BARINGS WAS FORCED TO DECLARE BANKRUPTCY AFTER REPORTING OVER USD...

2015 FRM PRACTICE EXAM

25.

Barings was forced to declare bankruptcy after reporting over USD 1 billion in unauthorized trading losses by

a single trader, Nick Leeson. Which of the following statements concerning the collapse of Barings is correct?

Leeson avoided reporting the unauthorized trades by convincing the head of his back office that they did

not need to be reported.

Management failed to investigate high levels of reported profits even though they were associated with a

low-risk trading strategy.

Leeson traded primarily in OTC foreign currency swaps which allowed Barings to delay cash payments on

losing trades until the first payment was due.

The loss at Barings was detected when several customers complained of losses on trades that were

booked to their accounts.

Correct Answer: b

Rationale:

Leeson was supposed to be running a low-risk, limited return arbitrage business out of his Singapore

office, but in actuality he was investing in large speculative positions in Japanese stocks and interest rate futures

and options. When Leeson fraudulently declared very substantial reported profits on his positions, management did

not investigate the stream of large profits even thought it was supposed to be associated with a low-risk strategy.

Section:

Foundations of Risk Management

Reference:

Steve Allen, Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk, 2nd

Edition

(New York: John Wiley & Sons, 2013), Chapter 4, “Financial Disasters.”

Learning Objective:

Analyze the key factors that led to and derive the lessons learned from the following risk