Amaranth Advisors: Burning Six Billion in Thirty Days Harvard Case Solution & Analysis

QUESTION # 01:It was said that at one point Hunter “held 100,000 contracts in a single maturity month.” (p. 7) How much money would a long position, say in the January 07 futures contract, and lose if the futures price dropped just 1 cent in a certain day? From August 31, 2006 until September 19, 2006, winter contract prices fell $2 on average. If these contracts were the only ones Amaranth was holding, how many would be needed to generate the $ 3.8 billion estimated loss over that period. Is this position plausible?

ANSWER:

If the future price just drops by 1 cent, then the total money that would be lost by the Amaranth will be $20,861,280 and if prices will fall on average $2 for the winter contracts then the loss would be around $74,863,714. The total number of contracts required for the loss of $3.8 billion will be 12,550 contracts. In this position Amaranth is not reasonable.

QUESTION # 02:What are the Winter-Summer and March-April spreads? What is the rationale for trading these spreads?

ANSWER:

Spread means that the difference between the two variable prices and other financial variables, the future spread is the difference of the short futures and long futures to give exposure to a spread. The winter, summer spread is the difference of the ask price of winter and the bid price of the summer or the ask price of summer and the bid winter. Ask price is the closing price of the session that is may be the summer or the winter as the case may be, and the bid price is the opening price of the next session that is may be the summer or winter as the case may be.

The March, April spread is the difference of the asking price of March and the bid price of April. The difference calculated is the spread for that year. The March, April spread is the alternative of the winter, summer spread, and many investors prior to choosing the March April spread.

Rationale:

Spread combines both the position of the future contracts that is long position as well as short on the same time. The combination of the positions that is long position and a short position is to minimize the risk associated with the holding of future contracts.

QUESTION # 03: Of the scenarios given on pages 7-8 which is most plausible? Be sure to support your position.

ANSWER:

The most plausible scenario is scenario 1 where the losses incurred is near to the losses incurred on September 18 and 19 which is around $0.8 billion to $1.1 billion.

Table: 1

QUESTION # 04:       Amaranth paid around $2.4 billion (to Merrill, JPM, and Citadel) to get rid of its positions? Why was that large payment warranted?

ANSWER:

Amaranth had paid $2.4 billion and the payment was made because Amaranth would face the liquidity risks if those positions remained with the Amaranth. To get rid of those positions Amaranth paid $250 million to Merrill Lynch on the Partial sale of its energy portfolio and $2.15 billion to JPM and Citadel. Another reason behind this payment was that, if Amaranth did not pay this amount to get rid of the holding position and went in the market for liquidation of its positions then the prices would reduce more and more and eventually it would lead to the market crunch.

QUESTION # 05:Did Amaranth have adequate risk controls in place? What could the Fund’s management have done differently to avoid the precarious situation created by Hunter?

ANSWER:

Amaranth has not the adequate risk controls in his way as the he has transferred the supervision of 50 percent of the assets to the Hunter with having almost 420 employees. Hunter suffers approximately a billion of losses to Amaranth due to the large investment in the energy sector, and the prices of the natural gas had fallen down dramatically................

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This event gives students a thorough understanding of the commodity futures markets in general, and natural gas markets in particular. It also provides an introduction to hedge funds and awareness of the largest hedge fund collapse in history. Third, it introduces concepts such as liquidity risk, value-at-risk of a trade and the use of derivatives. At the date of the event, amaranth is not publicly disclosed positions, which led to the $ 6 billion in losses during the month of September 2006. The case was written using public information and provides key data elements to enable students to redesign the possible positions Amaranth can be carried out. "Hide

by Walid Busaba, Zeigham Khokher, Anuroop Duggal Source: Richard Ivey School of Business Foundation 15 pages. Publication Date: July 7, 2008. Prod. #: 908N03-PDF-ENG

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