LONG TERM CAPITAL MANAGEMENT CASE STUDY

LONG TERM CAPITAL MANAGEMENT CASE STUDY

In 1993 something that could be seen as a sophisticated money-making machine was

born. It was run by people in the forefront of both practical and scientific finance and it

generated its profits by utilizing seemingly risk free trading strategies. Even though the

concept of a perfect financial strategy had been disproved so many times in history this

new invention was still seen as a trading vehicle that would continue making profits year

after year. This “money-making machine” was hedge fund LTCM, Long Term Capital

Management. Long Term Capital Management primarily used absolute-return strategies

such as pairs trading and different arbitrage strategies to generate income. A common

denominator for these investments is that they are rather low risk but also rather low

return. Therefore LTCM had to leverage their portfolio hugely to be able to return any

substantial sums of money. In its first years of operation the fund returned around 40%

annually. An impressive rate of return but also somehow expected from a firm whose

partners included Nobel Laureates and a former vice chairman of the Federal Reserve.

Despite being foretold a brilliant future LTCM was short lived. A series of events initiated

by the Russian financial crisis of 1998 caused the fund to suffer enormous losses

eventually leading to a bailout organized by the Federal Reserve.

Please complete a 10-page report. Your assignment is to summarize the red flags

that went undetected at Long Term Capital Management and how should Long

Term Capital Management have avoided failure; Describe the lessons to be

learned from this crisis

including:

● Market values matter for leveraged portfolios

● Liquidity itself is a risk factor

● Models must be stress-tested and combined with judgement; and

● Financial institutions should aggregate exposures to common risk factors.

Purpose of Assignment

-Own deep understanding regarding risk management

-Learn critical points in managing corporate risk