View the step-by-step solution to what was nick leeson’s strategy to earn trading profits on




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View the step-by-step solution to what was nick leeson’s strategy to earn trading profits onView the step-by-step solution to: What was Nick Leeson’s strategy to earn trading profits on

This question was answered on Sep 24, 2012. View the Answer

What was Nick Leeson’s strategy to earn trading profits on derivatives?

2. What went wrong that caused his strategy to fail?

3. Why did Nick Leeson establish a bogus error account (88888) when a legitimate account (99002) already existed?

4. Why did Barings and its auditors not discover that the error account was used by Leeson for unauthorized trading?

The Collapse of Barings

(Questions are on page 7)

In February of 1995, one man single-handedly

bankrupted the bank that financed the

derivatives contracts on the Singapore

Mercantile Exchange and Japan’s Osaka

Exchange. A scandal ensued when Leeson left

a $1.4 billion hole in Barings’ balance sheet

due to his unauthorized derivatives

speculation, causing the 233-year-old bank’s

Nick Leeson grew up in London’s Watford

suburb, and worked for Morgan Stanley after

graduating university. Shortly after, Leeson

joined Barings and was transferred to Jakarta,

Indonesia to sort through back-office mess

involving ?100 million of share certificates.

Nick Leeson enhanced his reputation within

Barings when he successfully rectified the

situation in 10 months (Risk Glossary).

In 1992, after his initial success, Nick Leeson

was transferred to Barings Securities in

Singapore and was promoted to general

manager, with the authority to hire traders and

back office staff. Leeson’s experience with

Mercantile Exchange (SIMEX) alongside his

traders. According to Risk Glossary:

quot;Leeson and his traders had authority to

perform two types of trading:

1. Transacting futures and options orders for

clients or for other firms within the Barings

organization, and

2. Arbitraging price differences between

Nikkei futures traded on the SIMEX and

Japan's Osaka exchange.

Arbitrage is an inherently low risk strategy

and was intended for Leeson and his team to

garner a series of small profits, rather than

spectacular gains. quot;

As a general manager, Nick Leeson oversaw

both trading and back office functions,

eliminating the necessary checks and balances

usually found within trading organizations. In

addition, Barings’ senior management came

from a merchant banking background,

causing them to underestimate the risks

involved with trading, while not providing

any individual who was directly responsible

for monitoring Leeson’s trading activities

(eRisk). Aided by his lack of supervision, the

28-year-old Nick Leeson promptly started

unauthorized speculation in futures on Nikkei

225 stock index and Japanese government

bonds (Risk Glossary). These trades were

outright trades, or directional bets on a

market. This highly leveraged strategy can

Nick Leeson opened a secret trading account

numbered 88888 to facilitate his furtive

trading. Risk Glossary says of Leeson:

Downloaded on 06262007 from

stock-market-crash/barings. htm.

He lost money from the beginning. Increasing

his bets only made him lose more money. By

the end of 1992, the 88888 account was under

water by about GBP 2MM. A year later, this

had mushroomed to GBP 23MM. By the end

of 1994, Leeson's 88888 account had lost a

total of GBP 208MM. Barings management

remained blithely unaware.

As a trader, Leeson had extremely bad luck.

By mid February 1995, he had accumulated

an enormous position—half the open interest

in the Nikkei future and 85% of the open

interest in the JGB [Japanese Government

Bond] future. The market was aware of this

and probably traded against him. Prior to

1995, however, he just made consistently bad

bets. The fact that he was so unlucky

shouldn't be too much of a surprise. If he

hadn't been so misfortunate, we probably

wouldn't have ever heard of him.

Betting on the recovery of the Japanese stock

market, Nick Leeson suffered monumental

losses as the market continued its descent. In

January 1995, a powerful earthquake shook

Japan, dropping the Nikkei 1000 points while

pulling Barings even further into the red. As

an inexperienced trader, Leeson frantically

purchased even more Nikkei futures contracts

in hopes to gain back the money already lost.

The most successful traders, however, are

quick to admit their mistakes and cut losses.

Surprisingly, Nick Leeson effectively

managed to avert suspicion from senior

management through his sly use of account

number 88888 for hiding losses, while he

posted profits in other trading accounts. In

1994, Leeson fabricated ?28.55 million in

false profits, securing his reputation as a star

trader and gaining bonuses for Barings’

employees (Risk Glossary). Despite the

staggering secret losses, Leeson lived the life

of a high roller, complete with his $9,000 per

month apartment and earning a bonus of

?130,000 on his salary of ?50,000, according

to “How Leeson Broke the Bank.”

The horrific losses accrued by Nick Leeson

were due to his financial gambling, as he

placed his trades based upon his emotions

rather than by taking calculated risks. After

the collapse of Barings, a worldwide outrage

ensued, decrying the use of derivatives. The

truth, however, is that derivatives are only as

dangerous as the hands they are placed in. In

this case, Nick Leeson was reckless and

dishonest. Derivatives can be tremendously

useful if used for hedging and controlling risk

or even careful trading.

After a series of lies, cover ups and falsified

documents, Leeson and his wife fled

Singapore for Kuala Lumpur, Malaysia. By

then, Barings’ senior management had

discovered Nick Leeson’s elaborate scheme.

The total damage suffered by Barings was

?827 million, or $1.4 billion. In February

1995, England’s oldest, most established bank

was unable to meet SIMEX’s margin call, and

was declared bankrupt. Leeson and his wife

were arrested in Frankfurt, Germany on

March 3 rd. 1995. That same day, the Dutch

bank, ING, purchased Barings for a mere ?1

and assumed all of its liabilities (eRisk).

Nick Leeson was placed on trial in Singapore

and was convicted of fraud. He was sentenced

to six and a half years in a Singaporean

prison, where he contracted cancer (Risk

Barings Fiasco: 'Natural born trader' who thrived on risk dodged controls and fell

into black hole

Donovan and Dan Atkinson on how one man broke the bank by

running up a possible pounds 1bn bill

The Guardian (Pre-1997 Fulltext); Manchester; Feb 28, 1995;

IF ANYBODY had the background, the

to Baring. However, Richard Raeburn,

skill and the temperament to gamble

partner with accountants KPMG, warned

Baring Brothers into insolvency, it was

that another catastrophe could happen

Nick Leeson. He had long experience in

quite easily, especially in the corporate

the bank's paperwork department and its

sector. Big companies, seeking to invest

investigation division to allow him to

He was a quot;natural born traderquot; with the

nerve and inclination to go double or quits

quot;Most corporations lack the systems and

quot;In a well-controlled bank it should not

have been possible to build up such an

He had at least one accomplice - Barings'

enormous position. quot;

computer system, proved once before to

be incapable of monitoring properly the

bank's multi-million pound global trading.

Barings' computers were scarcely up to

All these factors clicked into place in

Barings' Singapore office, with the result

the job, and Mr Leeson used his quot;backofficequot; knowledge to conceal the problem.