Nick Leeson Case Free Essay Example

Why did Nick Leeson sell numerous short straddles for each long futures contract he bought?

When Nick Leeson was being promoted on the Singapore branch of the Barings bank, the strategy of the bank was to reduce the risk exposure by using a combination of one short straddle (combination of put / call) and for one long future. Since Nick Leeson used to be a specialist on Future contracts on Nikkei 225 and Japanese 10 years bond and was sure this market would arise.

So he decided to sell disproportionate numbers of short straddles for each long futures position he took to pay the required initial margin deposits and new trades and also to meet the mounting margin calls on his existing futures positions, he used the cash the bank made from the sale of the short straddles.

Explain Nick Leeson’s doubling strategy.

On a bet, if you lose, you can then decide to double the bet. This way, if you win, you can get the same profit you could you win on the previous bet.

The problem is that if you lose again, then you would have doubled your losses. So, for the profit you could win on the first bet, you double your losses on all the other bets you make and lose. At the end of the day, you can bet enormous amounts to just have a very small profit.

As an example, we can take the fair coin. On the first bet, you can bet $1. If you lose, then you have lost .

So, on the second bet, in order to have the chance to do $1 profit, you need to bet $2 (you could get a profit of $2 on the second bet but you have made $1 loss on the first one). After like 5 time you lost, you should bet $16 to just get the chance to have 1$ profit:

For the bet: 1 x 2 x 2 x 2 x 2 = 16 Previous losses: 1 + 2 + 4 + 8 = 15

So you get $32 revenue but you have bet $16. So you earn $16 but you have lost $15 from previous losses. So at the end of the day, you got $1 profit for a $16 bet.

Has Nick Leeson drawn too much of the blame for what went wrong at Barings Bank? Who else bears some of the responsibility? Why?

First of all, it is obvious that Nick Leeson had big responsibilities in the failure of Barings because he used fraud. He also increased the risk exposure of the bank and had hidden it from its superiors. By using his reputation and the trust from the bank he speculated while he should not have been able to do so.

But after all, the bank had given Nick Leeson virtually free rein and let him do both the back and front office work which was not relevant. The controlling at Barings had failed because the “88888 account” Nick Leeson did not appear on trader reports. So the Barings should given so much responsibility to one single man.

Was the Barings board of directors culpable for the losses of Nick Leeson? What is a fair way to evaluate the performance of Barings’ board of directors?

The board of directors is not directly but indirectly culpable because of the lack of control on Leeson’s activity. None of Nick Leeson’s supervisor realized the risks he was taking and the way it could damage to the Bank.

The biggest mistake the board of directors made was to trust a single man only because of his reputation. Just because Nick Leeson was reporting large profits, he was given virtually free rein and nobody had knowledge of his activity, when a trader on arbitrage strategies should not report such profits. The fact that Nick Leeson was reporting such profits should have been interpreted by the board of directors as a warning bell.

The board of directors also ignored Nick Leeson’s growing cash demand he needed to finance his trading positions (and losses).

Nick Leeson traded simultaneously on two exchanges in two different time zones. Does the fact that he was trading on two exchanges simultaneously automatically mean he was speculating, or is it what he was doing that made the trades speculative?

Nick leeson’s job was trading on the Osaka Stock Exchange and the Singapore International Monetary Exchange for arbitrage strategies. Arbitrage is not a speculative position. Speculative positions are highly exposed to risk while Arbitrage is not. So, since arbitrage includes low risk exposure and since Nick Leeson’s supervisors trusted him, they let him work without knowledge of his activities.

So, it is what Nick Leeson did that was speculative. Selling short straddle to buy long futures on Nikkei 225 index is a very speculative position.

Nick Leeson sold short straddles and combined them with long futures contracts. What hybrid would he have created if he combined long call options on the Nikkei Index and with short forward contracts? Why did he sell options instead of buying them?

The hybrid would have been a Long Put. He sold options because he was sure of the rise of the Nikkei Index so he took riskier positions to get higher returns.

Was the existence of the 88888 Account one of the fundamental problems at Barings Bank PLC, or was the problem with its use?

The 88888 Account was used for discrepancies caused by delays between payment and its reception so the bank’s books would balance.

Since Nick Leeson had to deal a lot with this account when he was working in the Indonesia branch of Barings, he knew precisely how to use it and how to abuse from it. So he used it a wrong way to hide his losses from his superiors. Indeed, this account would not appear on the control reports of traders but on the financial statement of the bank.

So he put his losses on this account and also took speculative positions thanks to this account and his superiors would not be able to understand why this account was used.

Since his superiors trusted him and knew his strong knowledge about this account, they let him use it the way he wanted.

So, in fact, the bank needed to use this account. The problem here was the way Nick Leeson used it because he was certainly both clever and unscrupulous.

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