Long-Term Capital Management - LTCM
A large hedge fund comprising Nobel Prize-winning economists and renowned Wall Street traders that nearly collapsed the global financial system in 1998 as a result of high-risk arbitrage trading strategies.
The fund formed in 1993 and was founded by renowned Salomon Brothers bond trader John Meriwether.
Investopedia Commentary
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.
Due to its highly leveraged nature and a financial crisis in Russia (i.e. the default of government bonds) which led to a 'flight to quality', the fund had sustained massive losses and was in danger of defaulting on its loans. This made it difficult for the fund to cut its losses in its positions. The fund held huge positions in the market totaling roughly 5% of the total global fixed-income market. LTCM had borrowed massive amounts of money to finance its leveraged trades. Had LTCM gone into default there would have been a widespread financial crisis around the globe, caused by the massive write-offs its creditors would have had to make. In Sept 1998, continuing to sustain losses, the fund, with the help of the Federal Reserve and its creditors, was bailed out and taken over. A systematic meltdown of the market was prevented.
Related Links
Introduction To Hedge Funds - Part Two
Introduction To Hedge Funds - Part One
Trading the Odds with Arbitrage
See also: Arbitrage, Default, Flight to Quality, Hedge Fund, Leverage, Sytamatic Risk
Also spelled: Long Term Capital Management, Long Term Capital Hedge FundLTCM