Long Term Capital Management

Problem Statement

The Long Term Capital Management hedge fund lost $5 billion between April and October of 1998 resulting in a bailout by several larger investment banks to liquidate the company.

Introduction to Long Term Capital Management

Long Term Capital Management (LTCM) was a hedge fund created by John Meriwether in the early 1990’s. At its peak the fund had $100 billion in assets with fewer than 200 employees including 16 partners. Its strategy consisted of using detailed market history to evaluate opportunities in bond markets. Through quantitative and algorithmic analysis a group of PhD’s and Nobel Prize Winners developed computer programs that would communicate when a profitable opportunity would arise in bond markets.

The fund used an investment strategy called arbitrage that took advantage of price differences in two or more separate markets. These price differences were very small but using the huge sums of cash the fund had in assets it was able to make very large bets since it was using mostly borrowed money. The funds leverage ratio was 20 to 30 times that of their equity. But with risk comes high reward. The fund was able to make unimaginable amounts of money and netted John Meriwether, LTCM founder, $500 million before the collapse.

LTCM was quite clever in the way it acquired its vast sum of leveraged assets. First, by declaring itself a hedge fund and utilizing a limited partnership with a small number of extremely wealthy investors, they were exempt from SEC laws. Second, since this fund was successful in its infancy it had Wall Street banks eating from their hands. This allowed them to demand low trading fees and place each side of their arbitrage trades with different banks. This meant that no one bank would have enough information to truly know how leveraged the fund actually was.

For the purpose of this case study, our team will be directing its focus on the organizational design, decision making...