Lehman Case

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A Case Study of the Lehman Brothers Bankruptcy

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Financial Risk MVE220 Work distribution: 2010-11-24 Both the members of the project team have contributed equally to the case. Even though several parts have been written individually, the analyzing and key concepts have been developed mutually together. Examinator: Holger Rootzén Robin Feng 910911-1675 Niklas Fredriksson 900310-1855

Abstract Lehman Brothers was the fourth biggest investment bank in America until it filed for the bankruptcy in September 2008, less than a year after the bank presented its biggest profit ever. This report is a part of a reading project about the bankruptcy and aims to establish an overview of the risks included in Lehman Brothers’ business, how they were neglected and finally led to the downfall. The authors have examined five different types of risks that constituted the inherent risk in Lehman Brothers; market risk, credit risk, liquidity risk, operational risk and reputational risk. After analysis, the authors can conclude that all of the above mentioned risks were exceptional high and played a significant role in what would become the largest bankruptcy in history. Finally, the authors present a summary of recommendations for more sustainable risk management in investment banking.

Key words: Lehman Brothers, Investment bank, market risk, credit risk, liquidity risk, operational risk, reputational risk, Bankruptcy

Table of Content

Introduction ........................................................................................................... 4 Background ........................................................................................................... 4 Risks in Investment Banking................................................................................. 4 From Boom Years to Crisis ................................................................................... 5 The Strategical Failures ......................................................................................... 6 Exceeding the Risk Limits .................................................................................... 7 Summary of Recommendations ............................................................................ 8 References ........................................................................................................... 10 Further reading .................................................................................................... 11

Introduction
When the investment bank Lehman Brothers fell on 15 September, 2008, it was the largest bankruptcy ever, and it still is. The bank had assets of $639 billion, which is about as much as the five subsequently largest bankruptcies combined. The size of the bankruptcy could also be described as more than one and a half time the gross domestic product of Sweden in 2009. (Investopedia Staff, 2010) This report aims to establish an overview of the financial risks included in Lehman Brothers’ business, how they were neglected and finally led to their bankruptcy. Furthermore, to analyze the risks and give a recommendation of a more sustainable risk approach.

Background
The foundation for Lehman Brothers was laid by the German immigrant Henry Lehman and his brothers in the 1850s. For the first decades the company traded cotton, but in the beginning of the 20th century it started with banking and securities trading, eventually becoming an investment bank. Investing and doing business in growing sectors of the 20th century as well as going global and acquiring other firms, Lehman Brothers expanded and became one of the world’s largest investment banks. (Historical Resources, 2010) Modern investment banks like Lehman are complex institutions with advanced and opaque structures, with daily transactions of several billion of dollars. The main business areas of Lehman before the collapse was typical investment banking as well...
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