The pre course assignment of international finance 2
The Pre-course Assignment of International Finance Group members Magdy A.Sattar Abd El-Hameed Mohamed Yasser Kortam
Group Objectives To analysis the three cases. To recommend what implementations should have been done in order to avoid the collapse of BARING BANK. To create either a futures, an option of a swap linked with weather for ENRON WEATHER DRIVATIVES. To answer the questions at the end of the VIVENDI & SEAGRAM case and to find what has been happening lately for Vivendi Universal.
Presentation Elements The BARING BANK case presentation The ENRON WEATHER derivatives case presentation. The VIVENDI & SEGRAM case presentation.
First Case Elements BaringGroup presentation.. Current situation & key names. Case summary. Account 88888.
First Case Elements Identified facts & indicators. How did Leeson deceive everyone? Conclusions & reasons. Recommendations.
1-Baring Group Presentation The Baring Group was undergoing an organizational restructuring, creating the Baring Investment Bank Group (BIB), to be an integrating structure to conduct both the banking and the securities business of the Group. The group functioned on a matrix management structure. They were selling and buying money, money value is their core business.
2- Current Situation & Key Names Baring Futures (Singapore) BFS, Sep. 1986. Baring Securities Limited “BSL”. Singapore International Monetary Exchange Ltd (SIMEX). BFS start trading on SIMEX July 1992.
2- Current Situation & Key Names Mr. Lesson joined BSL in 1989 in the settlement department. In April 1992 Mr. Leeson was posted by BSL to BFS to establish the settlement operations of BFS. It was decided that Mr. Leeson would also be involved in trading at BFS, as its floor manager at SIMEX.
2- Current Situation & Key Names Mr. Leeson was reporting to a local manager in BFS, and to his product manager in London. “ALCO” the high-level Asset & Liability Committee that monitor the Baring Group’s risk positions, trading limits, trading performance, and the allocation of funding. Mr. Norris the CEO of the Group.
3- Case Summary The senior managers of BG did not take firm actions to address the problem? The matrix management structure of BFS did not work in practice. In 1994 the Group Treasury proposed a regional Treasurer to coordinate and resolve the funding problems, Mr. Norris, resisted this on the ground of cost?
3- Case Summary October 1994 the internal auditor highlighted a significant risk, that Mr. Leeson could override internal controls. January 1995 two letters send by SIMEX questioned BFS to meet its financial obligations. BFS answer on Feb. 10, 1995 that the entire assets of the Group were available to enable BFS to meet its financial obligations.
3- Case Summary This letter singed by Mr. Hawes (Group Treasurer), and approved by ALCO? In 1994 Dec. the external auditors discovered a discrepancy of (70m $). When reported to London Mr. Norris downplayed the significance of the matter, and discouraged all independent investigations?
3- Case Summary Mr. Norris took no action against Mr. Leeson, and instead allowed him to increase the size of the positions he managed? One week before the collapse a supervisor with BSL discover a discrepancy of 128m $, on Feb.17 1995. Between Feb. 17 1995 and Feb. 23 (the night Mr. Leeson Fled Singapore) BSL remitted to BFS a sum of over 300m $.
4- Account 88888 The transactions were distinguished by: The large size of positions. Not hedged by matching positions. Consistently reflected losses. Cumulative losses, Sep. 1992 (6m $). Cumulative losses, Oct. 1993 (8m $). Cumulative losses, Dec. 1994 (24m $). By the collapse Feb. 1995 losses are, (1.2 billion $)
5-Identified Facts & Indicators Mr. Leeson was a 25-year old settlements’ officer with no experience when he first came to Singapore. Mr. Leeson opened account 88888 and booked large volume of transactions in it (July 1992). Mr. Leeson innovated a series of measures to conceal the true nature of the account from the external auditors and his superiors.
5-Identified Facts & Indicators The net effect of these transactions was to artificially inflate the Baring Group’s reported profits which were attributed to his performance. Information related to account 88888 and the margin calls on the account was available in London at all times. In spite of the growing discrepancy between the funds remitted to BFS and the transactions in respect to which the funds had been requested, other Baring Group companies continued to remit funds to BFS.
6- How did Leeson Deceive Everyone? Break down the total number of cross-trade contracts into several different trader at prices different to those transacted on the floor, but still reconciling to the total originally traded. Entry of fictitious trades which were never crossed on the floor of the exchange. These abovementioned actions were necessary to the create the deception that the reported profitability in the switching accounts was a result of authorized arbitrage activity.
