Background of the Research
The background of the research began in the mid 1980’s where Nick ended up working in Barings after working as a clerk with the royal bank Coutts. Later Nick also served a string of positions with different banks and ended up working at Barings bank which was the oldest bank in the town. Due to various impressions from Nick, he was promoted to the trading sector. It did not take long until Nick got appointed as a manager of a fresh business under futures markets on the Singapore monetary Exchange. Soon Nick was making a lot of money for Barings by laying a bet on the future track of Nikkei Index. Other managers who were in London viewed the huge profits that Nick made with glee.
The research on Nick report is important because it reflects my clear and precise understanding concerning money, financial institutional risks and capital markets. Some of the limitations imposed from the research include: The research is time consuming because it involves a lot of scandals that the trader Nick was involved in by collapsing the Baring bank. The main purpose of this project is to provide understandable information regarding money and capital markets and also financial institutional risks under a research on Nick. To achieve the thesis of the report I have structured my project into an understandable context by dividing it into subsections.
Barings bank that is previously known as Baring brothers and corporative was the oldest merchant banking organization or company that was founded in 1762 in England. In 1995 February 26, Barings bank collapsed as a result of fraud activities that Nick the trader of the company performed secretly by losing $1.4 billion through investing in the Singapore International Monetary Exchange with primarily imitative securities. However, following the collapse of Barings bank, the bank was later purchased by a bank company known as the Dutch Insurance organization. Today the bank no longer exists as a corporation entity because Baring family’s name lives in Baring Asset Management.
Due to the impressions that Nick gave to the bank, in January 1992, Barings assigned Nick as the trade manager in another branch that was opened in Singapore. Nick became the head of imitative trading at the Barings Futures Singapore office. Nick focused his trading operations under three main markets on futures contracts, the three main markets involved: euro-yen 4, 10-year Japanese government bonds and the Nikkei 225 stock exchange index. The main markets were traded concurrently under the Osaka Securities Exchange. Nick’s job involved taking advantage over the arbitrage chances between the three markets: euro-yen 4, 10-year Japanese government bonds and the Nikkei 225 stock exchange index.
Importance and Limitations of the Research
Nick traded very many contract more than the expected limits and once Nick lost trades that could imperfect his status as the best trader, Nick assigned an immediate extra trade and the lost transactions to the account 88888 and later used the account to cover up the reality that he was adjusting the loses and not arbitraging. The supervisors of Barings bank allowed Nick to have large positions but in reality the trader exaggerated the amounts and the supervisors realized that Nick had an aim of offsetting the enormous exposures. Nick introduced the doubling method where in 1994, the Asian stock markets cooled behind and Nick began focusing his trading operations on Japanese government bond futures and Japanese stock index futures.
Nick placed a bet that Japanese Stocks and the interests rate would increase at a precise while the Japanese market was sinking, with time the losses that Nick made piled up in the 88888 account. Later the trader decided to cover up for the lost money by beginning the fatal. During the next operation of the trading Nick losses in the 88888 account continued to increase and this amounted to £70 million but still he was comfortable with the doubling strategy that he had began, but his trading operations began to face a major problem.
In 1994, December, Nick had accumulated losses of £208. At this period Japanese stocks went above to 19,000 and at the same time an earthquake had occurred in Kobe In 1995. After the Earthquake, the fall of Nikkei index forced Nick to engage himself in a massive operation in order to hold Japanese stock prices which amounted to 19,000. In the next trading operations, Nick handed in a total of 20,000 futures contracts. In February 1995, Nick’s comprehensive position accumulated to 61,000 futures contracts and this is the time the Japanese common stocks fell drastically this was the period when the other partners realized that Barings bank was drastically and massively falling because of the fraud trading operations that Nick conducted.
In 1995, the reckless trader was identified by the Barings directors who were in London. The Barings directors realized that Nick’s trading was not arbitrage and that he was only trying to repute his name as a star trader. Barings sent a group of inspectors but it was late because the losses accumulated and even exceeded the bank’s net worth $500 million. Barings had no way to recover up for the lost money because the financial status of the bank was completely ruined.
Barings Bank: History and Collapse
A futures contract refers to a legal agreement that is usually made on a trading operation floor of a futures swap to either buy or sell a scrupulous product or a financial gadget at a fixed or determined price at a particular period in the future. Futures contracts are designed to enhance trading on a futures exchange but it depends on the basic asset that is being traded. Futures contracts also specify the quality and quantity of the commodity. However, some futures contracts usually require physical delivery of the asset while other futures contracts are immediately settled in cash. Moreover there is a difference between the futures contracts and the futures. Futures contracts only describes the specific characteristics of the specific asset that is being traded while future refers to the overall market meaning a futures trader, for instance I can say that Nick was a future trader.
