The Rise and Fall of LTCM Essay Example | Topics and Well Written Essays - 1000 words

The Rise and Fall of LTCM - Essay Example On the other hand, there are differences between hedge and mutual funds, whereby the hedge funds are managed more aggressively compared to the mutual funds, hence making it possible to take speculative positions in derivative securities like decisions to short sell stock. Moreover, this increases leverage and risk of the funds hence are making it possible for the funds to gain profits when the market is declining. On the other hand, mutual funds are not allowed to be involved in highly leveraged positions; hence, they are considered safer than the hedge funds. Main sources of LTCM initial success The main sources of success for LTCM were associated with a complex mathematical model that the company had established in order to benefit from fixed income arbitrage deals within the bonds of U.S.A, Japanese and European governments (Dunbar, 5). They applied the fundamental idea of the changes in the values of the long dated bonds issued a short time apart, which becomes similar. Neverthel ess, the bonds were approached at a different rate, and they were more traded bonds like the US Treasury bonds, whereby the long-term prices are approached more effectively, though they are less heavily traded and liquid. The other main of success factor was the financial transactions, which related to purchasing cheaper bonds, short selling them more expensive and liquid, hence generating profit from the difference in the value of the bonds. In fact, their capital grew, and they were willing to invest the capital somewhere; hence, they run out of outstanding bond-arbitrage bets leading to LTCM to apply strategies that were beyond their expertise (MacKenzie, 349). Nonetheless, their trading strategies were nonmarket directional, whereby they did not depend on the overall market interest rates or fluctuations of stock prices, since they had no convergence trades. Main reasons for LTCM collapse The success of the LTCM in the financial markets occurred within a short period, and this w as attributed to informational asymmetries by the fund managers, hence resulting to a downfall before the establishment of the East Asian financial crisis, in 1997. The downfall began with a reduction noted on the net returns in 1998 for the period between May that had 65% and June, 10.4%, resulting to a reduction of their capital by $461 million, in fact, when the Salomon Brothers withdrew from the arbitrage business in July 1998, the downfall was escalated. The losses were accentuated by crisis experienced in Russia during the month of August and September in 1998, when the bonds were defaulted in Russia by their government, leading to investors’ decision to sell European and Japanese bonds in order to purchase the treasury bonds in U.S.A due to their worries. Profits anticipated as the value of the bonds purchased in U.S.A resulted to losses due to convergence of bonds while their value diverged; consequently, the LTCM had incurred losses worth 1.85 billion dollars by the end of August. LTCM could no longer provide investors with annual returns of 40%; instead they were they went through a Flight–to-Liquidity, and in the beginning of September, their equity reduced from 2.3 billion dollars to 600 million dollars with no dwindling portfolio, and this resulted to a further increase in