7- Conclusions & Reasons This is classical case of lack of control and poor financial management. Barings collapsed because it could not meet the enormous trading obligations, which Leeson established in the name of the bank. Barings had outstanding notional futures positions on Japanese equities and interest rates of US$ 27 billion.
8- Recommendations The collapse could have been avoided if: The group had questioned the integrity and competence of Mr. Leeson having twice made false statements that there were no unsatisfied judgment debts against him. The group has thoroughly and promptly investigate the growing difficulty in recording Mr. Leesons funding request. Steps had been taken to overcome the inability of Group Treasury and BSL settlements since 1994.
8- Recommendations The significant risk highlighted by the internal auditors had been addressed. Initiatives such as the Asian Regional Treasurer or the middle office person had been effectively implemented. ALCO had taken Me. Leeson to task for increasing his positions, despite it’s instructions, that he should reduce it.
8- Recommendations The external auditor discovery of discrepancy had been fully investigated and resolved. The reasons behind the requests for very large amounts of funds by Mr. Leeson, in January and February 1995, had been analyzed and understood. ALCO had understood and effectively addressed the concerns expressed by SIMEX in its letters to BFS.
Second Case The ENRON Weather Derivatives Case.
Second Case Elements Firm presentation. Current situation. Measuring Weather Risk. Motives and instruments for hedging weather risk.
Second Case Elements Structures of Weather protection products. The Market for weather protection. A swap Contract Elements. Conclusions & Recommendations.
1-Firm Presentation Pacific Northwest Electric (PNW) is a significant producer of electric power It covers the Pacific Northwest region of USA Marry Watts, the chief financial office of PNW
1-Firm Presentation Company revenue affected by winter temp the colder the season the greater the revenue. Enron Corporation is the world’s leading integrated natural gas and electricity company The Co. delivers Physical commodities, risk management and financial services to provide energy solutions to customers around the world
2- Current Situation Marry Watt is reviewing the financial plan for PNW 2000 – 2001 for winter season, PNW revenue in 1999 $11 Billion, net income $800 million and Earning per share (EPS) was $1.04 Last few years weather was warmer than average which resulted adverse financial results for PNW
2- Current Situation The firm reported no EPS growth from 1995 ($1.03) to 1999 ($1.04) which affected its stock price. The weather advisors predicting another warm winter Securities analysts were reluctant to advocate holing PNW share. Its debt rating had slipped from A-to BBB+
3- Measuring Weather Risk The utility industry measured weather conditions in term of heating or cooling degree-days (HDD, CDD) Degree-days were determined by the deviation of the average daily temp. 65 Fahrenheit Weather conditions for a particular season were stated in terms of degree-days accumulated across the entire period.
4- Motives and instruments for hedging weather risk Smooth revenuesOr compensate for loss of demand through insurance Cover excess costsThrough hedging against it Reimburse loss opportunity costsInsurance against stock outs due to high demands
4- Motives and instruments for hedging weather risk Stimulate sales By using weather derivatives to back up their “ money back guarantee” of consumer satisfaction Diversify investment portfolios Exploit the low correlation between returns associated with weather and returns from other financial instruments. Weather derivatives could potentially reduce risk, and/or increase return in a portfolio
5- Structures of Weather protection products A floor Provide the customer with compensation if the underlying weather variable such as degree-days falls below the established threshold. The upside opportunity remains unconstrained. A ceiling cap Provide the customer with compensation if the underlying weather variable such as degree-days goes above the established threshold
5- Structures of Weather protection products A collarIs a two-part transaction in which a customer buys a cap or a floor to provide financial protection against adverse weather conditions, and simultaneously sells a floor or a cap at a different strike price that limits its financial upside if weather is favorable. The second par (the sale) helps to finance the first part (the purchase of the insurance)
5- Structures of Weather protection products A swapAllows the customer to generate a fixed revenue stream. If actual degree days were less (grater) than the threshold, the utility receives a payment equal to the degree day differential times an agreed upon price per degree day ($/dd) if actual degree-days were greater (less) than the threshold, the utility pays the seller. A swap was generally similar to the collar in its economic effect except that it offered a single trigger level, whereas the collar offered two.