Futures contracts are categorized and used by two types of market applicant: the speculators and the hedgers. The consumer or the producer of a particular asset is the one who guarantees the price at which a specific commodity is sold. For instance in the trading operations, the managers or the traders like Nick can decide to create a bet on the movement of the price of the particular asset through the use of futures. Various futures contracts that are available on different dozens of major stock markets around the world are traded. However, as for the commodities, large quantities of contracts are accessible for each and every commodity that gets produced. Examples of the commodities include the industrial metals, oil, precious metals, grains and livestock.
Wash- sale rule refers to an international Revenue Service rule that forbid a taxpayer from declaring a trade or a sale of a security in a wash sale. The rule is defined as a wash sale when an individual trades a security at a loss and in the same operation within 30 days before or after the sale; the trader buys a significantly matching stock or acquires a contract to do so. A wash sale also results due to an individual selling a security and the corporation proscribed by the person purchases a substantially corresponding security.
A wash sale is describes a double transaction on significantly similar securities in a 61 day operation. However, the 61 days are added as the date of the trade and the 30 days before the transaction and 30 days after the transaction. In addition this explains that if a trader holds a stock, purchase another extra share and sells the stock at a loss within the 30 days after the purchase then this type of trade is simply considered as a wash sale because an individual’s stock is sold at a loss and then the same person purchases another stock within the 30 days of the sale loss.
Nick Leeson: The Trader
Example, from the trading operations that Nick operated, Nick introduced the doubling method where in 1994, the Asian stock markets cooled behind and Nick began focusing his trading operations on Japanese government bond futures and Japanese stock index futures. Nick placed a bet that Japanese Stocks and the interests rate would increase at a precise while the Japanese market was sinking, with time the losses that Nick made piled up in the 88888 account. Later the trader decided to cover up for the lost money by beginning the fatal. During the next operation of the trading Nick losses in the 88888 account continued to increase and this amounted to £70 million but still he was comfortable with the doubling strategy that he had began, but his trading operations began to face a major problem. In 1994, December, Nick had accumulated losses of £208. At this period Japanese stocks went above to 19,000.
Procedure 1: Determining an individual’s outlook
This is the first step that an individual needs to look upon when buying a futures contract. Having an outlook is an important step that enables a trader to look at the challenges that may incur. Example if a trader expects the price of the particular asset to go up then the trader is supposed to go long on the particular futures contracts but if the trader expects the price of a particular asset to go down then the trader should go short instead.
Procedure 2: Positioning size and determining the risk tolerance
This is the step that if most traders are not keen they have to miss. Losses can accumulate very quickly and empty an account at a high rate. It is important if a buyer of a futures contact looks at the risks of the tolerance and positioning the accurate size.
Procedure 3: Determining Initial Margin Requirement
Another crucial stage is determining the correct number of futures contracts that a trader wants to buy; this involves determining which futures contracts are to trade and the amount of the initial margin that is required to trade. Initial margin is usually required even if the trader prefers to take either the long or the short side.
Procedure 4: Entry
The entry procedure is now followed once the trader has determined which direction to trade, how many contracts to purchase in order to trade and the amount of cash required to pay to trade now it becomes time to make an entry and later set a stop loss organize.
Futures Contracts and Trading Operations
Procedure 5: Offset
Offsetting refers to captivating an equivalent trade so that the trader can neutralize the existing position by effectively managing it out.
Implication of being long or short in a futures contract
Both the long and short positions are mostly used by investors to achieve various results which are different. Many a time’s both long and short positions are developed concurrently by an investor so that the investor can produce a great income on the security. Long positions are optimistic because the investor expects the price of the purchased stock to rise and later purchases calls at a lower price. However, it is an implication that an investor s capable of hedging his long stock situation by developing a long option position.
Short option positions tender the same strategy to the short selling without any particular need to borrow the stock. Short position also allows an individual or the investor to pick up the option payment as an income with the opportunity of distributing the long stock position usually at a high price. Moreover, a short position offers the investors the opportunity to buy a particular stock at a specific price and later collects the payment as the investor waits.
