Managing financial risk
A London International Financial Futures and Options Exchange case study

Page 1: Introduction

There is an element of risk in an activity when the outcome cannot be predicted with any certainty, or when the outcome is known but its full consequences are not. As individuals we have widely different attitudes to taking risks. For example, it is possible to identify three different positions. The risk lover - Someone who enjoys a gamble, even when mathematical analysis shows that the odds are...
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Page 2: Change in a competitive market

During the 1980s, however, there was a considerable change when the Conservative government encouraged increasing competition in the Financial Services markets. Prior to the 1980s, financial service organisations had tended to specialise so that: if you wanted a loan you went to a finance house or bank a mortgage - to a building society an insurance policy - to an insurance broker, or insurance...
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Page 3: Interest rates

Hedging is an action which is taken to avoid making a financial loss, in this case because of adverse movements in interest rates. This is achieved by setting up an identical, but opposite, contract in the futures market to the one in the ‘cash’ market, i.e. the ‘cash’ market here is the mortgage market.Interest rate futures are bought and sold according to an index pricing...
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Page 4: How LIFFE works

A client (such as a Building Society) wishes to buy or sell futures or options and telephones his/her broker, a member of LIFFE. The broker contacts his/her booth on the LIFFE trading floor with his or her client’s instructions. The order is received in the booth and time stamped and dated. The pit trader is given the information either by hand signals or by written order from the booth...
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Page 5: Traders

Open outcry, as it is known, is a traditional method of trading, which combines the use of shouting and hand signals. Most of the business conducted at LIFFE is carried out this way. Every trader in the pit can be thought of as an auctioneer, each announcing his or her bids and offers to indicate willingness to trade.There are many conventions in open outcry trading, including the order in which...
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Page 6: Conclusion

This case study provides a fascinating insight into the work of LIFFE. It is one of the most colourful markets existing in the world today, but it is one with a very serious purpose. LIFFE makes it possible for organisations like Building Societies, which have always operated on a prudent basis, to avoid taking risks with their members’ or shareholders’ money. This case study has...
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