Question

(b) Explain the peformance of LTCM investment during 1994-1997.

(c) Explain the major trading strategy of LTCM investment.

(d) Explain why LTCM collapsed in 1998.

( Please give me a little bit long explaination)

Answer 1

LTCM Stands for Long Term Capital Management founded by John Meriweather in 1994

b) Performance during 1994-1997:

Hedge fund is a private Investment Partnersip fund takes short and longer position in Markets which was not regulated by Securities Exchange Commission had investment objective to take advantage of difference in Securities prices which are closely related to each other.

LTCM charges annual Fees of 2% and amount will be locked for 3 years period

Initially the LTCM Hedge fund generates higher profits for example Returns after Fees is

as follows in 1994:20%,1995-96:40%,1997- decreased to 17% and capital increased right from $1 Billion to $7 Billion by 1997.

c) Major trading strategy:

Meri weather appointed highly intellectual Proffessionals to Predict Securities prices by developing

most complicated mathematical models to derive huge returns by Buying at the time when Prices meet the norms developed and waiting till the Price Convergence occurs to sell.

There is more uncertainity in the mathematical models developed and failed mostly because of Arbitrage Convergence which was predicted wrongly

d) LTCM Failure:

LTCM Balance sheet value for example = $25M where as capital = $1 M

It leads to high Leverage ratio of 25:1 and it went up to 250:1 more dependent on Borrowings

They even entered in to sale & Purchase arrangements by selling some of their assets under assets on the condition that they will repiurchase back after some period of time.

According to the complex mathematical models used by LTCM, the positions were low risk. Judgement tells us that the key assumption that the models depended on was the high correlation between the long and short positions. Certainly, recent history suggested that correlations between corporate bonds of different credit quality would move together (a correlation of between 90-95% over a 2-year horizon). During LTCM's crisis, however, this correlation dropped to 80%.  

LTCM failed in managing and analysing the risk and Value at Risk(VAR)

The ultimate cause of the LTCM failure was the flight to liquidity across the global fixed income markets. As Russia's troubles became deeper, fixed-income portfolio managers began to shift their assets to more liquid assets. In particular, many investors shifted their investments into the U.S. Treasury market. In fact, so great was the panic that investors moved money not just into Treasurys, but into the most liquid part of the U.S. Treasury market.

When there is liquidity Problems most of the lenders ask immediately their funds after seeing the down trend there by results in giving priority to lenders rather than investors and ensure that Liquidity constraints become major from investing suddenly by diverting from non liquid funds to most liquid funds