Meriwether took with him a group of traders and academics, who had been part of Salomon’s bond-arbitrage group that had racked up billions of dollars in profits. LTCM’s main strategy was to make convergence trades. Retrieved from ” https: How was that achieved? Rather it was the way this risk management tool was employed.

An option is a non-linear derivative of which we define two types: There was a flight to quality, bidding up the prices of the most liquid and benchmark securities that LTCM was short, and depressing the price of the less liquid securities it owned. The earnings for partners in a hedge fund was taxed at the higher rate applying to income, and LTCM applied its financial engineering expertise to legally transform income into capital gains. Federal Reserve Bank of New York actions raised concerns among some market observers that it could create moral hazard since even though the Fed had not directly injected capital, its use of moral suasion to encourage creditor involvement emphasized its interest in supporting the financial system. A capital surplus of R million was realised and is accounted for as an exceptional item.

Corporates and Financial engineering: a few case studies

With the help of Merrill Lynch, LTCM secured hundreds of millions of dollars from business owners, celebrities and even private university endowments and later the Italian central bank.

Corporates’ desire to de-leverage and clear the balance sheet of unpopular cross-shareholdings without indulging in a fire-sale or a rights issue means they are willing to look at other ways of monetising assets. Get unlimited access to videos, live online training, learning paths, books, tutorials, and more. Rather it was the way this risk management tool was employed. A vivid illustration of the consequences of these forced liquidations is given by Lowenstein Much has been said about LTCM’s positions in the press.


The issuing company does not have to pay any dividends until the warrants are exercised. However, it had the non-strategic summart in Richemont that it could use. This was embarrassing, as LTCM touted itself as having the same risk as equities.

There were four main types of trade:.

Long-Term Capital Management

Under prevailing US tax laws, there was a different tlcm of long-term capital gains, which were taxed at K is the strike price. Accordingly, we have the price equality: The creditors themselves did not lose money from being involved in the transaction.

If the company was unable to extend its financing agreements, then it would be forced to sell the securities it owned and to buy back the securities it was short at market prices, regardless of whether these were favourable from a valuation perspective. Venfin thus financed the deal at R Since bonds of similar maturities and the smumary credit quality are close substitutes for investors, there tends to be a close relationship between their prices and yields.

ltcm case study summary

Few companies, however, utilise the equity derivative markets to their advantage – to hedge certain corporate action events. Overall, the fiasco portrays a failure of the firm to implement a broad-based risk management strategy and to properly stress test its models.


Start Free Trial No credit card required. But, when Russia defaulted on some of its loans, share markets around the world went into a tailspin. Archived from the original PDF on The loan of some R million to HCI set a series of transactions in motion during August of to achieve these goals by 31 December Why did UBS lost so much money due to the failure of a hedge fund?

ltcm case study summary

The put was struck at R After the conversion Venfin owned A proper hedge for a short put is a short position in the underlying share — delta hedging is done by selling the underlying share. Payoff profile for a capped collar 4. They bought a put caes 51 Richemont shares from Merrill Lynch International.

Part of the income from the structure was used to pay HCI R million for a 1. Venfin had various options like taking a loan from a bank.

We will now explain how they were linked and what was achieved [4].

Being short a put is a very risky strategy. Conclusion Corporates can utilise equity etudy effectively and efficiently if they understand the risks involved. Adventures in a New World.