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JPMorgan & the London Whale
Presented by Joey Froehlich and Laura Tack
Case Summary
● JPMorgan had a Synthetic Credit Portfolio (SCP) that experienced a lot of
growth from 2011 to 2012.
● For S...
Case Summary Cont.
● A lot of IG investments ended up performing poorly.
● Proceeds from HY investments could not make up ...
Case Summary Cont.
● SCP growth:
○ 2011:
■ $4 billion to $51 billion
● SCP proceeds and losses:
○ Proceeds:
■ $1 billion i...
Risk Management Framework
● VaR:
○ Estimates possible magnitude of decrease in value of financial instruments over a fixed...
Risk Management Framework Cont.
● CSBPV
○ Measures price sensitivity for each basis point change in credit spread.
○ Usefu...
Appropriate type of Exposure
● For this case, Gross exposure is more appropriate:
○ “Indicates total exposure to financial...
RWAs
● Different types of derivatives should be regarded as separate RWAs.
● Multiple types of investments can have differ...
Cash Management
● Derivatives can be employed in this function.
● Cash management was not tempered by risk management func...
Mistakes Made by the CIO Team
● The CIO team emphasized maintaining profitability more than it emphasized
risk management
...
Mistakes Made by the CIO Team, cont.
● The CIO team responded to losses by doubling down on their losing strategy
○ Losses...
Mistakes Made by the CIO Team, cont.
● The CIO team engaged in unethical practices to hide their problems
○ Created a new ...
Risk Management
● Inadequacies
○ Dismissal of VaR and CSBPV metrics by management
■ Ina Drew, the Chief Investment Officer...
Organizational Structure
● Inadequacies
○ Inherent conflict of interest
■ Drew was responsible for both trading and risk m...
Citigroup Inc.
● Citigroup has been buying risky derivatives in bulk
○ 2009 - Citibank, Citigroup’s primary banking subsid...
Citigroup Inc., cont.
● If Citigroup wishes to avoid a catastrophe such as the one experienced by
JPMorgan, it must:
○ Ens...
References
● Eavis, P. (2015). Citigroup’s Roaring Revival on Wall Street. The New York Times. Retrieved from
http://www.n...
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London Whale Presentation

  1. 1. JPMorgan & the London Whale Presented by Joey Froehlich and Laura Tack
  2. 2. Case Summary ● JPMorgan had a Synthetic Credit Portfolio (SCP) that experienced a lot of growth from 2011 to 2012. ● For SCP, JPMorgan invested in both High Yield and IG investments. ● High Yields are high risk, IGs are low risk. ● Protection was purchased for both HY and IG. ● IG protection was sold and the proceeds were used to pay off the protection for HY.
  3. 3. Case Summary Cont. ● A lot of IG investments ended up performing poorly. ● Proceeds from HY investments could not make up for losses on IG. ● In response, metrics used to assess risks were adjusted. ● VaR and CSBPV limits were also adjusted to make it look like SCP was performing well. ● SCP was in a position where it could not back out, so it continued to grow.
  4. 4. Case Summary Cont. ● SCP growth: ○ 2011: ■ $4 billion to $51 billion ● SCP proceeds and losses: ○ Proceeds: ■ $1 billion in 2011 with $400 million in derivatives ○ Losses: ■ 2012 ● January: $100 million ● February: $69 million ● March: $40 million ● March 23, Ms. Drew ordered “Phones Down.”
  5. 5. Risk Management Framework ● VaR: ○ Estimates possible magnitude of decrease in value of financial instruments over a fixed time period. ○ Calculated with either historical market data or Monte Carlo simulation. ○ Useful for monitoring market risk. ○ Limitations: ■ Used to analyze credit indices. ■ Relies on analysis of correlation between underlying assets, which is subjective.
  6. 6. Risk Management Framework Cont. ● CSBPV ○ Measures price sensitivity for each basis point change in credit spread. ○ Useful in estimating impact credit spreads have on small moves. ○ Limitations: ■ Cannot accurately account for convexity. ■ Not good for when large moves happen in the market. ● CSW10% ○ Measures expected change in portfolio value if credit spread on each position is widened by 10%. ○ Useful for stress testing portfolios. ○ Trusted by Ms. Drew. ○ Not subject to limitations of other two metrics.
  7. 7. Appropriate type of Exposure ● For this case, Gross exposure is more appropriate: ○ “Indicates total exposure to financial markets, thus providing an insight into the investment amount at risk from market fluctuations” (Investopedia, 2016). ○ Can comprise value of short and long investments. ○ Useful because SCP uses both short and long investments. ○ Can provide important insight for risk management.
  8. 8. RWAs ● Different types of derivatives should be regarded as separate RWAs. ● Multiple types of investments can have different levels of risk. ● These differing levels of risk can lead to diverse characteristics. ● Such diversity can lead to different effects on other assets. ● If each derivative has its own RWA, the risk of SCP can be assessed more accurately.
