Case Study The Collapse Of Barings Bank

883 words - 4 pages

Case study- The Collapse of Barings Bank
1. What was Nick Leeson’s strategy to earn trading profits on derivatives?
The play here was very simple – trading futures on the Nikkei 225 as the underlying. The Nikkei 225 was traded as a future on both the SIMEX and the Osaka markets. There were always known to be differences between the two markets which could be arbitraged. The idea was to exploit the differences between the 2 markets , and execute in the cheaper market on client orders. This would then allow Barings to net a profit as they execute in the cheaper market but quote the client the price in the more expensive market. The underlying idea was of course to always be long one and ...view middle of the document...

This is where he created the infamous error 88888 account. An error account per se is quite normal; it is used by brokers to to book small small intraday errors which are then settled at the end of the day. Leeson started to use this error account to engage in cross trading (the process of netting trades within the same counterparty). Trades would be booked as normal into regular accounts, however by the end of the day the trades would be crossed with the error account and essentially the risk transferred out. He also booked the trades with false prices so that profits would be shown on trading in the accounts that were being reported to management. Leeson made sure that error account 88888 was excluded from management reports. This meant that the management in London never saw the true picture of the size of positions that Leeson was taking. In fact they naively believed that their golden boy was making them huge profits, so they let the show go on.

4. Why did Barings and its auditors not discover that the error account was used by Leeson for unauthorized trading?
Barings and its auditors did not catch on, in time, to what Leeson was up to because its management failed to institute a proper managerial, financial and operational control system. Barings failed to ensure that there was adequate segregation between various functions of the Singapore operations in that way undermining the effectiveness of any controls that would have been put in place. Leeson was in charge of -the dealing desk and also had control over the back...

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