AIR, an airline company, used to deal only in derivatives of futures and swaps to hedge its jet fuel market risk. However, in the mid 2003, AIR started trading in speculative derivative options and took a bullish view of the jet fuel market. The company predicted correctly but by the end of 2003, AIR revised its strategy to a bearish stance. The CEO signed contracts with several banks, buying put options and selling call options, but the prices soared above the strike price of the call, and AIR faced a large deficit. 1. Explain how AIR could have floored the losses through an adequate risk management procedure Despite mark to market losses of $30 million by mid 2004, the CEO increased AIR exposure. In addition, the trading was not disclosed in the financial statements, and AIR accounted for the options at intrinsic value, ignoring the time value component. From March 2003, AIR started trading options on its own account. AIR was unable to meet some of the margin calls, resulting in the company being forced to close the positions with some of its counter parties. From October 2004 to date, the accumulated losses from these closed positions amounts to approximately US$390 million; In addition, AIR breached insider trading laws by selling 15% shares of AIR to Goldman Sachs without informing the shareholders. 2. Which category of risk were involved?
AIR, an airline company, used to deal only in derivatives of futures and swaps to hedge its jet fuel market risk. However, in the mid
2003, AIR started trading in speculative derivative options and took a bullish view of the jet fuel market.
The company predicted correctly but by the end of 2003, AIR revised its strategy to a bearish stance.
The CEO signed contracts with several banks, buying put options and selling call options, but the prices soared above the strike price
of the call, and AIR faced a large deficit.
1. Explain how AIR could have floored the losses through an adequate risk management procedure
Despite mark to market losses of $30 million by mid 2004, the CEO increased AIR exposure.
In addition, the trading was not disclosed in the financial statements, and AIR accounted for the options at intrinsic value, ignoring
the time value component.
From March 2003, AIR started trading options on its own account.
AIR was unable to meet some of the margin calls, resulting in the company being forced to close the positions with some of its
counter parties.
From October 2004 to date, the accumulated losses from these closed positions amounts to approximately US$390 million;
In addition, AIR breached insider trading laws by selling 15% shares of AIR to Goldman Sachs without informing the shareholders.
2. Which category of risk were involved?
3. Which risk management procedures did AIR breached?
4. As an independent Chief Risk Officer, advise on which risk management policies could be implemented using the appropriate
risk management strategy analysis
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