Case Study on Sumitomo Corporation Essay

1.Case Study on Sumitomo association on Derivative Losses and Lesson acquire 1.1IntroductionSumitomo Corporation was top in market in grunter art in the beingness prior to 1996 in status of trading surface and it operations. pig bed business is part of their portfolio and it was delegated to Yasuo Hamanaka who was the Head of sloven Trading and he was engaged in illegal pig bed trading and face drawn- break bolshyes and massive c over-up. As the result of this loses, he attempted to neutralize losings umpteen times. This was against the rules and regulation of the London Metal Exchange (LME). LME created juvenile regulation to prevent the market domination, as the result of this he faced losings on his operations. There were two malfunctions record he stop two types of books, wiz is to showing big profit, and the assist one is to keep secrete account, un effronteryworthy trades over 10 old age. No one draw out Hamanaka was not aware of accumulated loss of $ 1 800 jillion.1.2Background of the CompanySumitomo Corporation is one of the subsidiaries of Sumitomo Group which is one of top 5 Sogo Shosha general trading in Japan. It has 120 overseas branches in 65 countries, and having diversified business of Metal, mineral Resources, Energy, Chemical & Electronic and Infrastructure. Copper Department is one of the departments in Copper Corporation which is owned Mineral Resources, Energy, Chemical & Electronic Business unit. In 1800s, Sumitomo Corporation was diversified the business into Sumitomo buzzword, Sumitomo Metals, and Sumitomo Corporation. In 1980, they obtained strong come out & compulsory re assignation in the Copper market. Competition in Copper persistence was very high Copper was traded on LME listed in London and COMEX in USA. Copper was placed 3rd used Metal after press out & Aluminum.There were two types of market participants i.e. one is supplier who does physical supply, and the second is speculators who arbitrage dea l without delivery. Sumitomo was acted as speculator and after acquiring mines in Philippines in 1984, Sumitomo changed from speculator to supplier. After 1988, they made of $3 to 4 jillion profit and they followed cost leadership st trampgy which caused wide loss because of having high inventory while declining demand. LME is popular for providing spot and future markets where clearing systems muffle counter party take a chances. The delivery would be taken place for the countenance warehouses and storage facility.The specification of copper would be included i.e. quality, trading unit, damage quotation, trading month, minimum fluctuation, and tick value. The copper edit would meet the followers conditions i.e. counter party information is open, and delivery condition is by the party, not LME. Yasuo Hamanaka was the Chief/Head of Copper Corporation. He was committed wrongful prompt during the 1985-1996. He was referred as by many a(prenominal) Mr. Five percent/Mr. Copper. He traded 0.5 million metric dozens per year which was the 5 % of total world demand and having experience of 23 days in copper trading.1.3Sumitomo Copper S orduredalsFrom 1985, Hamanaka lost a total of $1800 million. He executed as many as $20 billion worth of unaccredited trades a year. His of conditional relation st targetgy was the diddle squeeze. The future market was particularly unguarded to manipulation since the market volume was relatively small. By buying up futures and choosing physical delivery, future seller completioned up buying copper in a spot market, which resulted in backwardation the spot impairment is higher(prenominal) than the send on price. As far as LME concern, it considers scarce the inventory in their authorized warehouses. If someone moves away from copper inventory exterior of an authorized warehouse, LME inventory appear to decrease and in that respectfore, copper price rise refer able to a perceived tight supply in the market.Hamanak a implemented such(prenominal)(prenominal) st sum upgy because of all his illegal trades was not booked, but is clear that this was a doable way to induce backwardation. In December of 1991, the LME decidbed to set reinvigo aimd regulations that would limit the range of backwardation at bottom 25 pounds to prevent market manipulation. Backwardation shrunk to close to $0 or even negative, thus causing a spacious loss in Sumitomos portfolio. To recoup the loss, he conducted a Radr work in June 1993, but at the end he ended up closing their Radr position and incurred a $1.1 billion loss. Hamanaka tried to recoup the loss by increasing the trade volume and made a contract with Winchester for1 million metric tons over two geezerhood at the price of $2,800, however, due to price declines, the loss kept expanding.Hamanakas close step was to create an option portfolio named Radr minutes. He made six opposite transactions in Radr. The counterparty of these transactions was Credit L yonnais Rouse (CLR, currently Calyon Group). Since the position held by CLR was large and caused backwardation, LME tightened the backwardation limit to $5 in September 8 1993. In addition, LME informed Credit Lyonnais that they were to canfulcel part of their transactions with Sumitomo on September 17th,, Thus resulting in a $1.16 billion loss for Sumitomo. maiden In June 25, 1993, Hamanaka buys call option with an average price of $2,400 and which expires after 2 years. The transaction is totally irregular because the total volume was 1 million metric tons as compared to all LME inventory of 0.5 million.The portfolio could make a profit if the price went up to $2,480. To salary a premium of $69 million, Hamanaka made a 2nd trade. 