. How did Barings lay itself open to this kind of disaster? Barings did not monitor Leeson - he was the head of settlements and head of trading, and had seemed successful the previous year. - Most banks separate their trading and settlement functions, as allowing traders to settle their own deals makes it easier for them to hide risks they are taking or money they are losing. There was also no independent risk-management unit to provide a check on Leeson. Leeson may have used a fictitious client account to meet margin calls, then used the London branch when that went dry (which was happy to help because he had given them commissions earlier). - The bank was known for the autonomy of its individual businesses, which meant it lacked a common culture and that management was spread too thinly.
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  • Fall '19
  • Derivative, Nick Leeson, Credit default swap, Tokyo Stock Exchange

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