Describe the Key Factors, Strategies That Led to and the Lessons Learned from the Demise of Long Term Capital Management. Provide a Brief Summary of What Happened and What Were the Strategies Used by the Fund.
Syndicate 2 1. Describe the key factors, strategies that led to and the lessons learned from the demise of Long Term capital Management. Provide a brief summary of what happened and what were the strategies used by the fund.
The most well know strategy which hedge fund managers or practitioners undertake was “market neutral arbitrage”, thus, from this particular trading strategy, of course what they are doing is not like what the name suggested “hedging”, instead, hedge fund participants are trying to speculate from every financial markets. More specific, the trading strategy indicates that it take a long position in those securities which was viewed by hedge fund managers as under priced securities or illiquid, high rate of return, and high risk assets, such like high risky CDOs. On the other hand, it simultaneously take a short position in those assets which was overpriced or low rate of return, low risk and more liquid assets, one example was U.S. Government T-bonds. What’s more, the trading mechanism that how hedge fund make profit and loss we should know is, if the yield spread between high and low risk assets widened, hedge fund need to payout and suffers a loss, otherwise it can make profit as the spread narrowed and receive the different.
Now let’s discuss the turning point of hedge fund from success to huge losses. In late 1997 and early 1998, the Asian financial crisis leaded to a very wide gap between high and low risk bonds and liquid and illiquid assets, at that time, LTCM believe that the investors will reassess the potential risk and markets will also repricing riskless assets, as a consequence, risk spread will eventually be narrowed, and because LTCM has enormous leverage level, and the leverage ratio was 20 to 1 at 1998. Those funds were borrowed from a lot of banks, institutions and wealth retail investors all over the world, even a small shrink of risk spread can finally make huge profits.
Yet, unfortunately, the yield spreads
The most well know strategy which hedge fund managers or practitioners undertake was “market neutral arbitrage”, thus, from this particular trading strategy, of course what they are doing is not like what the name suggested “hedging”, instead, hedge fund participants are trying to speculate from every financial markets. More specific, the trading strategy indicates that it take a long position in those securities which was viewed by hedge fund managers as under priced securities or illiquid, high rate of return, and high risk assets, such like high risky CDOs. On the other hand, it simultaneously take a short position in those assets which was overpriced or low rate of return, low risk and more liquid assets, one example was U.S. Government T-bonds. What’s more, the trading mechanism that how hedge fund make profit and loss we should know is, if the yield spread between high and low risk assets widened, hedge fund need to payout and suffers a loss, otherwise it can make profit as the spread narrowed and receive the different.
Now let’s discuss the turning point of hedge fund from success to huge losses. In late 1997 and early 1998, the Asian financial crisis leaded to a very wide gap between high and low risk bonds and liquid and illiquid assets, at that time, LTCM believe that the investors will reassess the potential risk and markets will also repricing riskless assets, as a consequence, risk spread will eventually be narrowed, and because LTCM has enormous leverage level, and the leverage ratio was 20 to 1 at 1998. Those funds were borrowed from a lot of banks, institutions and wealth retail investors all over the world, even a small shrink of risk spread can finally make huge profits.
Yet, unfortunately, the yield spreads