Questions:
608.1. Consider two very different financial disasters the both happened in 1994: Proctor & Gamble's (P&G's) $150+ million loss and a much bigger loss by the city of Orange County. In the case of Orange County, a $1.5 billion investment loss forced the city to file bankruptcy in December 1994. Until Jefferson County went bankrupt seventeen years later in 2001, this had been the largest municipal bankruptcy in U.S. history. Orange Country treasurer Robert Citron had entered into reverse repurchase agreements, collateralized mortgage obligations, indexed amortizing notes, and structured notes, including inverse floaters. Citron's strategies at Orange Country where highly profitable in the early 1990s, but unraveled into massive losses in 1994.
Although the Proctor & Gamble (P&G) differs from the Orange County case study, among the following which do the disasters most have in common?
a. The managers at P&G and Orange County falsified trading activity in order to fabricate artificial profits, which were ultimately discovered by accountants
b. In both cases, unanticipated regulation prompted an abrupt shift in the stock market, and an increase in equity volatility, that could have been managed with additional derivatives hedges
c. Both P&G and Orange County entered highly complex derivative positions than neither suited their objectives, nor were deeply understood by them, such that the client's banks were blamed
d. Both P&G and Orange County entered positions that were profitable during an environment of increasing interest rates (e.g., inverse floater) but experienced losses when interest rates dropped
608.2. Consider the following four financial services firms and their associated financial disasters:
a. In each, investors and/or lenders were seriously misled about the size and nature of the positions it had
b. In each, a rogue trader started with a garden variety position and gradually accumulated in an unauthorized position
c. In each, the firm and its investors and lenders had reasonable knowledge of its positions, but had losses resulting from unexpectedly large market moves
d. In each, losses did not result from positions held by the firm, but instead resulted from fiduciary or reputational exposure to positions held by the firm's customers
608.3. The Enron scandal led to the largest bankruptcy in U.S. history at the time (November 2001. It was surpassed by WorldComm's bankruptcy the next year). According to Allen, each of the following is true about the Enron scandal EXCEPT which is false? (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. Enron's stack-and-roll strategy was profitable until the oil futures market shifted from backwardation to contango
b. Just as Greece entered an off-market currency swap in 2001 to disguise debt, Enron used oil futures contracts to disguise debt
c. Enron used hundreds of special purpose entities (SPE) to limit transparency, overstate equity, hide debt and to misrepresent risk by asserting that certain SPE were hedges when they did not mitigate risk
d. Enron's dubious accounting practices (e.g., aggressive revenue recognition) were enabled by its auditor, Arthur Anderson, whose failure to fulfill its professional responsibilities led to the break-up of the accounting firm
Answers here:
608.1. Consider two very different financial disasters the both happened in 1994: Proctor & Gamble's (P&G's) $150+ million loss and a much bigger loss by the city of Orange County. In the case of Orange County, a $1.5 billion investment loss forced the city to file bankruptcy in December 1994. Until Jefferson County went bankrupt seventeen years later in 2001, this had been the largest municipal bankruptcy in U.S. history. Orange Country treasurer Robert Citron had entered into reverse repurchase agreements, collateralized mortgage obligations, indexed amortizing notes, and structured notes, including inverse floaters. Citron's strategies at Orange Country where highly profitable in the early 1990s, but unraveled into massive losses in 1994.
Although the Proctor & Gamble (P&G) differs from the Orange County case study, among the following which do the disasters most have in common?
a. The managers at P&G and Orange County falsified trading activity in order to fabricate artificial profits, which were ultimately discovered by accountants
b. In both cases, unanticipated regulation prompted an abrupt shift in the stock market, and an increase in equity volatility, that could have been managed with additional derivatives hedges
c. Both P&G and Orange County entered highly complex derivative positions than neither suited their objectives, nor were deeply understood by them, such that the client's banks were blamed
d. Both P&G and Orange County entered positions that were profitable during an environment of increasing interest rates (e.g., inverse floater) but experienced losses when interest rates dropped
608.2. Consider the following four financial services firms and their associated financial disasters:
- Morgan Grenfell: In 1995, a fund manager at Morgan Grenfell Asset Management directed mutual fund investments into highly speculative stocks
- JPMorgan and Citigroup: JPMorgan and Citigroup agreed to pay a combined $286 million and to put new controls in place, in one outcome of the Enron scandal
- Prudential-Bache Securities: after a long investigation by the SEC, Prudential-Bache Securities had to pay over $1.0 billion in fined and settlements due to limited liability partnerships
- Investment banks during the dot-com bubble and crash: Prior to the large fall in the value of technology stocks in 2001 and 2002, some widely following stock market analysts working at investment banks issued favorable recommendations for companies
a. In each, investors and/or lenders were seriously misled about the size and nature of the positions it had
b. In each, a rogue trader started with a garden variety position and gradually accumulated in an unauthorized position
c. In each, the firm and its investors and lenders had reasonable knowledge of its positions, but had losses resulting from unexpectedly large market moves
d. In each, losses did not result from positions held by the firm, but instead resulted from fiduciary or reputational exposure to positions held by the firm's customers
608.3. The Enron scandal led to the largest bankruptcy in U.S. history at the time (November 2001. It was surpassed by WorldComm's bankruptcy the next year). According to Allen, each of the following is true about the Enron scandal EXCEPT which is false? (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. Enron's stack-and-roll strategy was profitable until the oil futures market shifted from backwardation to contango
b. Just as Greece entered an off-market currency swap in 2001 to disguise debt, Enron used oil futures contracts to disguise debt
c. Enron used hundreds of special purpose entities (SPE) to limit transparency, overstate equity, hide debt and to misrepresent risk by asserting that certain SPE were hedges when they did not mitigate risk
d. Enron's dubious accounting practices (e.g., aggressive revenue recognition) were enabled by its auditor, Arthur Anderson, whose failure to fulfill its professional responsibilities led to the break-up of the accounting firm
Answers here:
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