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BUSI 3410U (20)
Bin Chang (14)
Lecture 10

BUSI 3410U Lecture 10: Lecture 10

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BUSI 3410U
Bin Chang

Lecture 10: Derivatives Financial Institutions Short Position Shares are mainly held in street name o Canadian Depository for Securities (CDS) o Brokerage firm accounts o Individuals are book entries in brokerage accounts Short sale borrow the share from a broker o Buy them back at a lower price For simplicity, we do not consider transaction costs, short selling costs and other costs Long position positive exposure to the asset Short position negative exposure to the asset Derivatives not original Contingent claims securitys payoff is determined by or is contingent on that of other securities Significant Derivatives losses Barings Nick Leasons 1.4 billion loss broke the bank Societ general7.5 billion P G in 1994; liquidating two contracts for the interest rate swaps cost the company 157 million Orange county it was betting that interest rates would fall or stay low o The investment strategy worked until 1994, when the Fed hiked interest rates that caused severe losses to the book o By liquidating the pool in 1994, the country locked in a loss of 1.6 billion; leading to bankruptcy Subprime mortgage problems exacerbated by derivatives (credit default swaps) Barking Nick Leason worked on the trading floor of Singapore Monetary Exchange (SIMEX) for Barring. He bet on Nikkei 225. An account had been set up to cover up a mistake made by an inexperienced team member, which led to a loss of 20,000. Leeson now used this account to cover his own mounting losses. As the losses grew, Leeson requested extra funds to continue trading, hoping to extricate himself from the mess by more deals. Over three months he bought more than 20,000 futures contracts worth about 180,000 each in a vain attempt to move the market. Some three quarters of the 1.3 billion he lost Barrings resulted from these trades. Society Generale Kerviel is a handsome 31 yearold who figured out how to circumvent computer security and the rules and regulations governing world securities trade. Over 2007, while securities were booming, Monsieur Jerome played the securities markets like an intoxicated slot machine player who keeps winning. Kerviel gambled with investors money until the financial markets dipped and the system Kerviel had manipulated so well finally sent up the red flags of margin calls Two Basic Contracts Forward or future contracts contracts that obligate two parties to exchange a predetermined quantity of something at a fixed price sometime in the future Oldest contract is foreign exchange forward contracts Option contract gives the buyer the right but not the obligation to buy and sell a fixed quantity at a predetermined price sometime in the future The seller is obligated to fulfill the contract if called on Call options on stocks are the older traded contract Markets are Over the counter (OTC) largely between banks and big institutions forwards, CDS, interest rate swaps, CDOs Exchange traded more retail oriented future and option
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