2nd Hamanaka made a short strangle, combination by selling a 0.5 million $2, c call and $1,900 put option. The portfolio could make a profit if the price remained in the midst of $1,900 and $2,140. From this transaction, he got $94 million of premium and paid for the 1st option. With 1st and 2nd strategy, total breakeven was $2,700. 3rd marketing future at a price of $2,000 which increase payoff to around $1,900. 4th Buying 1.35 million metric tons of $1,750 put, breakeven was $1,580.He predicted that the copper price would go down below $1,600 level. fifth Buying 1.35 million metric tons of $1,800 put again, breakeven was changed to $1,680. This portfolio could make a profit middling if the price went down below $1,700 level. 6th Selling 1.2 million metric tons of $1,950 call to get $29 millions of premium. With this transaction, breakeven was changed to $1,680. However, if the copper price exceeded $1,950, Sumitomo suffered a huge loss.1.4Lesson lettered from Sumitomo CaseThe Sumitomo Case explains down the stairsmentioned lessons base on inhering control and risk management prospective, and it believed that if controls were in place, losses would go been detected much earlier.(a) circumspection Level Control Sumitomo C orporation failed to execute a risk management practices and they believed the expertise and specialized friendship of Hamanaka. The essence of the problem was unauthorized trading that the culprit undertook to enhance his menages profitability and then his own career and pay. Hamanaka tries to cover up the losses through taking more risk that end up with further losses. Setting up corporate discipline and sound Management structure is all-important(a) to manage the risks.(b)Independent Transaction Monitoring Sumitomo should create a separate and independent supervisor system within the company pecking order to avoid these result issues specifically the issues amongst recording and checking procedures. Segregation of duties is important to prevent the malpractices. Middle and bank office should be totally quarantined from the front office. (c)Corporate Responsibility We should too consider corporate responsibility with ask to timely reporting. In the Sumitomo faux pas, the management waited ten days until issuing a press release. Sumitomo needed some time to calculate their losses they could have avoided additional declines in copper prices that were caused because of the rumors and uncertainty in the market.(d)Government Regulations The regulatory agency should execute more stringent rules on the differential coefficients market to avoid price manipulation and impose new regulations on corporate reporting obligations so as to provide investors and other market participants with greater information regarding the governances willingness to take risks and capability to manipulate market prices. The official and market pressures of stringent regulation will strengthen the internal auditing and information systems of many firms and provide a check against possible management discretions.2.Case study on the orange arena on Derivatives Losses & Lessons Learned The purpose of this case is to explain how a municipal lost $1.6 billion in the monetary mark et. In December 1994 Orange County stunned the market by announcing that its enthronization puddle had suffered a loss of $ 1.6 billion this was the largest loss ever recorded by local government investiture bills pool and led to the unsuccessful person of the county shortly thereafter. The loss was the result of unsupervised investment activity of the trail Citron, the county treasure who was dealing with the $ 7.5 billion portfolio belonging to the county schools, cities, special districts, and county itself. In the tome of pecuniary restrains Citron was viewed as a wizard who could painlessly generate greater results to the investors.Citron generate 2% higher than the comparable evoke poolFigure 01 citrons compensate recordCitron was able to increase returns on the pool by investing in derivatives securities and supplement the port folio to the hit. The pool was such demand due to its track record that citron had turn down investments by agencies outside Orange Coun ty. Some local schools districts and cities even issued short consideration taxable notes to the investment in the pool by increasing the leverage even further. For that there was a repeated public warning, which was by notably by tail end Moorlach, who ran for treasurer in 1994, that the pool was too notional. Unfortunately, he was widely ignore by Citron when he was re elected. The investment strategy worked splendidly until 1994, when fed started a series of vex rate hikes that caused severe losses to the pool. Initially it was announced as a paper loss. Shortly thereafter, the county tell bankrupts and decided to liquidate the portfolio.This occurred because citron expect that pastime rates would happen or bridle the same, the citrons main purpose was to increase income by ontogenesis that the concomitant that medium term maturities had higher yield than short term investments. On Dec 1993, for instance short term yields were less than 3%, while 5year yield were aroun d 5.2% .which such positive sloped term structure of recreate tares , the tendency maybe to increase the eon of the investment to pick up extra yield . The boost, of cause comes at the expenditure of great risk .the strategy went as long as post rates went down. In February94 however the Federal Reserve Bank starred a series of six consecutive interest rate increases, which led to a bloodbath in the bond market. The larger duration led to a $1.6 billion loss2.1. Lessons Learned from Orange Country CaseDue to the activities of Bob Citron the municipality lost $1.6 billion in financial markets. Therefore, it is essential to understand the lessons to be learnt from the Orange Country case. (a). No autocratic decisions should make in investment activities Bob Citron was investing the halalty owned by the taxpayers in risky securities in paries Street as per his own interest. Since he managed to generate higher returns for the funds invested in the early stages Citron was viewed as a wizard. This made him over confident on his actions which resulted in huge losses at the end. When the leverage increase due to these activities Bob Citron, the treasurer was warned by flush toilet Moorlach thath the pool was too risky. However, counter arguments were widely ignored and Citron was re-appointed as the treasurer.