Big Losses by Financial

Derivatives Mishaps and Institutions

What We Can Learn from  Allied Irish Bank ($700 million)
Them  Amaranth (6 billion)
 Barings ($1 billion)
 Daiwa ($1 billion)
Chapter 25  Enron’s counterparties (billions)
 Kidder Peabody ($350 million)
 LTCM ($4 billion)
 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 limits set
 Allied Lyons ($150 million)
 Exceeding risk limits not acceptable even when
 Gibsons Greetings ($20 million) profits result
 Hammersmith and Fulham ($600 million)  Do not assume assume that a trader with a good
 Metallgesellschaft ($1.8 billion) track record will always be right
 Orange County ($2 billion)  Be diversified
 Procter and Gamble ($90 million)  Scenario analysis and stress testing is important
 Shell ($1 billion)
 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 speculators
 Liquidity risk is important  It can be dangerous to make the
 There are dangers when many are following the same Treasurer’s department a profit center
strategy
 Do not finance long-term assets with short-term
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