5- Structures of Weather protection products Futures contractsCan be purchased on the Chicago mercantile exchange and were introduced for trading in 1999. A futures contract is a legal agreement to deliver or accept a commodity at a specified time and an agreed price, the CME contracts are specially designed around temperature variation. Variation in temperature above or below the value lead to a daily cash settlement between the buyer and the seller. Option on futures contractThe CME also permitted trading in options on Futures
6-The Market of weather protection InsuranceThe insurance industry provided weather related protection typically for catastrophic events such as hurricanes, flood and tornados. Capital and commodities marketsIn 1997 Enron had organized contracts in weather protection that were relatively liquid securities and dealt with standard variation in weather. In 1999 the CME began trading in weather futures and options, which also were standardized contracts. The rise of this market as a second source for weather protection reflected the growing trend of securitization of assets through capital market
7- Swap contract for PNWReasons for Swap not Futures Futures contract usually done to hedge Price risk PNW needs to hedge volume risk against the lack of demands due to HDD in winter
8- Conclusions & Recommendations A swap Contract Elements Option type, HDD weather Swap Payment, For both sides after the floating amount for the determination period is determined The seller, Enron The Buyer, PNW
7- Conclusions & Recommendations Reference degree, 65 Fahrenheit The average temperature is less than 65 PNW pays Enron amount of ??/days- degree The average temperature is greater than 65 Enron pays PNW amount of ??/days- degree
Third Case Elements Vivendy Presentation. Seagram Presentation. Reasons for Failure. What Was Kept/Sold of Seagram by Vivendi? What is Happening Today ?
1-Vivendy Presentation Originally CGE, a company established in 1853 for Water distribution. Jean-Marie Messier turns around the firm from a waste management company to a multimedia conglomerate, concentrating around activities such as, utilities – water, power – transport and communication – pay TV – telecom – internet (spending more than € 15 billion in the latter area). He also relaunched the firm under the name “Vivendi” (from the Latin verb vivere: meaning “to live”) in 1998.
2- Seagram Presentation Headquartered in Montreal, the Seagram Company Ltd, operates two core, global businesses: beverages and entertainment/ communications. The company employs 30 000 people worldwide.
2- Seagram Presentation Seagram’s distilled spirits, wines, fruit juices, coolers and mixers are sold in more than 150 countries and territories. Affiliates and joint ventures in 41 countries comprise the largest distribution system in the spirits and wine industry.
2- Seagram Presentation Seagram’s entertainment/communications company, MCA Ins., makes motion pictures, television and home video products, publishes books, produces recorded music and operates theme parks.
3- Reasons for Failure Huge debt level. Bad management (especially cash management). Excessive and disorganized communication. Doubts on the firm’s accounts. Pessimism of financial analysts.
3- Reasons for Failure Information given to public was insufficient. Messier lost credibility. Too many diversified assets, too many different industries.
4- What was kept/sold of Seagram by Vivendi? The spirit end of the business was sold off to French Pernod-Ricard and British Diageo for € 7.5 billion. Sale of healthcare and business publishing units for € 1.2 billion. Sale of group Express-Expansion, l’Etudiant and Comareg to Hersant’s Socpresse for € 330 million. Stake reduction in Vivendi Environment to 40.8%.
4- What was kept/sold of Seagram by Vivendi? Sale of Elektrim Telekomunikacja stake. Sale of Vivendi’s 50% share of Vizzavi for € 142 million. Sale of 89% of Canal + Technologies to Thomson Multimedia for € 190 million. Sale of EU and Latin American publishing units to Hachette for € 1.2 billion.
4- What was kept/sold of Seagram by Vivendi? Further sale of 20.4% Vivendi Environment for € 1.8 billion. Sale of US film studios, theme parks and cable TV channels TO NBC. Sale of MP3.Com to CNET.
5- What is Happening Today ? US investors have filed a securities fraud lawsuit against VU and its formal chairman J.Messier, that alleges the ousted chief executive inflated the value of the group’s shares by concealing a financial crisis. Vivendi names new CEO at Houghton Mifflin, Mr. Hams Gieskes, effective July 1.
5- What is Happening Today ? Further steps towards cutting its debts burden by announcing the sale of a 49.9 % stake in its Sithe North America Energy business to PECO energy for $680m. Also the sells of its stake in Monaco Telecom for 169 million Euros. The performance of the first quarter of 2004 showed significant progress compared to a year ago.
5- What is Happening Today ? May 2004, NBC and VU entertainment unit to create NBC Universal. VU withdrew its case against Mr. J.Messier and Mr. E.Licoys at the Paris commercial court. June 1, 2004, standard & Poors raises Vivendi Universal back to investment grade.