Long-Term Capital Market(LTCM)

Essay by linchitingUniversity, Master'sA-, April 2005

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What is LTCM?


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 the height of the fund in 1998 it had $5 billion in assets, controlled over $100 billion and had positions whose worth amounted to over a $1 trillion.

LTCM was primarily engaged in what hedge fund practitioners call "market-neutral arbitrage." Its main holdings appear to have been long positions in bonds that it considered undervalued and short positions in bonds that it considered overvalued. More specifically, it bought high yielding, less liquid bonds, and "junk" corporate bonds, and sold short low-yielding, more liquid bonds.

When did it start and fail?

LTCM was formed in 1993 and was founded by renowned Salomon Brothers bond trader John Meriwether. In Sept 1998, with the help of the Federal Reserve and its creditors, the fund that nearly collapsed the global financial system in as a result of high-risk arbitrage trading strategies was bailed out and taken over. A systematic meltdown of the market was prevented.

What's the performance?

In 1994, the fund returned 19.9 percent after fees to its investors, 42.8 percent in 1995, 40.8 percent in 1996, and another 17.1 percent in 1997. By late 1997, the equity in LTCM had grown to over $7 billion. In December 1997, however, the fund returned $2.7 billion to its investors, claiming diminished investment opportunities, leaving equity of about $4.8 billion at the start of 1998.

Why did it Collapse?

LTCM believed that in late 1997 and early 1998, partly...

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