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    What Are The Major Founders of LTCM and Their Backgrounds?

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    LTCM was a large hedge fund founded in 1994 by John Meriwether and several other Wall Street veterans. It employed sophisticated quantitative models to pursue arbitrage strategies between similar financial instruments. Initially very successful, LTCM reported average annual returns of over 40% through 1997. However, the fund collapsed in 1998 due to extreme leverage and exposure to risky trades. When global financial markets experienced turmoil, LTCM lost billions and faced bankruptcy. The Federal Reserve intervened to facilitate a rescue plan where major banks contributed $3.65 billion to unwind LTCM's positions in order to prevent broader economic damage. The LTCM collapse highlighted the dangers of relying on quantitative models alone and demonstrated how the failure of one institution could pose systemic risk.

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    What Are The Major Founders of LTCM and Their Backgrounds?

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    msirisekara
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    LTCM was a large hedge fund founded in 1994 by John Meriwether and several other Wall Street veterans. It employed sophisticated quantitative models to pursue arbitrage strategies between similar financial instruments. Initially very successful, LTCM reported average annual returns of over 40% through 1997. However, the fund collapsed in 1998 due to extreme leverage and exposure to risky trades. When global financial markets experienced turmoil, LTCM lost billions and faced bankruptcy. The Federal Reserve intervened to facilitate a rescue plan where major banks contributed $3.65 billion to unwind LTCM's positions in order to prevent broader economic damage. The LTCM collapse highlighted the dangers of relying on quantitative models alone and demonstrated how the failure of one institution could pose systemic risk.

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    LTCM was a large hedge fund founded in 1994 by John Meriwether and several other Wall Street veterans. It employed sophisticated quantitative models to pursue arbitrage strategies between similar financial instruments. Initially very successful, LTCM reported average annual returns of over 40% through 1997. However, the fund collapsed in 1998 due to extreme leverage and exposure to risky trades. When global financial markets experienced turmoil, LTCM lost billions and faced bankruptcy. The Federal Reserve intervened to facilitate a rescue plan where major banks contributed $3.65 billion to unwind LTCM's positions in order to prevent broader economic damage. The LTCM collapse highlighted the dangers of relying on quantitative models alone and demonstrated how the failure of one institution could pose systemic risk.

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    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    64 views4 pages

    What Are The Major Founders of LTCM and Their Backgrounds?

    Uploaded by

    msirisekara
    LTCM was a large hedge fund founded in 1994 by John Meriwether and several other Wall Street veterans. It employed sophisticated quantitative models to pursue arbitrage strategies between similar financial instruments. Initially very successful, LTCM reported average annual returns of over 40% through 1997. However, the fund collapsed in 1998 due to extreme leverage and exposure to risky trades. When global financial markets experienced turmoil, LTCM lost billions and faced bankruptcy. The Federal Reserve intervened to facilitate a rescue plan where major banks contributed $3.65 billion to unwind LTCM's positions in order to prevent broader economic damage. The LTCM collapse highlighted the dangers of relying on quantitative models alone and demonstrated how the failure of one institution could pose systemic risk.

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    Reading assignment 1: Long Term Capital Management 1. What are the major founders of LTCM and their backgrounds?

    John William Meriwether, the well-known former bond trader from Salomon Brothers founded the long term capital management (LTCM), a large speculative hedge fund in 1994. John Meriwether, also known as the American hedge fund executive, was born in Chicago, Illinois on the 10th of August 1947. He graduated with an undergraduate degree from Northwestern University and also earned an MBA degree from the University Of Chicago Booth School Of Business. Meriwether also employed two Nobel Prize-winning economists which are Myron Scholes and Robert C. Merton to help manage this hedge fun. Myron Samuel Scholes, a Canadian-born American financial economist was born on the 1 of July 1941. He is also popular for being one of the people behind the Black-Scholes equation.
    st

    Other than Meriwether, Scholes and Merton, the firm was also headed by Eric Rosenfeld, Greg Hawkins, Larry Hilibrand, William Krasker, Dick Leahy, Victor Haghani, James McEntee, Robert Shustak, and David W. Mullins. Jr.

