Six Derivatives Mishaps

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FI475-Project Study
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Six Derivatives Mishaps|

2012/5/8
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Sumitomo (future contracts)
Background:
1996, Sumitomo Corporation was one of the top copper market makers in the world. During the over 10 years under Hamanaka, who was a genius charged on allegations that he could manipulate the price of the metal, Sumitomo lost at least $1.8 billion as a result of what it said were unauthorized trades, which then lost a third of its value on world markets in less than two months. The affair was a major scandal which is at times compared in magnitude to the Silver Thursday scandal, involving the Hunt family's attempt to corner the world's silver markets. It currently ranks in the top 5 trading losses in financial history. Cause:

In this whole scandal, Hamanaka keept two sets of trading books, one was reported showing big profits for Sumitomo and a second which secret account that was recorded unauthorized trades for over 10 years that how he used company’s money to made own profit. Because Sumitomo’s poor managerial, financial and operational control systems, which enabled Hamanaka to carry out unauthorized trading activities undetected by the top management. There was a lack of effective monitoring and supervision of his trading activities. The sorts of risks that cause this loss are market risk, operational risk – supervision and fraud – market manipulation. Aftermath:

Even though, Sumitomo was able to cover the losses since it had a net worth of $6billon and another $8billon in hidden reserves. Also the losses estimated to be $2.6billon which is amount of only 10 % of Sumitomo’s annual sales. Otherwise Sumitomo was also able to prevent further escalation of losses by aggressive liquidation of its uncovered position. Sumitomo’s reputation still went down for the traders. Every time speculators tried to move the price, the company threw more money at Hamanaka. Hamanaka was transferred from his trading post and charged for the forgery on his supervisor's signature on a form. Sumitomo's reputation was tainted because people believed the company ignored Hamanaka's hold on the copper market. Amaranth (future contracts)

Background:
A Connecticut hedge fund that bet heavily on the natural gas futures market lost almost $6 billion as it sold assets at a loss to stay afloat while its bets on natural gas plummeted, the fund told investors. Greenwich-based Amaranth Advisors said in a letter late Wednesday that the fund lost about 55 percent of its year-to-date assets and about 65 percent month-to-date as of Tuesday, leaving the hedge fund’s assets below $3.5 billion. Amaranth was forced to decrease the price to balance off the losses. However, futures price acceleration down and increase its original size losses degrees, to the end of September 2006, Amaranth fund losses of expanded it to us $6.6 billion, as 70% of its total assets. Cause:

Most of Amaranth's initial energy investments associate with nature, when hurricanes Katrina and Rita disrupted natural gas production and really pushed the price of natural gas up nearly three-fold from the low to the high. The leverage used in hedge fund, for the high percentage of leverage, if the investments succeed that will be having a very high return. But also on the opposite view, it will be a disaster. Also most hedge funds lack transparency that makes the situation more badly. From day to day basis, investors have no idea what the fund is doing with their money. But in reality, the hedge fund has free rein over its investors' money. Most hedge funds make their money with performance fees that are generated when the fund achieves large gains; the bigger the gains, the bigger the fees for the hedge fund. If the fund stays flat or falls 70%, the performance fee is exactly the same: zero. This type of fee structure can be part of what forces hedge fund traders to implement exceedingly risky strategies. Aftermath:

Due to margin calls and liquidity issues Maounis, a...
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