Procedures for closing out the long and short positions proceeding to delivery
The process that is involved in the closing out of the long and short positions prior to delivery is simple. First for short sales, delivery is always made by three resolution days that is immediately after the trade days. However, for the long sales, delivery must also be made by five settlement days that is after the trade date. In both positioning sale if an investor fails to make a delivery within the specified period then a penalty is given.
The Barings management failed due to the internal auditors or investigators of Barings bank. The investigators of the bank performed well but the comments that the delivered regarding the collapse of the bank were ignored. In February 1994, the treasurer of Barings bank had identified the double role of Nick, which is the treasure realized that Nick was working both in front of the offices and at the same time at the back of the offices. The internal audits that were given did not disclose the fraud existence activities; the internal report did not make the expected recommendations in reference to the separation of roles in Barings bank. The recommendations of the bank were never implemented and no significant steps were taken because according to the management response, the local manager, Nick had stated in the report that with an immediate effect that he would cease to perform some of the functions and ensure adequate supervision of all the recording processes.
Wash Sale Rule
Risk management is preferred as one of the most crucial management tasks so that the long term survival of a corporation is ensured. However all the risks that correspond to a threat in a particular organization area always inspected systematically. Risks happen in most organizations and such risks arise from bad investments, other risks occur due to failure to secure the liability claims. If such risk incur in a particular firm it is important if risks that cause threat to an organization are identified, assessed with good methods and controlled so that the company does not suffer from bad investments. It is also important to ensure long-term survival of a corporation so that the productivity of a company is ensured.
The Nature and purpose of risk management is critical in many firms. Risk management is the process of identifying a hazard, analyzing and controlling the particular threat. Naturally risk management occurs anytime an investor in a company manages the losses that have occurred in an investment and looks for the better and appropriate measure for the action. However, risk management usually occurs in various places mostly everywhere in the financial world. Risk management mostly occurs when an investor in a particular company prefers to buy low risk Government bonds, this happens over more risky corporate bonds. The purpose of risk management in this case is to ensure the productivity of a firm and prevent various losses from the investment that the business is trading. Effective risk management is important for the large projects that are built.
The Person responsible for the establishment of risk management is the manager or investor of a particular organization. Identifying a risk threat in the organization reduces the threat of the spread through a controllable measure. Measuring the risk in a systematic way involves inspecting the risk before trading operations in an organization worsens. Managing risk ensures a lot of productivity in the firm and strengthens the reputation of the business. Another importance of identifying, measuring and managing risk is that the large projects that are built in an organization are maintained in a systematic way due to the proper management. Key function of capital is to facilitate growth and this is achieved by enabling individuals to change their own savings into investment.
The first pillar of the framework is minimum regulatory capital requirements whose function is to build the foundation of the current accord. The second pillar is the supervisory evaluation of capital sufficiency and the primary role is to ensure that the capital position of a particular bank is regular. The third pillar is market discipline which enhances market participant’s role by motivating banks to obtain and hold adequate capital.
Procedures to Buying a Futures Contract
Credit risk is a financial term that refers to the risk that a particular borrower happens not to refund a loan and the lender ends up losing the interest associated with the loan. A credit risk happens because individuals who borrow money expect that they will use the future cash flow to settle the current debt. However, in credit risks, interests that are gained from the insurer of the debt are obligated.
Example of how a bank calculates the minimal capital requirement is through the use of tiers. Through the Basel method, the capital of a bank consists of tier one capital and tier 2 capital but the two types of capital are different. Tier 1 capital is a core capital of the bank and tier 2 capital is the supplementary capital of a bank. A banks total capital is therefore calculated by adding the capitals together that is adding tier 1 and tier 2. Example, Barings bank in a quarterly period had tier 1 capital of $171 billion and the risk weighted assets were worth $1tillion. However, the bank’s tier 1 capital ratio for the quarterly period was$171/ $1 trillion which add to 13% which later met the minimum requirement of Basel III of 10 %.
The different types of acceptable capital are the debt financing and the equity financing. Where debt financing refers to borrowing money that is prepaid over a period time and the money is returned with interests. Equity financing involves exchange of a particular amount of money for a share in a business operation.
Conclusion
The research on Nick report is interesting because the research reflects my clear and precise understanding concerning money, financial institutional risks and capital markets. The main findings from the research involved that Nick dealt with risky financial imitative in Singapore under Barings offices. The significance of the findings is that the rogue trader was realized earlier and the immediate action was undertaken.
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