Long Term Capital

An Analytical Paper

Presented to the Financial Management Department

De La Salle University-Manila

LONG TERM CAPITAL MANAGEMENT

In partial fulfilment

of the course requirements in

DERVFIN K32

Submitted to:

Ms. Kristine Lagdameo

Submitted by:

Casco, Jillian Jovel Marie

Lam, Jennifer Joy

Sze, Dana Alyssa

Tan, Alyanne Haye

Date:

November 25, 2015

I. Company Background/Information

Long-Term Capital Management, L.P. (LTCM) was a private investment firm founded by John Meriwether in 1994 (Shirreff, n.d.). Before the inception of LTCM, John Meriwether had just been cut from, Salomon Brothers, an investment bank, because of a fraudulent scandal. However, LTCM still gained reliability in hedge funds after Nobel Prize winners Robert Merton and Myron Scholes, and ex- Federal Reserve vice chairman David Mullins joined the company. LTCM required its investors to invest at least $10 million without withdrawals for 3 years (Edwards, 1999). The charges were based on annual amounts, with 2% of the assets and 25% of generated profits for that year (Siconolfi, 1998).

The main profitability of LTCM involved convergence trading and dynamic hedging (Bureau of Treasury, 1999). Convergence trading, or arbitrage hedge funds, seeks to take advantage of arbitrage opportunities through buying and selling underpriced and overpriced securities, respectively (Azad, n.d.). The primary risk involved in this type of trading is high leverage, which translates to investing a debt and bearing the risk of having an excessive loss on the money that is borrowed (Convergence Trading Hedge Funds, n.d.). LTCM, like other high leveraged firms, operated in a mostly speculative environment involving merely a few deals but with high profit margins (Balasubramaniam, 2006, U.S. Bureau of Treasury, 1999).

The other type of primary activity that LTCM utilized was dynamic hedging. Dynamic hedging seeks to lessen the risk associated with delta, the price...