(b). local anesthetic governments need to maintain high standards for fiscal oversight and accountability. As mention in the state auditors report following the bankruptcy, a number of steps should be taken to ensure that local funds are kept safe and liquid. These include having the Board of Supervisors approve the countys investment fund policies, appointing an independent advisory committee to oversee investment decisions, requiring more frequent and detailed investment reports from the county treasurer, and establishing stricter rules for selecting brokers and investment advisors. Local officials should conform government structures to make sure th ey have the proper financial controls in place at all times.(c). State government should closely monitor the fiscal conditions of its local governments, rather than wait for serious problems to surface The state controller collects budget data from county governments and presents them in an annual report. These data should be systematically analyzed to determine which counties show abnormal patterns of revenues or expenditures or signs of fiscal distress. State leaders should discuss fiscal problems and solutions with local officials forrader the situation reaches crisis stage. (d).Always aware of the negative side on risky investmentsThe treasurer was assuming that interest rates would fall or stay low when he goes for huge investment activities. However, when the things moved the opposite perpetration and the interest rates went up the pool suffered severe losses. Therefore, always be cautious when making predictions on market phenomena. (e). Use proper statistical risk assess ing methods before invest in securities An investor could use a proper risk assessment method such as Value At Risk (VAR) method to assess the market risk of the portfolio. VAR is the upper limit loss over a target horizon such that there is a low, pre specified probability that the actual loss will be larger. Therefore, shareholder and managers can decide whether they feel comfortable with the given level of risk.3.Case study on the Procter & adventure on Derivatives Losses & Lessons LearnedProcter & essay Co. is a Fortune 500, American global corporation based in Cincinnati, Ohio, that manu particularures a wide range of consumer goods. In late 1993, Proctor & Gamble financial managers, well known for actively managing their interest costs, expected interest rates to decline and went to Bankers Trust searching for aggressive interest rate alternates that would allow them to profit on these vistas. P&G told to Bankers Trust somewhat ways of replacing a fixed-to floating swap that was maturing. P&Gs specific objective was to negotiate a new $100 million swap that wouldAgain put it in the position of give floating rates and Squeeze these to a minimum.Specifically, the company wanted to pay 40 seat points (0.4 of 1%) less than its standard, upper-crust commercial paper rate (then about 3.25% for six-month paper). Bankers Trust responded with a highly levered, extremely risky, and extremely knotty five-year interest-rate swap agreement. In this the P&G had to pay 75 basis points less than rate of Commercial Paper, if the interest rates of 30 years and 5 years treasury bills will remain constant or go down. Five-year exchequer rates rose from 5% in early November 1993 to 6.7% on May 4, 1994. P&Gs other benchmark, 30-year Treasury rates, went from about 6% to 7.3%. Because of large duration the effect of rise in interest rate on long term bonds was very high. When interest rates headed up, Proctor & Gambles treasurer realized the order of the companys p otential derivatives losses and decided to get out of the swap.Because of the intricate complexities and linked derivatives of the agreement, however, P&G lost $157 million to lock-in interest rates (which were 1,412 basis points (14.12%) above the commercial paper rate) in only six months of a five year contract. When interest rates headed up, Bankers trust entered into another contract with P& G- a wedding band. When this strategy also failed, it led P& G to pay even higher rate of interest from 14.12% above Commercial Paper (CP) to 16.40% above CP. CEO Edwin Artzt, called the swaps a violation of the companys policy against speculative financial transactions and banned all leveraged swaps. As the Bankers Trust had suggested the contracts, P& G goddamn them for the losses.3.1Lesson Learned from Procter & Gamble CaseThe Procter and Gamble Case explains following,(a)Legal dispute between P&G and Bankers Therein lies the crux of the legal dispute between P&G and Bankers. P&G claims that before the swaps were signed, Bankers repeatedly advised it that in the early stages of the swaps, the company would be able to do lock-ins at acceptable prices. Court papers, in fact, include letters from Bankers that make such assurances, though these consistently cite assumptions of stable or only slightly rising rates. P&G says, however, that on one occasion it pointedly asked the Bankers Trust person with whom it was dealing what the lock-in situation on the first swap would be if rates and volatility were not stable.The answer, P&G says, was that possible changes in rates or volatilities would not have a stuff or significant effect on