    2. What is the historical performance of LTCM before 1998?


    In an attempt to secure this fund, Meriwether started the firm with investments from 80 investors who provided a minimum of $10 million each. By February 1994, the company has already accumulated over $1 billion in initial assets and was concentrating more on the bond trading. Returns were then reaching up to 40% and managed to accumulate about $7 billion and a return of 27% by the end of 1997 which is almost as good as the return on U.S. equities that year. Meriwether returns about $2.7 billion of the fund's capital back to investors because "investment opportunities were not large and attractive enough"

    3. What are the trading strategies that LTCM uses?


    LTCM main aim was to make convergence trades which include obtaining arbitrage opportunities. This is done by finding securities that were mispriced comparative to one another. It started off by investing over $1billion in initial assets and was concentrating mostly on bond trading. There are four types of trades that can be used to acquire this - Convergence among U.S, Japan and European sovereign bonds - Convergence among European sovereign bonds

    Convergence between on-the-run and off-the-run U.S government bonds Long positions in emerging markets sovereigns, hedged back to dollars.
    The company used complex mathematical models to take advantage of fixed income arbitrage deals (termed convergence trades) usually with U.S., Japanese, and European government bonds. Government bonds are a "fixed-term debt obligation", meaning that they will pay a fixed amount at a specified time in the future.
    [12]

    Differences

    in the bonds' present value are minimal, so according to economic theory any difference in price will be eliminated by arbitrage. Unlike differences in share prices of two companies, which could reflect different underlying fundamentals, price differences between a 30 year treasury bond and a 29 and three quarter year old treasury bond should be minimalboth will see a fixed payment roughly 30 years in the future. However, small discrepancies arose between the two bonds because of a difference in liquidity.
    [13]

    By a series of financial transactions, essentially amounting to buying the

    cheaper 'off-the-run' bond (the 29 and three quarter year old bond) and shorting the more expensive, but more liquid, 'on-the-run' bond (the 30 year bond just issued by the Treasury), it would be possible to make a profit as the difference in the value of the bonds narrowed when a new bond was issued. As LTCM's capital base grew, they felt pressed to invest that capital and had run out of good bond-arbitrage bets. This led LTCM to undertake more aggressive trading strategies. Although these trading strategies were non-market directional, i.e. they were not dependent on overall interest rates or stock prices going up (or down), they were not convergence trades as such. By 1998, LTCM had extremely large positions in areas such as merger arbitrage and S&P 500 options (net short long-term S&P volatility). LTCM had become a major supplier of S&P 500 vega, which had been in demand by companies seeking to essentially insure equities against future declines. [14]

    Because these differences in value were minuteespecially for the convergence tradesthe fund needed to take highly-leveraged positions to make a significant profit. At the beginning of 1998, the firm had equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion, for a debt to equity ratio of over 25 to 1.
    [15]

    It

    had off-balance sheetderivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps. The fund also invested in otherderivatives such as equity options. In 1998, The chairman of Union Bank of Switzerland resigned as a result of a $780 million loss due to problems at Long-Term Capital Management.
    [16

    LTCM started with just over $1 billion in initial assets and focused on bond trading. The trading strategy of the fund was to make convergence trades, which involve taking advantage

    of arbitrage between securities that are incorrectly priced relative to each other. Due to the small spread in arbitrage opportunities, the fund had to leverage itself highly to make money. At its height in 1998, the fund had $5 billion in assets, controlled over $100 billion and had positions whose total worth was over a $1 trillion.

    4. What are the reasons for the breakdown of LTCM?

    Due to the high-risk arbitrage trading strategies, LTCM nearly failed the global financial system in 1998. The collapse started in 1997 in Asia and was spread to Russia and Brazil the year after. It was said to happen during the final stage of the world financial crisis. LTCM was a hedge fund set up by Nobel Prize winners Myron Scholes and Robert Merton to trade bonds. The professors believed that in the long run, the interest rates on different government bonds would converge, and the hedge fund traded on the small differences in the rates. However, in August 1998, bonds investors ran away from other government paper to the U.S. Treasury bonds as it is safer for them due to Russia defaulting on its government. This has caused the variations in interest rates between bonds to increase aggressively. LTCM lost billions of dollars as they had borrowed a lot of money from other companies. Therefore, they started selling Treasury bonds to liquidate its positions and this was found to be an aid in forcing the U.S. credit markets into turmoil and pushing up interest rates. As many of the leading U.S. banks were the ones investing in LTCM, they had been requested and persuaded to put in $3.65 billion dollars to save the firm from collapsing. The Fed itself made an emergency rate cut in October 1998 and markets soon returned to stability. LTCM itself was liquidated in 2000.HE

    Meriwether returns about $2.7 billion of the fund's capital back to investors because "investment opportunities were not large and attractive enough" (The Washington Post, 27 September 1998). Early 1998: The portfolio under LTCM's control amounts to well over $100 billion, while net asset value stands at some $4 billion; its swaps position is valued at some $1.25 trillion notional, equal to 5% of the entire global market. It had become a major supplier of index volatility to investment banks, was active in mortgage-backed securities and was dabbling in emerging markets such as Russia (Risk, October 1998)

    5. What are the consequences of LTCM? 6. Any implication?

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