Case 8 Question

1. Given the economic and political turmoil that took place in 1998, what bet would have earned John Meriwether and his team of arbitragers the highest profits?

2. Suppose the yield on a two-year Treasury note was 4%, and the yield on a five-year Treasury note was 6%. If you expected this yield spread to widen, explain the spread trade you would execute.

a. After a year, suppose the yield on a two-year Treasury note fell to 2%, and the yield on a five-year Treasury note fell to 5%. Would you profit or lose on your trade? Explain.

b. After a year, suppose the yield on a two-year Treasury note rose to 6%, and the yield on a five-year Treasury note rose to 7%. Would you profit or lose on your trade? Explain.

3. Using the information for Exhibit 8.8, calculate the return on assets and the return on equity if LTCM had earned only a 1% net return (instead of a 5% net return) on the investment assets purchased with borrowed funds.

4. Why did LTCM have difficulty raising its level of risk?

5. Why was long-term funding crucial to LTCM’s strategy?

6. “LTCM made basically one bet that it duplicated around the world.” Explain what this statement means.

7. Explain the causes of the Asian Tiger crisis and how it affected LTCM.

8. Explain the Russian ruble crisis and how it affected LTCM.

9. What role did the Federal Reserve play in the LTCM bailout? Why was the Fed involved?