Derivatives Mishaps Example For Free - Free Essay Example

Sample details Pages: 8 Words: 2539 Downloads: 4 Date added: 2017/06/26 Category Finance Essay Type Research paper Did you like this example? Metallgesellschaft Corporation is one of the subsidiaries of Metallgesellschaft A.G. , a German Conglomerate which largely owned by institutional investors and banks such as Deutsche Bank AG, the Dresdner Bank AG, Daimler-Benz, Allianz and the Kuwait Investment Authority. In 1993, Metallgesellschaft Refining and Marketing known as MGRM which is one of the Metallgesellschafts trading subsidiary, had decided to establish a huge amount of derivatives positions which consists of futures and swaps to perform hedging on its price exposure and MGRM was to sell certain amount of petroleum for up to 10 years at a fixed prices. Don’t waste time! Our writers will create an original "Derivatives Mishaps Example For Free" essay for you Create order Mostly the clients or customers of MGRM are retail gasoline suppliers, large manufacturing firms and government agencies. The total amount of petroleum barrels that MGRM had committed to deliver are 160 million barrels. MGRM provided their customer petroleum at a fixed price who they often face liquidity and margin issues when oil price rises and MGRM believed that it is possible to arbitrage with the spot market and long term contract. MGRM had provided their customers a chance to shift the price risk in the fluctuating oil price market as MGRM had confidence in their financial resources were able to manage risk transference efficiently. One of the MGRM hedging strategy in order to manage spot price risk was to use front-end month futures on NYMEX. Besides that MGRM employed stacked hedging strategy but not spreading them over longer dated and maturity. Eventually, things went opposite to MGRMs assumption and Metallgesellschaft had reported a total loss of $1.3 billion in late 19 93 . Metallgesellschaft had requested bailout from the investors and banks with a total amount of $1.9 billion in order to rescue and prevent it from going into bankruptcy. Causes of Derivatives Mishaps One of the causes that lead to derivative mishaps is the assumption of economics of scale and was mistaken by MGRM by going for long future and entered into OTC swap agreements. When the prices of the oil rises, MGRM will generates a gain but when the price falls, MGRM will suffer losses. Therefore, this rolling strategy is working when MRGM hedging against MGRM clients trades when only the oil price drops while MGRM suffer loses when the price rises . MRGMs forward contract has leaded them into a dangerous position when there is a rising price of the oil. Such hedging strategy had been exposing the firm to three risk which is the basis risk, liquidity risk and also credit risk. The firm was hedging with a maturity structure which was mismatch with its delivery contracts. It will expose the firm to basis risk because the value of the short dated futures positions is not compensated by equal and opposite variations in the value of the long-dated delivery contract. The value of th e contract will not be able to hedge perfectly because of the mismatch of the maturity. All the gain and losses are settled daily. The holder need to pay or receives an amount equal to the daily change in the future price. When the price drop, MRGM need to incur negative cash flow to fund for the margin calls. Besides that, the future contract contained an option which enabled the counterparties to closure the contract early if the New York Mercantile Exchange future contract was greater than the selling price of the MRGM. This option is attractive to the customer which have financial distress problem. Other than that, the hedge was created with a view that the market would be in backwardationÂÂ  situation. The risk manager believes that the market will remain in the backwardation because it is usually happen in the stock market. Therefore, they decided to follow the hedge strategy. However, the market has shifted to contangoÂÂ  where the futures prices are higher than the spot prices. This causes the increasing in the cost of the hedge. All the gain due to the short positions was more than offset by a loss due to the futures positions. It will causes certain issue as to the size of the firms total open interest was a larger percentage of the total and making these position to be liquidated will be harder and more challenging. The firm also exposed themselves with the risk that not having enough amount of funds in case of immediate margin calls. The firm faced some problems in providing certain amount of funds to maintain the position.A hedge is supposed to transfer away the market risk but the firm was exposed to the risk that needs to find out the cash for the immediate margin call that caused by the contango effect. They were exposing themselves to 85 days worth of the entire output of Kuwait. If oil prices happens to decrease, MGRM would incur losses on their dedicated hedging positions and would undoubtedly receiving margin calls. As such leading to negative cash flow in the short run as no cash would be received for the gain in the value of the forward contracts until the oil was sold although the gain in the forward contract positions would offset the losses. No economic loss would occur because of their hedge strategy, but the size of their position created a funding risk. The stack and roll strategy cause the losses because in a contango market the spot price decreased more than the futures prices. Other than that, German accounting standards also compounded MGRM problems. Lower of Cost or Market (LCM) accounting is a standard required in Germany. While in the United States, MGRM undoubtedly met the requirements of a hedge and received hedge accounting. Therefore, profit was shown in MGRM financial statement. Their hedge losses were deferred because they offset the gains of their forward contract. However, MG was required to subscribe their current losses without recognizing the gains on their fixed-rate fo rward positions until they were realized by using LCM. MGs income statement was a failure since the German accounting standards did not allow for the netting of position.. This drastically changed the market arena for MGRM. Therefore, the swap counterparties required additional capital to maintain their swap positions and the NYMEX imposed more margin requirements on MGRM more than doubling their performance bond requirement. MGRMs positions may not have alarmed the marketplace and they might have been able to reduce their positions in the OTC market without getting their eyeballs pulled out if the hedge accounting had been acceptable in Germany. Hedging Alternative to Avoid Mishaps In this hedging activity did by Metallgesellschaft (MGRM), by guarantying their customers fix price for gasoline, heating oil and diesel fuel. This hedging had make MGRM expose to many different risk, price risk, credit risk and delivery risk. MGRM could use many different ways to hedge their position. These hedging strategies have pros and con as shown below. Alternative A MGRM can use lower hedge ratio, reducing the hedge ratio will minimize cash flow variance and increase the companys liquidity risk. It also takes into account on basis risk, use correlation of assets as hedge ratio. However, by using this strategy MGRMs dynamic adjustments could be expensive; this is because the transaction cost will eventually increase. Alternative B MGRM could hedge with short maturity forwards; this action will let the company to reduce basis risk because MGRM has long short term futures. This action also increases the companys liquidity in market. Alternative C The other option for MGRM to hedge is to include option as part of their hedging strategy. Company could always use option to limit their lost to make sure the risk they face is manageable. MRGM could long zero cost collar as part of their strategy. Zero cost collar is a type of positive-carry collar that secures a return through the purchase of a cap and sale of a floor.ÂÂ  Also called zero cost options or equity risk reversals. This could limit their downside lost. Besides, MGRM also can use long call option with similar maturity to protect themselves from exposing to too much risk. With call option, the company face limited downside and have give the company to realize unlimited profit. As show in the graph, x-axis shows the profit of the company and y-axis shows the price for the underlying asset (gasoline, heating oil and diesel fuel). Alternative D Furthermore, MGRM can transfer all the risk to a third party by selling off all the delivery contracts. By selling the delivery contracts, the company will obtain an origination fee that makes sure a certain profit. The cons from the action is the company has to give up most of the expected profits because not matter how much the contracts earn; the profit will be transfer to the third party. Besides, due to the complexity of the contract it will be hard to sell it. These contracts have non-transparency problem including counterparty risk, embedded option, long term maturity contracts, etc. Alternative E Another alternative is the company own physical storage of the underlying asset. The company can create a large network of storage facilities, having lots of inventory will help company to meet customers demand. But, this alternative is not practical, because it is nearly impossible to store oil for 10 years and it will be very expensive to pay the storage cost. These are the suggested alternative that MGRM could use. But the final decision will still based on the financial experts. They will analysis the current economic performance, inflation and etc to make their final decision. Lessons Learnt from Hedging: Metallgesellschafts near-collapse and experience with derivatives suggests some lessons. Value hedging and cash flow hedging is very important because a hedge with mismatched maturity can create to an enormous funding risks. Problems may occur when a hedging strategy is set up without a careful regard for the financing it may require. MGs strategy should make both of the cash flow patterns and its firms value a crucial part to consider or put it as the main concern. Besides that, another lesson learned is that the accounting and disclosure conventions must be appropriate. Conflicting and inappropriate accounting and disclosure conventions can create uncertainty about a firms hedging strategy and make it difficult for the firm to raise income when it needs to. The case of MG shows the dangers of treating derivatives positions differently from the assets or liabilities that the derivatives are being used to hedge. There should not be accounting reorganization of gains and losses o n derivatives positions used for hedging unless the gains and losses on the positions that are being hedged also are recognized. In additional, it is also very important that both senior managers and the board of directors of a firm should understand how a firm is using derivatives. They should understand the risks associated with it if they use derivatives as part of the hedging strategy. In other words, approval from the board is needed before the strategy is implemented. Senior managers should understand the firms exposure to changes in prices and to basis changes, and should be informed about potential funding needs. For the case of Metallgesellschaft, it is believe that its supervisory board did not fully understand the risks associated with MGRMs forward-contracting and associated hedging strategy or did not correctly evaluate these risks when approved the strategy. Metallgesellschaft also gave us a lesson about the important of boards and managers to acknowledge financi al and regulatory constraints. It is important for hedgers to foresee or expect and to manage funding needs. Financial institutions or the creditor banks play an important rule here. It needs to have the backing of financial institutions that understand and approve of the firms use of derivatives, and are willing to advance credit to fund margin outflows on derivatives positions. For the case of Metallgesellschaft, it is believe that they did not have such an understanding with its creditor banks. Another lesson we can learn from Metallgesellschaft is that cash is the crucial thing when in the time of distress or debacle. Metallgesellschafts delivery contracts were not liquid enough and facing difficulty to the extent of very low possibility to sell it off at a reasonable price. As the strategy was not able to finance by it ownself, Metallgesellschaft had to request bailout from investors and banks to settle its market debts and avoid bankruptcy. Other than that, complexity is another matter influence the risk management which will makes the risk management more difficult. Somehow, the implementation and analysis of Metallgesellschafts strategy was rather complex than the original strategy planned beforehand. The complexity of cash-out option ,delivery contracts and their enormous derivative positions had cause difficulty in evaluating its economic of oil trading. Complexity indirectly building obscurity and confusion resulting in vulnerability in business and difficulty in financing. Last but not least, the other lesson that can be learned is that a firm which established a huge position in market will never gets undetected. When a firm controlling such a large share of open interest, markets can become dysfunctional in two ways which is either the company can gain competitive advantage and to eliminate its competitors , if those participants remain stagnant and disorganized; or the company itself can be eliminated, if other market competitors begin to fulfill the role of counterparty and trade against the company in an organized manner. As Metallgesellschaft gigantic hedging position is transparent enough to alert the specialists in the oil markets, the specialists knew that Metallgesellschaft would have no choice but continue rollin. The specialist traders were waiting for the chance when Metallgesellschaft started to move a big position . Eventually, the lessons we can learned from the case of Metallgesellschaft include the importance of value hedging and cash flow hedging, the accounting and disclosure conventions must be appropriate, both senior managers and the board of directors of a firm should understand how a firm is using derivatives, the importance of boards and managers to acknowledge financial and regulatory constraints, cash is King when in the time of debacle, avoid complexity which affects risk management and a big position in the markets never goes undetected. Conclusion Although hedging is a good way to manage a firms exposure to risk, risk manager should be always be aware and be careful when performing hedging. As what had lead to MGRMs derivatives mishaps is they had overhedged , all the necessary information and data must be collected and carefully calculated and the right amount of the underlying assets needed to be hedged should be measured well planned beforehand. Besides that, Board of Directors and managers must understand the derivatives strategies and implication. As from the case of MGRM , it suggest that the Board might not fully understand the risk associated with the hedging strategy and did not evaluate the risk when approving them. So its critical that Boards and manager must understand the using of derivatives as hedging strategy and their potential risk and ramifications. In conclusion , hedging will be beneficial to firms as it can work as protection against price movements but it will works against you like what had happ ened to Metallgesellschaft if one does not carry out the hedge cautiously, so everything must be planned carefully and managers must be sensitive and knowledgeable about the risk of hedging and always aware of regulatory actions by the officials and potential consequences when establish a hedging position.

What Made Non Violence Work - 1154 Words

Gandhi and Mandela: What Made Non-Violence Work? Background Essay The history of violence in the world is well documented. However it is also possible to use non-violence to bring about change. This DBQ will look at two countries where a non-violent movement was successful. Historic Context India and South Africa were two important nations on two different continents. But although they looked strong on the outside, each one suffered from a disease that threatened the health of the whole. For India, the disease was colonization. For South Africa, it was racial segregation. Three Conditions In each of these nations three conditions help explain why non-violence worked. The first condition was that both of them†¦show more content†¦This was the first time, though not the last, that Mandela felt disrespected for his blackness. In the 1930’s it was rare for a black South African to attend college. 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Case Study Harassment

Question: Discuss about the Case Studyfor Harassment. Answer: Facts In the provided scenario there has been an alleged act or corruption in which the principle of Bukit Brown Primary School [BBPS] has been involved. The act has been reported by Melissa who has been denied admission to her child even after paying $10000 as donation. After investigation it was found that the claim was false and Melissa was asked to remove her post against MOE but she did not do so. Melissa has been given a notice from MOE to remove the post or she would be subjected to legal action under the Harassment Act 2014 [POHA]. Issue The issue in this scenario is to advice Melissa and LMU whether or not MOE can make a successful claim against them. Legal Principles POHA has been enacted to protect persons in and outside Singapore from unnecessary harassment and distress. Section 4 of POHA specifically prevents any person form using any abusive, insulting or threatening word, behavior or communication which is perceived otherwise, heard or seen by any other person and is likely to cause alarm distress or harassment. The person who contravenes such sections shall have to pay a fine and serve imprisonment subjected to section 8[1]. According to Section 15 of POHA if a person publishes through any means a statement of fact about another person which is not true the aggrieved person can apply to the district court for a relief under Subsection 2. According to Section 15(2) the district court with respect to section 21(1) may upon such application by the aggrieved person make an order to prevent any person from publishing or continuing to publish the statements complained of by the aggrieved party unless that person he or she publishes notification which would make the court bring its attention to true facts and falsehood. According to section 15(3) the district court cannot publish such an order under Section 15(2) unless the balance of probabilities have been satisfied by it such as the relation of the statement of fact which has been complained about with the aggrieved party and whether or not it would be equitable and just to do so. According to section 15(4) the order provided under section 15(2) would be subjected to conditions and exceptions which would be specified by the court in the order. According to section 15(5) he order would have effect on the person on whom the order is applicable as soon as the order is placed on him in the way as provided by the order, from the date when the order has been dispensed by the court or at a date as specified by the district court. According to section 15 (6) the order may be cancelled by the court through an application of the author, any other person to whom the order applies and the aggrieved party. In the case of Attorney-General v Ting Choon Meng and another appeal [2017] SGCA 6 the respondents were directors of a mobile company owning a patent in Singapore[2]. The company had filed a case against the ministry of defense stating that the ministries have infringed their rights on the patent. The proceedings were not completed due to the financial position of the company. The respondents had made several allegations against the ministry of defense through a video the video was further posted on facebook. The MOD in this case had posted another post in response to the video making clear indications that they were not involved in any such acts and the video has been posted to harass them. The appellant in this case had appealed against respondents with respect to section 15(2) of the POHA. The appeal stated that the allegation made by the company was not true and had been posted without any notification. The order was granted by the district court but the high court upheld the appeal against the order. It was held by the high court in this case with Sundaresh Menon CJ dissenting that only a natural person is entitled to make an appeal for the order and the Ministry of Defense is not a Natural person. The court further provided that it would not be equitable and just for them to provide the order in the given circumstances. Using the doctrine of statutory interpretation the judges held that although Section 36 and 3 of the the Government Proceedings Act provides that the government bare entitled to enforce their rights through legal action but it fails to answer the fact that such rights actually exist in the first place or not. The court held that section 15 of the POHA was the only section which could apparently be applied to entities other than human beings. The section also does not have any counter parts in any other jurisdiction and thus merely giving relevance to the actual text of section 15 would distort and defeat the purpose of the parliament behind the incorporation of the Section. Parliament intention with respect to section 15 of the POHA can also be ascertained through the analysis of the speech of the minister provided at the time of brining the legislation into the legal framework. There was further no or little evidence with respect to the interpretation of section 15 which could provi de that the section extended to governments and non natural persons. In the case of Chee Soon Juan and another v Public Prosecutor and other appeals [2011] SGHC 17 it was ruled by the court that Article 14 of the constitution provides freedom of speech and the government can impose any restriction on it if it concerns the security of Singapore[3]. Unless such restrictions have been imposed by the government the right to freedom of speech under article 14 is valid. In the case of Derbyshire County council v Times Newspapers Ltd and others 1993 the local authority wanted to bring a defamation claim against two articles published in the defendant newspapers[4]. The appeal was dismissed by the high court stating that public authorities must be kept open to public criticism and upholding such an appeal would unnecessarily impose the threat of defamation on public criticism. Application In this part of the paper the law discussed above has been applied to facts of the case in order to come to an appropriate solution. In this scenario Melissa have posted a comment related to the corruption of Ministry of Education. She has received a letter from the MOE to take down the post or she would be subjected to legal actions under the provisions of POHA. As discussed above Section 3 of the POHA protest a person from being harassed unnecessarily. Section 15 further provides protection against any false statement of fact made by a person towards another. However is this case the MOE cannot be regarded as person under section 15 of the legislation as provided in the Ting Choon Meng case. Similar to that of ministry of defense ministry of educations also is not a natural person and as interpreted by the judges in the case section 15 of the legislation is only applicable on natural persons. Thus MOE has no right to make the claim which they propose to make through their letter against LMU and Melissa. Further Article 14 of the constitution provides freedom of speech to the citizens of Singapore. Although the right is not absolute it is only subjected to restrictions made by the parliament with respect to the security of Singapore as provided in the case of Chee Soon Juan. In this case the post made by Melissa is in no way threatening the security of Singapore or has the potential to do so. Thus Melissa is protected through provision of Article 14 related to freedom of expression. She is allowed to freely express her view and her post is not illegal. Therefore along with not having the capacity to sue Melissa, MOE would also not be able to prove that the post made by Melissa accounts to harassment. Applying the principles of the Derbyshire County case in this scenario where the court ensured the right to freedom of speech and criticism of public authorities it can be held that Melissa also has the right to criticize the ministry of education. The ministry of education can be subjected to public criticism as it is a public authority. Thus the case of Melissa would be made even stronger through the application of the principles of the Derbyshire County case as discussed above. Conclusion Concluding the paper it can clearly be made out that as MOE is not a natural person they do not have the right to make a harassment claim Melissa. Melissa has made her post in accordance to her right of freedom of speech provided to her by Article 14 of the constitution and there are no exceptions which prove that she has misused the right. Melissa has through her post criticized a public authority which is not legal and cannot be accounted to defamation. Thus the MOE have no claim against Melissa. Bibliography Attorney-General v Ting Choon Meng and another appeal [2017] SGCA 6 Chee Soon Juan and another v Public Prosecutor and other appeals [2011] SGHC 17 Derbyshire County council v Times Newspapers Ltd and others 1993 Harassment Act 2014