Assignment #01

Project Risk Management

Dr. Syed Arslan Haider
Due Date: 15-Mar-25

Nudrat Niaz MPM241005

Fajr Naeem MPM241007
Maryam Rubab MPM241024
Introduction
Financial risk is a critical issue for businesses and economies and arises from uncertainties in
markets, operations, and economic conditions. It can take various forms, including market
risk, credit risk, liquidity risk, operational risk, and interest rate risk, each of which can lead
to significant losses. This assignment examines these risks through real-life case studies: the
collapse of Long-Term Capital Management (LTCM) (market risk), the Coca-Cola Amatil-
Coles dispute (credit risk), the collapse of Silicon Valley Bank (SVB) (liquidity risk), the
Societe Generale fraudulent traders scandal (operational risk), and the Asian financial crisis
(1997-1998) (interest rate risk). These examples illustrate the causes, effects, and lessons of
financial risk.

Case Study 1: Market Risk – The Collapse of Long-Term Capital

Management (LTCM)
Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by a group of
financial experts, including Nobel Prize-winning economists Myron Scholes and Robert
Merton. The fund specialized in fixed-income arbitrage, using complex mathematical models
to identify undervalued securities and profit from small price differences.
Nature of Risk
LTCM's strategies were based on the assumption that markets would remain stable and that
historical relationships between securities would remain intact. However, this assumption
exposed the Fund to significant market risk, which is the risk of losses due to adverse
movements in market prices. The Fund used high levels of leverage to enhance its returns,
which further increased its vulnerability to market shocks.
Events Leading to the Crisis
In 1998, a series of unexpected events triggered a global financial crisis:
1. Russia defaulted, triggering panic in emerging markets.
2. Investors fled to safer assets, leading to a flight to quality securities.
3. The relationships between the securities on which LTCM models were based
collapsed, leading to massive losses.
LTCM's highly leveraged positions exacerbated these losses, and the fund was on the verge of
collapse. At its peak, LTCM had leveraged its $4.7 billion of capital into positions worth
more than $1.25 trillion.
Outcome and Analysis of Risk
To prevent a systemic financial crisis, the Federal Reserve organized a $3.6 billion bailout
through a consortium of major banks. LTCM was ultimately liquidated. This event
highlighted the dangers of excessive leverage and the limitations of mathematical models for
predicting market behavior.
Market risk resulted in a significant loss for LTCM. The fund's reliance on debt and its flawed
assumptions about market stability led to catastrophic losses and eventual collapse. The risk
was clearly negative for LTCM, resulting in financial ruin and reputational damage.
 Case Study 2: Credit Risk – Coca-Cola Amatil (2011)
Coca-Cola Amatil (CCA) is a leading beverage manufacturer in Asia-Pacific and a subsidiary
of The Coca-Cola Company. In 2011, CCA faced a significant credit risk issue when one of
its largest customers, Australian retail giant Coles, demanded a significant price reduction for
Coca-Cola products. Credit risk is the potential for financial loss due to a customer's inability
or refusal to pay for goods or services. In this case, the risk resulted from CCA's reliance on a
few large customers and its inability to effectively manage pricing pressures.
Nature of Risk
The main risk in this case was credit risk. This occurs when a company faces potential losses
due to the financial instability or bargaining power of its customers. CCA's credit risk was
determined by several factors. First, a significant portion of CCA's sales came from a small
number of large retailers, including Coles and Woolworths. Second, Coles demanded a 20
percent price cut for Coca-Cola products, threatening CCA's profitability. Third, weak
consumer spending and intense retail competition increased the bargaining power of retailers,
further exacerbating the risk.
Events Leading to the Crisis
Several key events led to the escalation of the crisis. First, Coles, one of CCA's largest
customers, demanded a 20 percent price cut for Coca-Cola products, citing competitive
pressures and weak consumer demand. Second, CCA initially resisted the demand, leading to
a public dispute between the two companies. Third, news of the dispute caused CCA's share
price to fall by 10 percent, reflecting investor concerns about the company's profitability.
Ultimately, after weeks of negotiations, CCA agreed to a smaller price cut, but the incident
highlighted the company's vulnerability to credit risk.
Outcome and Analysis of Risk
Credit risk had a significant negative impact on Coca-Cola Amatil. The dispute with Coles
led to a significant decline in CCA's share price and therefore a loss of shareholder value.
CCA's profitability was affected by the price decline, although to a lesser extent than initially
feared. The incident revealed CCA's dependence on a few major customers, thereby
increasing the company's vulnerability to credit risks. Credit risk had a significant negative
impact on Coca-Cola Amatil. The dispute with Coles caused the shares to fall, reduced
profitability, and exposed the company's vulnerability to customer concentration. The risk
was negative because it caused financial and reputational harm to CCA.

