Posted: August 26th, 2021
Case Study: LIA and Goldman Sachs
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Case Study: LIA and Goldman Sachs
Big Game: Goldman Sachs’ Elephant Hunt in Libya
Executive summary
The case study’s primary focus is on the ill-fated relationship of the Libyan Investment Authority (LIA) and Goldman Sachs. In the year 2008, LIA entered in a $1.2 billion derivatives contract on Goldman’s advice that proved to be ultimately disastrous as they were elephant trades. Furthermore, LIA combined two derivatives financial instruments: at-the-money forward contracts and at-the-money put options, which had a maturity period of three-years on underlying Citigroup stocks. Additionally, the analysis is concerned with basic derivatives instruments, terminologies, and concepts such as counterparty risks and leverage. Also, it deals with intuitive valuation issues such as arbitrage-based valuations bound and put-call parities. The case also addresses technical issues such as Black-Scholes formula, binomial tree, Monte Carlo simulation, and dividend yield and volatility calibrations. More so, it addresses hedging and pricing models of exotic derivatives in the stipulated period and how the underlying assets are affected by market forces. However, in October 2016, a London based court ruled against LIA holding that the derivatives trade was not entered into under undue influence though Goldman Sachs gave LIA gifts such as iPods, fine wines, odd finance textbooks, and aftershave. In conclusion, the case observed that Goldman Sachs exploited LIA’s lack of financial expertise on derivatives and financial instruments to lure it in elephant trades whose risk did not understand.
Introduction
LIA entered into a $1.2 billion derivatives trade in early 2008 following Goldman’s advice after twenty years of isolation that had crippled the country’s economy due to sanctions and unspent oil revenues. Additionally, bonds on Libya’s central bank earned a modest interest and renewed access to international financial markets, a situation that presented an opportunity to achieve greater returns. Therefore, in August 2006, Libya’s sovereign wealth funds through LIA opened for business, and at the end of the year, LIA held initial talks concerning the business opportunities with Goldman Sachs (Gromb et al., 2018). In July 2007, Goldman Sachs hosted LIA’s representatives, Zarti, in their London headquarters and was impressed by the scale of the bank’s investment of about $40 billion revenues, $10 billion profits, and thirty thousand employees. Therefore, Youssef, representing Goldman Sachs, commenced his training on call and put options and lured LIA with gifts and incentives.
Consequently, LIA invested $350 million by September 2007 to inform of two Goldman’s managed investment funds against an external financial advisor and legal counsel’s advice. During the 2007 financial crisis, the stock prices started to decline with colossal volatility and bear stream, but the investment bank termed the situation as only temporary and would recover (Gromb et al., 2018). Despite the warnings in the financial market, LIA made an additional $100 million investment on 25th January 2008 in approximately 11.2 million shares in Citigroup, which closed at $26.64 on a material day, as shown in Appendix 1. Essentially, this trade consisted of two derivative instruments of at-the-money forward contracts and at-the-money put options, with a maturity period of three years.
Hence, LIA had the sole responsibility to hedge the derivative despite their high risks in price movements as they are highly volatile, increasing their overall costs and generating huge losses. Therefore, LIA entered additional trades on derivatives, hedge funds, and private equity with other banks worth $5.5 billion. Every trade was worth between $100 to $ 300 million price ranges apart from an investment fund of $1 billion in Société Générale (Gromb et al., 2018). Furthermore, LIA took equity positions in Citigroup, Honeywell, and Occidental, amounting to $50 million. However, there was no direct contract between LIA and Citigroup as all the amounts passed through Goldman Sachs, who acted like agents, which was a perfect opportunity to maximize their returns.
