Case study-the collapse of barings bank

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Case study-the collapse of barings bankCase Study - the Collapse of Barings Bank

Case Study - the Collapse of Barings Bank

Case study - The Collapse of Barings Bank

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

The play here was very simple – trading futures on the Nikkei 225 as the underlying. The Nikkei 225 was traded as a future on both the SIMEX and the Osaka markets. There were always known to be differences between the two markets which could be arbitraged. The idea was to exploit the differences between the 2 markets. and execute in the cheaper market on client orders. This would then allow Barings to net a profit as they execute in the cheaper market but quote the client the price in the more expensive market. The underlying idea was of course to always be long one and short the other.

Leeson was long Nikkei 225 futures, short Japanese government bond futures, and short both put and call options on the Nikkei Index. He was betting that the Nikkei index would rise, but instead, it fell, causing him to lose $1.39 billion.

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

Nick Leeson’s strategy failed because the Nikkei 225 index kept falling while he continued to bet that it would rise. On the 17th of January 1995 a huge earthquake struck Kobe in Japan. The Nikkei plummeted putting Leeson’s positions under a lot of stress. The Nikkei plunged to 17950 by the end of that week and Leeson started recording big losses. Leeson’s solution was however to ask for extra funds from London to meet his margin calls and continue trading. His view was that the move down on the Nikkei was temporary and he could ride it out. In the weeks that followed he almost doubled his futures position to 55,000 contracts. However the Nikkei did not recover and the margin calls kept coming. Eventually Barings could not meet the margin call and ended up collapsing with losses of more than ?800 million.

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

Leeson used his control over the back and front.