What are misleading reporting cases?

Misleading reporting cases are cases where investors, firms and lenders were misled about the nature and size of investment positions

Describe the following case:

Drysdale securities and chase manhattan bank

example of misleading reporting case.

Drysdale were able to borrow $300m from Chase when their capital was only $20m.

Drysdale used the money to enter into bond positions which declined in value, resulting in Drysdale having to declare bankruptcy.

How did Drysdale do it? - they exploited a flaw in the market's system for computing the value of collateral of US government bonds which was often valued without considering accrued interest.

Chase were partly to blame for assuming they were only the middleman.

The case led Chase and other firms to seek the approval of a risk control function when issuing new funds.

It was a case of misleading reporting.

Head of bond trading desk falsy reported $350m in gains.

These had to be reversed (in reports).

Case triggered a loss of confidence in the company.

He was able to do it because the computer system did not accoutn for a forward contract's present value.

The case highlights the need to investigate large profits from unknown trading strategies.

case of misleading reporting.

Nick Leeson took speculative derivative positions in an effort to recoup prior trading losses that he was able to hide fraudulently.

the losses went undetected due to inadequate control systems.

Leeson was Barings floor manager in Singapore and in charge of settlement ops.

There was little management oversight of the settlement process.

Weak management failed to establish information, reporting and control systems.

Case of misleading reporting.

A currency trader hid $691m in losses from management usign a number of deceptive means.

Management was partly to blame for its inexperience.

The trader, John Rusnak, bullied  back-office employees and took advantage of the fact that trades were transacted in over the counter market which did not require cash settlement.

let me ask  ya something... what was the story with the UBS scandal in '97?

What were the 4 factors that caused the losses?

case of misleading reporting.

their equity derivatives business lost between $400-700m.

- British law changes

- large Japanese bank warrants which were inappropriately hedged against a drop in the underlying stocks

- incorrect valuation of long-dated options on equity baskets

- inappropriate modelling of other long-dated options.

Misleading reporting case.

went undetected due to the trader's dual role as the head of trading and back office support.

trader attempted to corner the copper market.

- by taking a dominant long position in futures contracts and at the same time purchasing large amount of physical copper. The idea was that as the contracts approached delivery the party with the short position would find very little physical copper available and have to pay a large premium of else unwind its short by taking a long. This would force the price of copper upwards.

- Massive risk to the firm if copper prices went down.

- He got away with it as there was very little supervision of him. High degree of operational risk which could have been reduced with proper internal controls.

- Large transactions should have required approval by management but this didn't happen.

The manager, David Askin, misled investors by valuing positions with incorrect values - he did this in order to generate interest in his funds.

Both funds went bankrupt in 1994 suffering losses of $600 million.

case of misleading reporting.

In '87 reported losses of $350m - due to a mistake in the firms calculation of duration.

case of misleading reporting.

Traders used incorrect volatility inputs for interest rate caps and swaptions.

Large market movement case.

- implemented a strategy designed to insulate customers from price volatility in the petroleum markets for a fee.

- The customer contracts gave MGRM a short position in long term forward contracts which they hedged with long positions in near-term futures using a stack and roll strategy.

- The fundamental issue for MGRM was a cashflow problem that constrained the company's ability to ride out the hedge.

What were the causes of the problems?

- Due to the different ways that losses and gails on forwards and futures were realised there was short term cashflow outflows which resulted in funding liquidity risk

- Declining oil prices also created margin calls resulting in more outflows of cash. Firm was forced to unwind postions at very unfavourable terms.

- Magnitude of losses caused credit rating to drop - futher restricting the firm's access to credit.

- Losses created a crisis of confidence with counterparties.

- Huge size of positions subjected the firm to trading liquidity risk. as to liquididate quickly would have shifted market prices.

- firm had a heavey debt load and little equity to withstand losses and cashflow problems on positions of this size.

Large market movement case.

Huge leverage... balance sheet leverage was in line with other large invesment banks, but it also had huge economic leverage in its positions.

LTCM's trading strategy involved arbitraging price differences among similar securities and profiting when prices converged. One benefit of this convergence strategy is that being long and short similar securities hedges risk exposures and reduces volatility.

Their strategy was based on the assumption that volatility (in fixed income and equity options) tended to revert to long term average levels. When volatility was abnormally high LTCM would sell volatility until it regressed to normal levels.

In '98 when russian rouble collapsed huge increases in volatility caused big losses in LTCM's equity volatility strategies.

Huge cashflow problems which LTCM was not able to ride out the period before convergence of asset prices.

One of the main risks faced by LTCM was model risk - models assumed historical relationships would hold (normally true but external shocks changed correlations). Models also assumed that low-frequency/high severity events were uncorrelated over time - thus their models (traditional VaR models) underestimated risk int eh tails of the distribution.

LTCM actions had a big impact on the market (trading liquidity risk)

Reports were incomplete and lacked disclosure (they got away with this cause they were a hedge fund)

What were the suggested improvments following LTCM:

- ensure an initial margin is provided.

- incorporate potential liquidation costs into prices in the event of adverse market conditions

- need for greater position disclosure

- better utilisation of stress testing

Customer conduct case (decreases in firm reputation amongst it's customers)

BT used derivatives for it's customer P&G and Gibson Greetings - to help them reduce funding costs. 

The derivatives resulted in significant losses.

The structure of the derivatives was intentionally complex and P&G and Gibson did not understand the risks involved.

BT fooled the clients with complex structures and used manipulated price quotes.

Matching trades with client needs and providing price quotes that are independent from the front office.

Also showed that firms should be cautious with communications forms that could be made public (phone converstaions between traders in BT's case).