  9. 9. Cash Management ● Derivatives can be employed in this function. ● Cash management was not tempered by risk management function.
  10. 10. Mistakes Made by the CIO Team ● The CIO team emphasized maintaining profitability more than it emphasized risk management ○ The profitable 2011 American Airlines bankruptcy incentivized the CIO team to maintain RWA exposure ○ The CIO team executed trades that were speculative in nature ■ Bruno Iksil, the senior trader of the SCP, bought protection on riskier credit indices and sold protection on the less risky credit indices ■ Abandoned the CIO’s traditional longer term, hedging-oriented investment approach
  11. 11. Mistakes Made by the CIO Team, cont. ● The CIO team responded to losses by doubling down on their losing strategy ○ Losses in the long IG protection could not be counterbalanced by the gains in the short HY exposure ○ JPM could not reduce their exposure ■ Illiquid credit market ■ High investment in the market ○ The CIO team responded by increasing both long and short exposure
  12. 12. Mistakes Made by the CIO Team, cont. ● The CIO team engaged in unethical practices to hide their problems ○ Created a new VaR model that lowered both the stated risk and the RWA ■ Successfully fought to have the approval process inappropriately expedited ○ Did not adequately inform JPM senior management or regulators of the SCP’s problems ○ Departed from U.S. Generally Accepted Accounting Principles in order to account for their derivatives more favorably
  13. 13. Risk Management ● Inadequacies ○ Dismissal of VaR and CSBPV metrics by management ■ Ina Drew, the Chief Investment Officer, ignored all metrics but the CSW10% ■ Higher management, such as Jamie Dimon, approved temporary bankwide metric limit increases to end breaches caused by the SCP ○ Lack of limitation on the market value of the SCP ● Recommendations ○ Utilize the CSW10% alongside other risk metrics and give them importance ○ Implement a limit on the market value of the SCP ○ Prevent individual employees from overriding policies ■ Risk metrics ■ U.S. GAAP
  14. 14. Organizational Structure ● Inadequacies ○ Inherent conflict of interest ■ Drew was responsible for both trading and risk management ○ Management did not exercise proper oversight of subordinates ■ Risk metric breaches and alterations ■ Accounting inconsistencies ■ Reports to management ● Recommendations ○ Hire a more experienced Chief Risk Officer and give this position the responsibility for risk management ○ Management should monitor the actions of subordinates more closely
  15. 15. Citigroup Inc. ● Citigroup has been buying risky derivatives in bulk ○ 2009 - Citibank, Citigroup’s primary banking subsidiary, had $32 trillion in derivatives (Eavis, 2015) ○ 2014 - Citibank had $70 trillion in derivatives (Eavis, 2015) ○ 2015 - Citigroup bought credit derivatives ($250 billion notional value) (Griffin & Voegeli, 2016) ○ 2016 - Citigroup bought credit derivatives ($380 billion notional value) (Griffin & Voegeli, 2016; Whittall, 2016) ● Experts say Citigroup does have the capital necessary to mitigate the risk associated with these derivatives (Eavis, 2015) ● It appears that Citigroup’s motive in investing in these derivatives is profit-related ○ Citigroup’s investment bank has begun generating much higher profits than its consumer bank (Eavis, 2015) ○ Citigroup successfully lobbied to weaken aspects of the Dodd-Frank law that apply to derivatives (Eavis, 2015)
  16. 16. Citigroup Inc., cont. ● If Citigroup wishes to avoid a catastrophe such as the one experienced by JPMorgan, it must: ○ Ensure its organizational structure does not create conflicts of interest ○ Ensure it does not purchase an unwieldy share of the credit derivative market ■ Many banks are currently shedding derivatives in order to conform with Basel III ■ Citigroup must be especially vigilant in monitoring how much of the market they own ○ Actively monitor its risk metrics ○ Ensure compliance with all governmental regulations and accounting principles related to derivatives
  17. 17. References ● Eavis, P. (2015). Citigroup’s Roaring Revival on Wall Street. The New York Times. Retrieved from http://www.nytimes.com/2015/03/11/business/dealbook/citigroups-roaring-revival-on-wall-street.html ● Griffin, D. & Voegeli, J. (2016). Citigroup Said to Purchase CDS Portfolio From Credit Suisse. Bloomberg Markets. Retreived from https://www.bloomberg.com/news/articles/2016-08-05/citigroup-said-to-buy-derivatives-portfolio-from-credit-suiss e ● Investopedia. (2016). Gross Exposure. Retrieved from http://www.investopedia.com/terms/g/gross-exposure.asp?lgl=no-infinite ● Wittall, C. (2016). Credit Suisse Sells Credit Derivatives Portfolio to Citigroup. The Wall Street Journal. Retrieved from http://www.wsj.com/articles/credit-suisse-sells-credit-derivatives-portfolio-to-citigroup-1470414328

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