Big Losses by Financial

Derivatives Mishaps and Institutions

What We Can Learn  Allied Irish Bank ($700 million)
from  Amaranth (6 billion)
 Barings ($1 billion)
Them  Daiwa ($1 billion)
 Enron’s counterparties (billions)
Chapter  Kidder Peabody ($350 million)
 LTCM ($4 billion)
25  Midland Bank ($500 million)
 Société Générale ($7 billion)
 Subprime mortgages (tens of billions)

Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 1 Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 2

Big Losses by Non-Financial Lessons for All Users of

Corporations Derivatives
 Risk must be quantified and risk
 Allied Lyons ($150 million) limits set
 Gibsons Greetings ($20 million)  Exceeding risk limits not acceptable even when
 Hammersmith and Fulham ($600 million) profits result
 Metallgesellschaft ($1.8 billion)  Do not assume assume that a trader with a good track
 Orange County ($2 billion) record will always be right
 Procter and Gamble ($90 million)  Be diversified
 Shell ($1 billion)  Scenario analysis and stress testing is important
 Sumitomo ($2 billion)
Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 3 Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 4

Lessons for Non-Financial

Lessons for Financial Institutions Corporations
⚫ Do not give too much independence to star traders
⚫ Separate the front middle and back office  It is important to fully understand the
⚫ Models can be wrong products you trade
⚫ Be conservative in recognizing inception profits
⚫ Do not sell clients inappropriate products
 Beware of hedgers becoming
⚫ Liquidity risk is important speculators
⚫ There are dangers when many are following the same  It can be dangerous to make the
strategy
⚫ Do not finance long-term assets with short-term
Treasurer’s department a profit center
liabilities
⚫ Market transparency is important
Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 5 Fundamentals of Futures and Options Markets, 7th Ed, Ch 25, Copyright © John C. Hull 2010 6