Ltcm Case

LTCM Case Study – B35000

HOMEWORK INSTRUCTIONS

Please review the general instructions on assignments and information on review sessions. The file is available in the Assignments folder on Chalk and has also been emailed to all students in class.

This case study is due in the 3rd week of classes, before the start of your class.

Your answers should not exceed 5 pages (1.5 spacing), excluding graphs. In addition to the online submission on Chalk, you should make a print out of the solutions and hand them in at the beginning of class. Please do not forget to write the name of the members of you group.

In addition, please prepare a Powerpoint presentation of answers #1 and #7, #8, #9: I will ask one group to present in class.

Questions

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

The value proposition for LTCM is that for bonds with similar maturities, the spread between the two bonds would be immaterial, so investors would not have to pay a premium from one bond to another. For example, the price of a 30 year governmental bond versus a 29.5 year governmental bond (same government) should be nearly the same price – the difference was due to the liquidity of the bonds. So there would be an arbitrage available by buying the off-the-run cheaper bond, and shorting the on-the-run more expensive bond when a new bond was issued. The strategy of convergence was used in bonds, but then they used this idea of arbitrage and convergence in other areas where they could find it (fixed-rate mortgages, equities

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? How can it be used to increase leverage?

The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial...