PART 1:(40 marks)“Derivatives are financial weapons ofmass destruction, carrying dangers that,while now latent, are potentially lethal.”Berkshire Hathaway Inc. Chairman of the Board Warren Buffet, “Letter to theShareholders of Berkshire Hathaway Inc.,” February 21, 2003Sincethe early 1990’s, there have beena numberof high profile businesses that have realisedhuge losses associated with the use of derivatives for hedging that went wrong. Better known cases in the 1990’s involved Barings Bank (1995), Long Term Capital Management (1998), Procter andGamble(1994), Metallgesellschaft AG(1993),and Orange County California (1993)whilst more recent cases include JP Morgan (2012),AIG(2008) and China Aviation Oil (2004).You are required to choose one of the abovecompanies.
In relation toyour chosen company, answer the following questions:
(i)Describe the facts, including background (nature of company business, trading history, size, etc.) and nature and amount of losses realised; (ii)Explain the risk that the companywas subject to and detail Risk Management (RM) techniques that were used. Please note any specific derivatives hedging strategy.(iii)Explain what went wrong in detail; (iv)Evaluate the RM performance; and detail any lessons learned from the experience.