Case Study 3: Liquidity Risk – Silicon Valley Bank (SVB) Collapse (2023)
Silicon Valley Bank (SVB) was a leading American bank specializing in financial services for
technology startups, venture capital firms, and innovation-driven companies. Founded in
1983, SVB became a major player in the tech ecosystem, managing billions of dollars in
deposits from startups and their investors. However, in March 2023, SVB experienced a
sudden and catastrophic collapse—one of the largest bank failures in U.S. history. This
collapse was largely due to liquidity risk—the inability of a bank to meet its short-term
financial obligations.
Nature of Risk
The main risk associated with SVB’s collapse was liquidity risk. Liquidity risk occurs when a
financial institution is unable to meet its short-term obligations due to a lack of liquidity (cash
or assets that can be quickly converted into cash). SVB’s liquidity risk was exacerbated by
two main factors. First, the bank had a high concentration of deposits from technology
startups and venture capital firms, which are highly sensitive to the economy. Second, SVB
had invested heavily in long-term US government bonds and mortgage-backed securities.
When interest rates rose sharply in 2022/23, the value of these bonds plummeted, leaving
SVB with unrealized losses and insufficient liquidity to meet repayment requirements.
Events Leading to the Crisis
Several key events led to the escalation of the crisis. First, the US Federal Reserve massively
raised interest rates in 2022/23 to combat inflation. As a result, the value of SVB's bond
holdings plummeted. Second, due to the strained economic situation, startups began
withdrawing their deposits from SVB to cover their operating costs. Third, SVB attempted to
sell its bond portfolio at a loss to cope with the flood of withdrawal requests. This further
worsened its financial situation. Finally, news of SVB's financial difficulties led to a bank
run. Customers withdrew their deposits, which ultimately led to the bank's bankruptcy.
Outcome and Analysis of Risk
Liquidity risk clearly had a negative impact on SVB. The bank's inability to meet withdrawal
requests led to a loss of depositor confidence and triggered a bank run. SVB was forced to
sell assets at a loss, further weakening its financial position. The collapse caused significant
disruption to the tech ecosystem, as many startups struggled to access their funds. The US
government intervened to protect depositors, but the incident highlighted the dangers of poor
liquidity management. Liquidity risk clearly had a negative impact on SVB. The bank's
inability to meet its short-term obligations led to its collapse and caused significant financial
and reputational damage. The risk was negative because it led to the bank's failure and
disrupted the broader tech ecosystem.

Case Study 4: Operational Risk – The Rogue Trader at Societe Generale

Societe General, one of France's largest banks, suffered a massive loss in 2008 due to the
actions of a single trader, Jerome Kerviel. Kerviel was a mid-level trader in the bank's equity
derivatives department and was responsible for implementing arbitrage strategies.
Nature of Risk
Kerviel opened unauthorized positions in European stock index futures, exceeded his trading
limits, and circumvented the bank's risk controls. This exposed Societe General to significant
operational risk—the risk of loss due to inadequate or defective internal processes, people, or
systems.
Events Leading to the Crisis
Kerviel's operations were initially profitable, but when the markets turned against him in
early 2008, losses quickly mounted. He successfully concealed his positions by introducing
fake offsetting trades and manipulating the bank's risk management systems. By the time the
bank discovered the fraud, losses had reached €4.9 billion (approximately $7.2 billion).
Outcome and Analysis of Risk
Societe General liquidated Kerviel's positions at a significant loss, resulting in Kerviel being
sentenced to three years in prison. The incident raised serious questions about the bank's
internal controls, risk management practices, and trader supervision. The operational risk
resulted in massive financial losses and reputational damage to Societe General. The bank's
failure to detect Kerviel's unauthorized transactions exposed weaknesses in its internal
control and risk management systems. The risk was clearly negative for the bank, as it caused
significant financial and reputational damage.

