Discussion on John Hull | Business SnapShot 5.1

[sudeepdoon]

H David,

The Bussiness Snapshot 5.1 frm John Hull talks about Joseph Jett, the trader at Kidder Peadody's; to have been buying a stock from the Spot Market at time t and at the same time selling a future for the same stock which maturies at time (t + 3months).

I understand the mistake done by Kidder Peadody, that is not to consider the time value of money.

Joseph bought stock at 70 and sold future at 70.70 and 0.70 was recorded as profit which was wrong, whereas there was actually no profit (under fair market conditions). that is beacause the cost to carry $70 for 3 months should be $0.70 in unarbitarged market.

So how is that the concluding lines says that there was a loss of $350 million where as the system told that the profit was $100 million.

Where did such a huge loss come from?

 

[David Harper CFA FRM]

Hi Sudeep,

I agree with your characterization; also, I agree this implies that gross of transactions (before deducting transactions), this implies the economics of the trade would have been, on average, nearer to zero rather than -$350 million.

My recollection of this fascinating "case" (http://www.sec.gov/litigation/opinions/33-8395.htm), which was sort of a pyramid-scheme (!), is that the losses were from his other trades. So, if that's true, your implication is correct, rolling the forwards should be near to net zero and, i think the guy was just using this to cover up $350 mm in other trading losses. I agree that Box is confusing to imply the forward roll was itself a big money loser - David

 

[sudeepdoon]

Thanks David, that was a good link.

Are are links to the cases as in the core reads like that LTCM.. It would be good to go through the details.

 

[David Harper CFA FRM]

Hi Sudeep,

I am not lush with extra links to the cases. I am aware of these (which i think you can access for free-yes?) at prmia:
http://prmia.org/index.php?page=exam&option=trainingWebBasedResource

Although, I will say our assigned reading is maybe the most detailed i've seen. In regard to Metallgesellschaft, I've not seen anything as deep (although it's organization is confusin) as our assigned Gallati; the MG case in his Chapter has taught me something new each year....

David