Derivatives Business of Banks & Insurance Companies

Thanks to the Subprime mortgage crisis, not only the banks, but also other financial organizations like Insurance companies are facing a real tough time. The shine may not be over completely from the US economy, but the problems don’t seem to have an end.It’s now the turn of insurance companies to be hit by the subprime mortgage crisis. It was AIG- or American International Group AIG whose share price hit a five-year low amid skeptical questions about how the insurance giant values some of its derivatives.

It’s easy to find a reason when things go wrong. It’s much easier to make assumptions and take a deadly position, thinking that our assumptions will work correctly. Problems with AIG are now contributed to an interest rate derivative called Swaps, that too credit-default swaps, which are very commonly used.

Right from the Subprime mortgage crisis making costly assumptions about the second or third tier lending, to the closing of BNP Paribas based Hedge Funds, to the exposure of a scam at SocGen, to the devastating listing of big stars like Reliance Power IPO and cancellation of Wockhardt Hospital IPO and Emaar MGF IPO in the Indian markets, everything was based upon assumptions. Assumptions that things will go well, there will be no problems with money flow, exchange rates will be stable, market conditions will be favourable, investors will remain stupid enough to throw away their money into Funds and IPOs, etc, etc.

As per the news: AIG said in a Monday SEC filing that the value of its credit-default swaps, used to hedge against fixed-income losses, fell by $4.88 billion in October and November, more than four times its prior forecast.
AIG's independent auditor, PricewaterhouseCoopers, said the insurer had a "material weakness" in its internal controls over financial reporting and oversight.
AIG's stock fell 12% to 44.74, the lowest since March 2003. Its shares have lost more than one-third of their value over the past four months.

God knows whom these great financial institutions employ, as Risk managers. What costly assumptions they make and who was supposed to check their workings. At the end, the shareholders are the ones who loose.

Kotak Mahindra Capital, UBS Securities India, ABN AMRO Securities, Deutsche Equities India, Enam Securities, ICICI Securities, JM Financial Consultants and JP Morgan India were the book running lead managers to the Reliance Power issue while Macquarie India and SBI Capital Markets are co-book running lead managers. All of these are great stalwarts in the business of money. Why did they go wrong?

Citigroup Global Markets India and Kotak Mahindra Capital Company (the joint global co-ordinators and book running lead managers), while ICICI Securities and SBI Capital Markets are BRLM. Why were they forced to close the IPO? All of them try to explain their theories and justifications to the markets. What they forget is that markets have their own theories, language and justification – and that all can be summed up in one word – RANDOM.

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