Rogue Trading in Security, Risk Public Listed Company Is Facing and Strategies to Minimize Such Risk - Assignment Example

Introduction Stock exchanges carry out a fundamental role in society by enhancing the listing and trading of securities. As well as they have a responsibility of maintaining superior market supervision to uphold public assurance in the securities market. The key confront facing market supervision today are increased disintegration and abusive trading practices. In November 2007, the Markets in Financial Instruments Directive commenced amid other things. These open up the countrywide exchange monopolies to competition, as well as to improve competence, market clearness and investor security (Adam, 2008). The introduction of Markets in Financial Instruments Directive (MiFID) has open up ways for fundamental structural improvement in the European equity markets. The introduction of the European equity markets to fare and free competition initiated a latest set of stipulation that have accurately required every market contestant, inclusive of exchanges, brokers, investors, listed companies and regulators, to endlessly reconsider as well as become accustomed to their operations. This task is difficult and challenging but this is the only available remedy in order to get rid of market abuse. Question A Real Case of rogue (abuse in) trading in security that has taken place in the last ten years According to Annika von Hartman who is the head of Surveillance at NASDAQ OMX Nordics there exist some market loop holes that brokers you used to abuse the market by capitalizing on the market discrepancy and earn more profit from investor money (Annaert, 2005). The act is deemed illegal. Annika von Hartman pointed out some market abuse executed at NASDAC OMX security. Below is one of the market abuses that were performed by market brokers. Market manipulation An abusive trading activities that is practiced in the security market from time to time. layering and from running is an abusive trading practices and occurs when a broker sends numerous orders priced closely to the existing ultimate bid price and offer to create misleading impression of liquidity in a share. A market maker in a proportion listed in NASDAQ OMX member phoned the NASDAQ surveillance department to point out a trading pattern that was executed in a share that lead to lose of money from the client (Annaert, 2005). A member has been selling way below the share though a direct market access (DMA) account. The transaction took place in small amount with price crash. Warrant was listed in a different exchange. It turn out that the member with similar DMA account as well had placed an order with deviated price in the warrant. The member shifted the price in threw warrant and got an execution at a lower price in the warrant. The manipulation was executed through awareness that the quotation in the warrant automatically was brought up to date by the latest price in the share. By setting up a fresh level in the share price, the member was able to profit by purchasing the warrant at an inferior price. The member then turned the trade in the warrant when share price returned to ordinary and thus the warrant was quoted sepirior. The member realized a profit of EUR 0.25 in spread when turning the trade. This act was considered as an abuse of trading rules and regulation since, the process acted in accordance to the market rules and regulation. This is an abuse and thus will lead to market distrust by investor since, they will be in doubt of their investment, and consequently the economic growth will stunted. the NASDAQ security market consequently implemented radical measures in order to enhance the trading as well as increasing investor awareness and trust in the secuiryt market. Question B Types of control sytem that could have averted the abuse 1. Delegation of Authority Delegating duties would help to minimize the consequence of fraud in the security market. In November 2007, the market in financial instrument directive (MiFID) was put into practice and thus it lead to eradication of competition and opened up the national exchange monopolies to competition (Chokesy, 2002). This lead to efficiency enhancement, market transparency as well as the investor protection. The opening of the European equity markets to contest lead to new set of environment that have factually required every market member, together with exchanges, brokers, shareholders, listed corporation and regulators, to constantly reconsider and become accustomed to their operations. The chore is intricate and challenging and thus minimizes chances of abuse in the, market trading. Job segregation is one of the fundamental duties to minimize market abuse since; the abuse of power in the office by few self-centered people will be executed. In this regards, the security market should segregate the duties and assign accountability in order to ensure that everybody is fully made accountable for any abuse of power. This will as a result lead to investor confidence of the security market. Segregation of duties also eradicates bureaucracy as well as gets rid of monopolistic market. Free and fare market competition enhance economic progression by ensuring that investors get the right information freely as well make an informed decision as to whether to invest in a security or not 2. Transparency in trading and reporting system Investor’s protection and trust is of paramount importance in the derivatives market given the case on fraud and abuse of stock market trading (Gerela. S. T. and Balsara. K. A, 2005). Market transparency can be achieved by installing security surveillance around and within the stock market in order to check for any unacceptable or double business dealings this is because, in the previous, trading of derivatives of listed corporation was centered to the exchange where the corporation was listed. Due to installation of surveillance, the shares can now be traded on multiple alternative trending avenues. The security market is anticipated to enhance the market surveillance on a European level. Trading avenues will be mandated to comply and exchange information to enhance the detection of cross avenue as well as cross control market exploitation. As much as this is warmly appreciated, it will just solve a portion of the issues because the surveillance might be on an adhoc basis. There will not be a merge perspective of the dealings. Question C. Risk that a public listed company is facing and strategies to minimize such risk Every registered public company that trade in a security market faces both the internal; and external risk in the course of the business situation.nut there some of the common challenge faced by almost entire companies in the security market. In order to exist in the competitive market, companies need to ascertain and appraise the business risk that might be faced in the market as well mitigating for such risk in order to guarantee the going concern assumption of the business .the challenges and risks faced by the company is discussed in details below. 