Page 58 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

BANKING
“ e higher the value of the index, the greater the spread, usually associated with market unease, such as political uncertainty
or economic uncertainty.”
(or what is known as its yield) a basis-point credit spread to compensate investors for taking on the risk that the corporation itself may default on its bond obligations.
In order to take this bet Iksil took signi cant volume positions in some- thing called CDX IG 9 – known to market-savvy investors as the Markit CDX North America Investment Grade Series 9 10-Year Index. is index is made up of the yields of 121 investment-grade bonds issued by North American corporations, and is measured as a spread against LIBOR.
e higher the value of the index, the greater the spread, usually associated with market unease, such as political uncertainty or economic uncertainty. During periods of market unease, there is usually associated a ight to quality, and demand for US corporate debt – as opposed to government debt – should weaken. is should lead to lower demand for US corporate bonds, lower prices, and inversely higher yields for these same bonds. e index would then increase in value during periods of severe turmoil and decrease in value during periods of relative calm.
By taking enormous volumes of short (sell) positions in the CDX IG 9 index, Iksil had essentially made a very large bet that markets would strengthen and these spreads would narrow. He had taken these positions unhedged. His bet was essentially precisely that: no more and no less than a bet one would make at a roulette table in a casino.
Had the trading positions been of a nature that would correspond to the idea of executing trades to support risk management within JP Morgan as a whole, there would have been corresponding positions in the bank in the opposite direction – that is, positions that assumed market disruption – which the CIO unit felt it had to hedge out. Ironically as it happened – and tellingly in terms of the failure of risk aggregation – other units within the bank had taken the opposite view and had taken opposite positions. is had occurred unbeknownst to Iksil, and certainly not for hedging purposes, but rather because they felt that the market-moving positions taken by other traders – including their own rm’s other traders – were wrong.
As with Nick Leeson, it was unexpected market events that blew up the short positions Iksil had taken. In Nick Leeson’s case his ‘straddle’ trade on the Nikkei 225 – in which one earns fees for selling short positions and long positions at the same strike price on the same index with the
56