Orange County Essay

After California passed a proposition limiting revenue gene come ind from local anaesthetic property taxes, pressure was put on local governments to raise nice m championy to fund services. orangish County, like many others in the US, essay to raise revenue without increasing taxes. Their treasurer, Robert L. citron tree, decided to get involved with a high essay high reward product. He chose to invest in derivatives and gamble with public money. Because spare-time activity place were beginning at the time, Citrons portfolio was returning at an average rate of 8. 52%. This was 5% higher than what the asseverate of California was earning.Orange County was enjoying the benefits of their treasures enthronizations. In 1994, 35% of the countys revenue was from the portfolios returns. The county continued to increase earnings and therefore no one looked into Citrons practices. He did inform the Board of Supervisors that the value of the countys portfolio depended on amuse rates remaining stable or decreasing. So when sideline rates rose, the value of the portfolio diminished, eventually leading to bankruptcy. In December 1994, Orange County announced a loss of $1. 6 jillion, the most signifi stoolt loss enter by a local government coronation pool.This as well as displayed the prejudicious side of the high risk investments made by Citron who was looseness with a $7. 5 billion portfolio made up of players such as cities, school, water works, and regional transportation. 1 There were many factors that led to the bankruptcy of Orange County. A Board of Supervisors member aread that there was a lack of oversight (not an accountable system) and failure of disclosure to investors. Citron also never met with the investment oversight committee that did exist, and as treasurer he had insure over Orange County and their trust.Many have questioned if Citron was ever measure up to hold his position in office. Some even blame the state government. Originally they used to fund local governments, but when they started taking spur they were taking $6. 5 million more than they were giving them. Before the county say bankruptcy, an investor First Boston, was selling its collateral because they saw that the countys portfolio was declining. This was a malarkey that problems were around the corner because soon many investors would realize this and pull out.In response, bankruptcy was declared so that the funds would freeze and banks would not be able to liquidate the collateral. Another responsible party was Merrill Lynch, the countys monetary advisor. The purpose they serve is to protect the interests of the county. They did warn Citron about the excitableness of the investments however they still bought him the same funds and underwrote a bond get along for $600 million. The warning was only sent to Citron and not to the Board of Supervisors. A lawsuit was filed in 1995 against Merrill Lynch by Orange County. 2Besides the mightiness h e held over the county, another reason for the bankruptcy was Citrons use of leveraging. As a leveraged fund, it could borrow money to increase its securities portfolio. Citron was able to leverage $7. 57 billion into $20. 5 billion. In essence, when the investment produces a high return rate, the stockholders will have a in truth high rate of return. On the other hand, if the investment produces a low return rate, the stockholders will have a very low return. They also used longer condition maturities which makes it more sensitive to changing interest rates.So there is a high leverage risk as well as interest rate risk. 3 Duration is interest rate sensitivity and because Citrons portfolio depended on interest rates it is a good measure. Because the portfolio used median term maturities over short term maturities to increase their return, the duration increased. In December 1994 the duration was 2. 74 years. With the leverage ratio at 2. 73, the actual portfolio duration was 7. 4 ( 2. 74*2. 73).When the interest rates rose in 1994, the estimated loss using duration was $1. 85 million, a little more than the actual amount. interest rates went up about 3. 5 and 5 year bond yield was 5%) volt-ampere could also have been used to find some risks of the portfolio. VaR is a statistical technique used to measure and quantify the train of financial risk within a firm or investment portfolio over a specific time frame. Value at risk is used by risk managers in order to measure and temper the level of risk which the firm undertakes.The risk managers argument is to ensure that risks are not taken beyond the level at which the firm can absorb the losses of a probable bruise outcome. investopedia definition) The portfolio was sensitive to interest rates so a change in the rate can be used in 3 dissimulation methods and the only impactive factor. Using a historical simulation approach, the VaR equals $1. 24 billion. This is lower hence the actual value but it is als o using past prices to determine the future. In the delta normal method VaR is reason as $1. 21 billion. This is a little less accurate then the historical method. The best way in theory to calculate var would be using the Monte Carlo Simulation.However in this situation it treats the portfolio as one asset and equals about $1 billion. Because none of these prove to be reliable enough, a exponentially slanted moving average can be used to improve the accuracy of VaR. What it does it give more weight to recent data then older data. 4 As a lead of the bankruptcy many unfortunate consequences arose. Of course there was the $1. 6 billion in debt that needed to be re-payed to investors. Additionally the lawsuit against Merrill Lynch was wearing funds from the community with no promising chance of recovery.The once absolute rating that Orange County held was now downgraded to a default rating by Standard & Poor. There were also many political consequences regarding the county and cou nty officials. If the risk of the portfolio was taken into consideration by the appropriate parties, the entire situation could have been avoided. regrettably the power to stop Citron was in the hands of Merrill Lynch who did not take the appropriate action. The County also failed to monitor and assess the deal which puts some(prenominal) more people at blame for the bankruptcy.