1. Uncertainty Derivatives is subject to frequent variation in value the derivatives in the market that makers it hard to forecast the trend in maker rise and fall. The present value of prospect liability is increasing due to inflation in the discount rate employed in the liability assessment process. This pose a serious threat to the price of the security in the market in that, a fall in a price of a security would imply a decline profit and consequently, the company will incur loss from investment and thus business need to be keen as well as study the trend of the security ands factor that causes the shift in price movement, this factors will help in making an informed decision and steps to undertake in order to safeguard the company from running at a loss much more. 2. Market risk Market risk is the sensitivity of an asset or portfolio to overall market price change in market risk such as interest rates, inflation, equities, currency, and property. Securities are greatly uncovered to the risk of interest and threat in price rises as these conclude the present value of the investor liabilities; characteristically these risks are consider as ‘unrewarded’ risks as these are inherent to the liabilities (Keith Cuthbertson, 2001). At the same time as market risk cannot be entirely eradicated by diversification of portfolio, it can be minimized by hedging. The application of interest and inflation rate swaps may generate counterbalancing positions since the risks are hedged In order to manage market risk. The business should therefore diversify portfolio investment to reduce investment risk. This is important since, the required rate to return for a portfolio is much lower, with high value as compared to a single investment. Minimizing such risk 1. Portfolio diversification Since market risk is a recurring threat to a company, it is hard for a company to constantly manage same recurring business risk year after year. To avoid such risk constant, the company should consider diversifying the portfolio investment. Asset diversification is the process of buying security of different company with different maturity and expiry periods. This will be relevant the financial risk lf a certain security will not be the same with the financial threat of another security and thus a company will be able to manage business risk. The caluclation according to Modigliani and miller proposition provides that a levered firm commands a higher value with low cost of capital implying that asset diversification is relevant if a business would be in position of minimising such market risk. 2. Value-at-Risk This is a normally used appraise of risk. As a distinct metric, it provides a distinct comprehensive outlook, which slots in the exposure to risk sensitivities. Value at risk is arrived at working out the anticipated loss amount that might not be surpassed at a particular confidence level over a given holding time, presumptuous of standard market situation (Koonce, 2005). The bigger the portfolio’s value at risk, the bigger its anticipated loss, and exposure to market threats. the advantage of value at risk is that it’s a complex risk measure that include interest rate, credit, inflation, equity risks and other external risk that can affect the performance of a security to a distinct number. 3. Commitment approach The commitment approach is normal method employed to work out the gross notional threat as well as the global exposure consequential from portfolio derivatives. The commitment method is referenced comprehensively in the guideline by the European Securities and Markets Authority. the guiding principle is build on standard market approach as well as practices to work out the underlying risk of derivatives instrument as well an appraisal of global risk. This approach therefore is an appraisal of advantage and do not entirely portray the market risk consequential from derivatives. Other measures comprising qualitative appraisal must as well be performed to guarantee that the market risk is sufficiently recognized. Conclusion In conclusion, investors persist to have substantial scope concerning the way they supervise and administer their asset’s risk. The derivative and portfolio structuring are turning out to be more and more difficult which for this reason demands additional refined risk administration and reporting. This therefore makes it much significant for investors and shareholders to comprehend appropriately supervise and manage their risk exposures. At the same time as value at risk, continue to be a significant metric for appraising market risk exposure, there are restrictions with this measure (Koonce, 2005). European market authority and global regulators are increasingly recommending a broader range of risk metrics to evaluate risk exposure. Eventually, every investor and shareholder must implement the excellent arrangement of risk metrics for its exclusive asset/liability, financing, and risk summary. Market risk is inevitable for every public company registered in a security market and thus every business registered in public trace must always ensure that it mitigate for such market risk in order to ensure that the investment earns a return inform of profit. Some of the mitigation include as diversification, employing value at risk as well as taking into consideration commitment approach. this are some of the security tool employed in order to forecast on the variability of a security as well s making an informed decision of whether to buy or dispose a security. In this case, much business will be avoiding risk and loss that was experienced in the economic crash of 2007 that made numerous companies to run insolvent. 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