Ltcm Questions

Questions

1. Describe LTCM value proposition; how the firm is financed; how they manage their leverage.

2. Give a definition of “Arbitrage” and explain the importance of the repo market for arbitrageurs. How repo contract can be used for shorting a security? Describe in detail the main characteristics of a Repo contract. How can it be used to (i) Short-sell; (ii) to increase leverage?

3. What do you think was the main cause of what happened at LTCM?

4. On September 2, 1998 John Meriwether sends a letter (see section D of the case) asking for additional capital from the investors. EX-ANTE, what would you have done?

5. Use any data can you can find to address the following questions (you have no limitations). An excellent source of data is provided by the Federal Reserve Bank of St Louis at http://research.stlouisfed.org/fred2/, but you are not limited (if you so wish) to use this source.

Alternatively, start from the Excel data file that I have uploaded in the folder: there you will have enough data to start your analysis. Then, answers the following:

a) Calculate the spread between the 10 year swap fixed rate and the 10 year treasury government bond. Is this spread, Δ1(t), mostly positive or negative for the periods t=[01/01/1990,12/31/2010]? Why? Do you expect the difference to be positive or negative, on average? Why?

b) What has been the spread on Jan 28th 1997? Based on the empirical evidence in the three years preceding this date, what is an “extreme” value (extremely high or low) of the spread?

c) Repeat the previous question but now assume to be on Jan 28th 2010, thus including data from 2008 Crisis.

d) Find a period in which the spread has consistently been above 70 basis points. What happened during that period? Provide and discuss some examples.

7. Now consider the spreads between the Interbank Libor rate and the Repo rate, Δ2(t), and the spread between the Interbank Libor rate and the Swap rate (also called the...