Reference no: EM132358931
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