the companys lock-in position. (b) pattern of Deliveries A P&G spokeswoman stressed that the transaction was speculative and goes outside the P&G policy of conservatively managing our debt portfolio. Asked whether the companys treasury was expected to be a profit center. In a speech, William J. McDonough, chairwoman of the Federal Reserve Bank of New York, warned that top managements of financial and nonfinancial companies have a responsibility to understand and constantly monitor derivative markets when their companies are involved in them. Also Mr. McDonough said. To put it simply and directly, if the bosses do not or cannot understand both the risks and the rewards in their products, their firm should not be in the business.4.Case study on the Showa puzzle Sekiyu on Derivatives Lossess & Lessons Learned Showa Shell Sekiyu is one of Japans leading cover refinement companies and is engaged in producing gasoline, diesel fuel, fuel oil, kerosene, lubricants etc. It was established in 1876 under Samuel Samuel & Co, and was later became a subsidiary of Royal Dutch Shell group, in 1985. And presently, 50% of shares are owned by Royal Dutch Shell Group. In the year 1993, the Company made history by making approximately USD 1.4 Bn with unauthorized forward bills transactions. As an oil importer, company imported grat ing oil in US Dollars and flip-flop the end products in Yen. Showa Shell had been used to hedge a remainder of its currency exposure using foreign exchange forward contracts. In 1989, company entered into a series of forward options where it agreed to buy dollars forward at an average rate of USD 145. Over the neighboring few years Yen strengthened ageist the dollar.However, at the time of maturing of these contracts, the foreign exchange rate was at USD 125, indicating a difference of USD 20 or a drop of approximately 14%. But, treasury department of the company decided not to recognize the losses and chose to roll over the forwards using diachronic rates, without appropriate internal authority. And consequently, the actual losses made were concealed within the new forward contracts, and this actually meant that the company was borrowing money under the guise of forward contracts. This practice or rather malpractice was continue until the end of 1992, and at that time the comp any had in excess of USD 6.4 Bn of forward contracts on their accounts, and out of this, it was revealed by the management of the company that hidden financial losses were USD 1.4 Bn. And the losses amounted to more than five times of its annual oil import at that time.Four senior executives of the company had resigned following the discovery of unauthorized currency dealing including, Kiyoshi Takahashi chairman of Showa, Takeshi Hemmi the president, who took responsibility for the dealings that resulted in the huge losses. The resignations were made as shell, one of the biggest world oil groups , reported a 28% decline in net profits. Main reason for the losses was that treasury department of the company, entering into unauthorized forward currency transactions, with the expectation of US Dollar to rise against Yen, and attention was not given to the fact of worsening the situation in case of Yen strengthening against Yen.John Jennings, then Shell Group managing director, had state d that, an unauthorized currency possibility was like A gross contravention of established rules and practices which was deliberately canceled. The continued dealings that were made were the result of one treasury manager try to recoup losses amounting to single figure millions, incurred during normal course of his job, although with failures in attempts made, continues dealings were made by exposing the company to increasingly large exchange rate risks.4.1Lessons Learned from Showa Shell Sekiyu CaseThese huge losses made, oblige the company to centralise on more tight internal controls and focus on the importance of having internal controls. Although defining of risk limits is not needfully provide results, if proper controlling is not there to take disciplinary measures, in case of deviations. And furthermore, it is never advantageous to assume that market fluctuations can be predicted accurately, at all times. And if being successful in the past, it can purely be due to luck and it does not guarantee that next time would be the same. Company incurred the losses on the assumption of currency value increasing rather than decreasing. The purpose of using derivatives is to hedge the risk and not to make profits by speculating and speculators take huge risks, rather than hedging risks.Company should have focused on the fact of maintaining their crude oil import price by mitigating exchange rate risks by using the forward contracts. If a loss is made in the do work of trying to maintain price level, although losses are made in the profit and loss account, the objective of maintaining price level is still achieved. This fact is very important in dealing with derivatives and should not make sour judgments on losses made when trying to maintain price level. It is hard-fought to measure the exact point, where, the hedging of risks ends and being speculative starts.And in Showa case, treasury department of the company, who were there to hedge risk, had dealt a s a speculator and without adhering to the internal controls and not obtaining proper approval for its dealings. In addition, it took more than four years to recognize this malpractice by the higher authorities, which pin points the lack of transparency in method of accounting practices. And it was blamed by some experts on the Japanese accounting system, since the dealings were not identified earlier. And the dealings were only revealed by chance, during a conversation between a Japanese bank manager and Showa manager.