Questions:
607.1. In January 2008, Société Générale reported trading losses of €4.9 billion (~ $7.1 billion) that the firm attributed to fraudulent and unauthorized activity by a junior trader, Jérôme Kerviel. According to Steve Allen, each of the following is a "lesson to be learned" from the crisis EXCEPT which is NOT a direct lesson to be learned from the crisis? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Vacation policy: Rules for mandatory time away from work should be enforced.
b. Dealing risk; aka, endogenous liquidity risk: Because huge positions (measured as a percentage of the total trading activity) can take too long to liquidate, impose concentration limits so any position does not represent more than 40% of a market's total trading activity
c. Trade cancellation: Institute systems for monitoring patterns of trade cancellation. Flag any trader who appears to be using an unusually high number of such cancellations. Any trader flagged should have a reasonably large sample of the cancellations checked to make sure that they represent real trades by checking details of the transaction with the counterparty.
d. Gross positions: Gross positions must be monitored and highlighted in control reports. This is particularly important since unusually high ratios of gross to net positions are a warning sign of potentially inadequately measured basis risk as well as a possible flag for unauthorized activities. The Kidder Peabody and Allied Irish Bank frauds could also have been uncovered by investigating unusually high ratios of gross to net trading.
607.2. After its first three years of earning almost 40% in annualized returns, Long-term Capital Management (LTCM) experienced a rapid downfall in August and September of 1998 triggered by the 1998 Russian financial crisis (which included Russia's default on its domestic debt and a moratorium on repayment of foreign debt). LTCM teetered on bankruptcy before it was rescued in a bailout. According to Steven Allen, which of the following is critical lesson learned from LTCM? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Because it was a rescue of management and investors by the U.S. government, LTCM contributed to the perilous attitude that some firms are "too big too fail" (TBTF)
b. The lack of transparency (information sharing) and tendency to promote key decision-making by individuals rather than groups enabled the emergence of rogue traders
c. A simple calculation of LTCM's balance sheet leverage (assets to equity) would have demonstrated it was much too risky, especially in comparison to investment banks in 1998
d. LTCM should have relied on forward-looking stress tests (rather than backward-looking convergence patterns) that included a flight-to-quality scenario which might widen credit spreads and spikes in equity option implied volatiltiy
607.3. The financial disasters at Metallgesellschaft in 1993 and Long-term Capital Management (LTCM) in 1998, although very different, shared in common that no rogue trader was involved. According to Steven Allen, which of the following best summarizes briefly the key dynamic shared in common between the LTCM and Metallgesellschaft disasters? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Both were disasters due to large and unanticipated market moves exposed a lack of liquidity management
b. Both were disasters due misleading reporting in particular exacerbated by atypical and outdated accounting systems
c. Both were disasters due to the conduct of customer business, specifically they did not adequately explain their strategy's risks to their clients
d. Both were disasters due to the conduct of customer business, specifically they hid the magnitude of their exposure from their clients
Answers here:
607.1. In January 2008, Société Générale reported trading losses of €4.9 billion (~ $7.1 billion) that the firm attributed to fraudulent and unauthorized activity by a junior trader, Jérôme Kerviel. According to Steve Allen, each of the following is a "lesson to be learned" from the crisis EXCEPT which is NOT a direct lesson to be learned from the crisis? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Vacation policy: Rules for mandatory time away from work should be enforced.
b. Dealing risk; aka, endogenous liquidity risk: Because huge positions (measured as a percentage of the total trading activity) can take too long to liquidate, impose concentration limits so any position does not represent more than 40% of a market's total trading activity
c. Trade cancellation: Institute systems for monitoring patterns of trade cancellation. Flag any trader who appears to be using an unusually high number of such cancellations. Any trader flagged should have a reasonably large sample of the cancellations checked to make sure that they represent real trades by checking details of the transaction with the counterparty.
d. Gross positions: Gross positions must be monitored and highlighted in control reports. This is particularly important since unusually high ratios of gross to net positions are a warning sign of potentially inadequately measured basis risk as well as a possible flag for unauthorized activities. The Kidder Peabody and Allied Irish Bank frauds could also have been uncovered by investigating unusually high ratios of gross to net trading.
607.2. After its first three years of earning almost 40% in annualized returns, Long-term Capital Management (LTCM) experienced a rapid downfall in August and September of 1998 triggered by the 1998 Russian financial crisis (which included Russia's default on its domestic debt and a moratorium on repayment of foreign debt). LTCM teetered on bankruptcy before it was rescued in a bailout. According to Steven Allen, which of the following is critical lesson learned from LTCM? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Because it was a rescue of management and investors by the U.S. government, LTCM contributed to the perilous attitude that some firms are "too big too fail" (TBTF)
b. The lack of transparency (information sharing) and tendency to promote key decision-making by individuals rather than groups enabled the emergence of rogue traders
c. A simple calculation of LTCM's balance sheet leverage (assets to equity) would have demonstrated it was much too risky, especially in comparison to investment banks in 1998
d. LTCM should have relied on forward-looking stress tests (rather than backward-looking convergence patterns) that included a flight-to-quality scenario which might widen credit spreads and spikes in equity option implied volatiltiy
607.3. The financial disasters at Metallgesellschaft in 1993 and Long-term Capital Management (LTCM) in 1998, although very different, shared in common that no rogue trader was involved. According to Steven Allen, which of the following best summarizes briefly the key dynamic shared in common between the LTCM and Metallgesellschaft disasters? (Source: Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd Edition (New York: John Wiley & Sons, 2013))
a. Both were disasters due to large and unanticipated market moves exposed a lack of liquidity management
b. Both were disasters due misleading reporting in particular exacerbated by atypical and outdated accounting systems
c. Both were disasters due to the conduct of customer business, specifically they did not adequately explain their strategy's risks to their clients
d. Both were disasters due to the conduct of customer business, specifically they hid the magnitude of their exposure from their clients
Answers here:
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