London Whale Trade Case Study

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Answer to Question 1
Basel III introduced new requirements regarding liquidity risk in the banking sector under the Liquidity Coverage Ratio (LCR). Firstly, explain the criteria and rationale for banks to identify the kinds of assets that qualify as HQLA and the relative ratios for each kind of HQLA is required for compliance with the LCR requirement. One of the consequences of this ratio is that banks are required to model their expected net cash outflows during a 30 day period of acute market stress. Secondly, explain the types of outflows – and give specific examples - that could arise during such periods of stress. Thirdly, by making reference to different approaches to Funds Transfer Pricing (FTP) models, explain how those business units
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It derived its name from a trader Bruno Iksil, which was involved in huge amount of CDS trades that resulted to billions of loss for the bank (same type of securities involved in Lehman Bros fallout, 2008). It is a good example of a big reputable and stable bank’s lapse in trading judgement, bypassing controls, misrepresentation of reports, violation of regulatory policies set for more effective controls, and inadequate risk monitoring by US financial regulators to enact on such fraudulent activities of a too big to fail financial …show more content…
The volatility smile is so named because it looks like a person smiling. The implied volatility is derived from the Black-Scholes model, and the volatility adjusts according to the option's maturity and the extent to which it is in-the-money (moneyness). The volatility smile may be explained by investor demand for options of the same expiration date but disparate strike prices. In-the-money and out-of-the-money options are usually more desired by investors than at-the-money options. As the price of an option increases all else equal, the implied volatility of the underlying asset increases. Because increased demand bids the prices of such options up, the implied volatility for those options seem to be higher. Another explanation for the enigmatic strike price-implied volatility paradigm is that options with strike prices increasingly farther from the spot price of the underlying asset account for extreme market moves or black swan events. Such events are characterized by extreme volatility and increase the price of an option. (Source:

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