A:

When an earthquake shook Kobe, Japan in 1995, it also broke open an ongoing scandal within the walls of Barings Bank. At the epicenter of the financial earthquake was Nick Leeson, a derivatives trader who, by the age of 28, had risen through the ranks of Barings to head its operations on the Singapore International Monetary Exchange (SGX).

Leeson initially was very successful in speculative trades, making huge profits for Barings and ensuring his upward mobility. Unfortunately, Leeson lost his touch as his speculative range increased. Leading up to 1995, he had been hiding losses from bad trades in a secret account. Leeson was able to accomplish this because of a management flaw in Barings that gave him the responsibility of double-checking his own trades, rather than having him report to a superior. Instead of reigning in his speculative gambles, Leeson continued to play increasingly bigger odds in an attempt to recover lost money.

Ironically, the trade that undid Leeson and the 200-year-old bank was one of his more conservative positions. Leeson placed a short straddle on the Nikkei, guessing that the exchange would remain stable overnight, neither going up nor down by a significant margin. Normally, Leeson would have been safe in such a position, but the earthquake in Kobe caused a sharp drop in the Nikkei and other Asian markets.

Faced with huge losses, Leeson panicked and attempted to offset the losses with increasingly desperate, short-term gambles that were based on the rate of recovery of the Nikkei. Sadly, the severity of the earthquake squashed all hopes of a rapid recovery. Leeson fled the country, but eventually he was arrested in Germany. Barings, having lost over $1 billion -more than twice its available capital - went bankrupt. Leeson wrote his aptly titled Rogue Trader while serving time in a Singapore prison. Leeson held the world title for losses due to unrestricted trades for over a decade, but he was eclipsed on January 25, 2008 when French bank Societe Generale announced that a rogue trader had lost more than $7 billion.

(For more on this topic, read The Biggest Stock Scams of All Time and Trading's 6 Biggest Losers.)

This question was answered by Andrew Beattie.

RELATED FAQS

  1. What are some examples of smart beta ETFs that use passive and active management?

    Learn about smart beta investment strategies and discover examples of smart beta exchange-traded funds that use both passive ...
  2. What are examples of inherent risk?

    Explore two famous examples of inherent risk with the collapse and ultimate bankruptcy of Lehman Brothers and the downfall ...
  3. How does implied volatility impact the pricing of options?

    Learn about two specific volatility types associated with options and how implied volatility can impact the pricing of options.
  4. Which federal regulatory agencies approved and are now responsible for enforcing ...

    Learn which federal regulatory authorities approved and are jointly responsible for the implementation and enforcement of ...
RELATED TERMS
  1. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...
  2. Ginnie Mae Pass Through

    A type of investment issued by the Government National Mortgage ...
  3. Accelerated Resolution Program (ARP)

    A program designed to reduce the time and cost of resolving failed ...
  4. Agency Swap Program

    A form of securitization whereby single-family residential mortgages ...
  5. Accelerated Return Note (ARN)

    A short- to medium-term debt instrument that offers a potentially ...
  6. Altman Z-Score

    The output of a credit-strength test that gauges a publicly traded ...

You May Also Like

Related Articles
  1. Professionals

    Top ETFs, Mutual Funds for Investing ...

  2. Professionals

    Are Energy MLPs a Good Bet Right Now?

  3. Forex Education

    Trading Forex Options: Process And Strategy

  4. Fundamental Analysis

    How Private Equity Dividends Work

  5. Forex Education

    Understand the Indirect Effects of Exchange ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!