Case Study 5: Interest Rate Risk - Asian Financial Crisis (1997-1998)

The 1997-98 Asian financial crisis was a period of severe financial and economic turmoil that
affected several Southeast Asian countries, including Thailand, Indonesia, South Korea, and
Malaysia. The crisis was triggered by a combination of internal and external factors. Many
Asian economies experienced strong growth thanks to large foreign currency loans,
particularly US dollars, to finance infrastructure projects and economic growth. However,
these countries had weak financial systems, inadequate regulation, and inadequate risk
management. In addition, increased speculative investment in real estate and stock markets
led to speculative bubbles that eventually burst. The crisis in Thailand began in July 1997
with the collapse of the Thai baht after the government abandoned its fixed exchange rate
system. This triggered a domino effect across the region, leading to currency devaluations,
capital flight, and economic recessions.
Nature of Risk
The main risk of this crisis was interest rate risk—the potential for losses due to changes in
interest rates. In the context of the Asian financial crisis, interest rate risk manifested itself in
two main ways. First, the US Federal Reserve's decision in the mid-1990s to raise interest
rates increased borrowing costs for Asian countries with high foreign currency debt. Second,
many Asian countries raised domestic interest rates to stabilize their currencies and prevent
capital outflows, further increasing borrowing costs for firms and consumers. The
combination of rising global and domestic interest rates created a vicious cycle. Higher
interest rates made debt servicing more expensive for countries and firms, while currency
devaluations increased the burden of foreign currency debt, as more domestic currency was
required to repay the same amount of external debt.
Events Leading to the Crisis
Several key events led to the escalation of the crisis. First, investors lost confidence in Asian
economies and withdrew their investments. This led to sharp devaluations of local currencies
such as the Thai baht, the Indonesian rupiah, and the South Korean won. This currency
devaluation made it even more difficult for countries and businesses to repay their foreign
currency debts. Second, the sudden withdrawal of foreign capital exacerbated the crisis as
countries struggled to maintain their foreign exchange reserves. Third, many businesses and
financial institutions were unable to repay their foreign currency debts due to rising
borrowing costs and currency devaluations, leading to numerous bankruptcies. Ultimately,
the crisis led to a sharp decline in economic activity; GDP growth rates turned negative in
several countries. Unemployment skyrocketed, and poverty increased, causing significant
social and economic hardship.
Outcome and Analysis of Risk
Interest rate risk during the Asian financial crisis had a significant negative impact on the
affected economies. Rising global and domestic interest rates increased the cost of debt
repayment, leading to a liquidity crisis and numerous bankruptcies. Currency devaluations
further exacerbated the debt burden, as more local currency was needed to service foreign
currency debt. To stabilize their currencies, many countries raised domestic interest rates,
leading to a decline in economic activity and rising unemployment. The crisis highlighted the
dangers of overreliance on foreign currency debt and the importance of risk management. In
the long term, many Asian countries were forced to seek financial support from the
International Monetary Fund (IMF), which imposed strict austerity measures as a condition
for granting loans. The crisis also led to reforms in financial regulation, risk management,
and corporate governance in the affected countries.

Conclusion
Case studies illustrate the devastating consequences of financial risk. The collapse of LTCM
highlights the dangers of excessive leverage, while the Coca-Cola Amatil dispute highlights
the risks of customer concentration. The bankruptcy of SVB underscores the importance of
liquidity management, and the Société Générale scandal underscores the need for strict
internal controls. The Asian financial crisis illustrates how interest rate risks can destabilize
economies. Taken together, these examples underscore the importance of sound risk
management practices—including diversification, supervision, and preparedness to minimize
financial risks and ensure stability.