Problem Identification and Analysis
The overall transactions were synthetic position as LIA was not involved in making direct investments in Citigroup stocks and only cash change hands during purchase and at maturity. More so, the forwards were over-the-counter contracts on the Goldman Sachs and LIA, where it committed to purchase the 11.2 million shares at maturity period, and Goldman Sachs committed to selling the shares to LIA at $26.64 per share. Furthermore, the forward contract terms were at-the-money, implying that the delivery price was the stock price of the material day of $26.64 per share, the total amount of $298 million for the 11.2 million shares purchased by LIA (Gromb et al., 2018). Additionally, the forward contracts were cash-settled, indicating that instead of delivering the stocks to maturity, Goldman Sachs owed LIA cash amounts equivalent to $298 million (11.2 million shares x $26.64 share). Therefore, if the amount exceeded the total amount, Goldman Sachs would compensate the excess, and if the share price fell below $26.64, LIA owed the balance.
Furthermore, the at-the-money put options were over-the-counter contracts. They gave LIA the right to sell the 11.2 million Citigroup stock to Goldman Sachs on maturity as it was a European option and would not be exercised before. Goldman Sachs also committed to purchase the stocks when LIA exercised the option. However, LIA would only exercise the option when it was in-the-money at the end of three years. The trade was cash-settled, implying that when LIA exercised the put option, it was neither supposed to deliver the shares to Goldman Sachs nor settle the total amount of $298 million (Publishing.insead.edu, 2020). Contrarily, Goldman Sachs would settle LIA with 11.2 million times the variance between Citigroup’s share price strike and maturity period. Additionally, Goldman Sachs would hedge the loss by having reciprocal trades on over-the-counter with other banks and offset market transactions such as Citigroup stocks (Publishing.insead.edu, 2020). Therefore, in all the scenarios, the performance metrics included the cash-on-cash returns, payoff, and IRR on the initial investments and additional seven equity derivative trades by LIA on companies with declining stocks with Goldman Sachs.
Conclusion
The forward and put contracts entered by
LIA through Goldman Sachs were exotic contracts with high volatility to price
changes. More so, the derivatives were European contracts. As such, LIA would
only exercise after the maturity period of the stipulated period of three
years. Additionally, the derivatives were over-the-counter contracts that were
at-the-money forwards and put options. Finally, Goldman Sachs lured LIA with
gifts into their white elephant trades to make abnormal returns as LIA did not
conduct the necessary due diligence in derivative trading.
References
Gromb, D., Antin Infrastructure Partners Chair Professor of Finance at HEC Pari, A., & Peress, J. (2018). Big Game: Goldman Sachs’ Elephant Hunt in Libya. Big Game: Goldman Sachs’ Elephant Hunt In Libya.
Publishing.insead.edu.
(2020). Big Game: Goldman Sachs’ Elephant Hunt in Libya. Retrieved 28 August 2020, from
https://publishing.insead.edu/case/big-game
Appendices
Appendix 1- Citigroup stock price of $26.64
Figure 1: Citigroup Stock Price History
Appendix 2: Ex1- Citi Divided History
Ex-Dividend Date |
Dividend per Share ($) |
Closing Stock Price ($) |
03 August 2006 | 0.49 | 48.47 |
02 November 2006 | 0.49 | 49.74 |
01 February 2007 | 0.54 | 54.73 |
03 May 2007 | 0.54 | 53.95 |
02 August 2007 | 0.54 | 47.24 |
01 November 2007 | 0.54 | 38.51 |
Appendix 3: Ex3- Listed American Options
Expiration Date | Option Symbol | Type | Strike Price ($) |
Bid ($) |
Ask ($) | Open Interest |
17 Jan 2009 | VRN.AE | Call | 25 | 4.70 | 4.70 | 39,297 |
VRN.AF | Call | 30 | 2.60 | 2.61 | 87,923 | |
VRN.ME | Put | 25 | 3.40 | 3.45 | 69,211 | |
VRN.MF | Put | 30 | 6.25 | 6.25 | 105,537 | |
16 Jan 2010 | WRV.AE | Call | 25 | 6.10 | 6.40 | 19,821 |
WRV.AF | Call | 30 | 4.15 | 4.45 | 44,015 | |
WRV.ME | Put | 25 | 4.75 | 4.90 | 23,785 | |
WRV.MF | Put | 30 | 7.55 | 7.90 | 49,501 |
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