Question

Research the failure of the so called hedge fund, Long Term Capital

Management. . Was LTCM a hedge fund? Why or why not? What was the problem with

their hedging strategy? Does hedging really reduce risk to large extent ? Why or why not?

Answer 1

LTCM was a large hedge fund. The strategy involved involve taking advantage of arbitrage between securities. These securities are priced wrongly at the time of the trade.

LTCM also dealt in interest rate swaps. Often interest rate swaps consist of changing a fixed rate for a floating rate or otherwise in order to minimize exposure to general interest rate fluctuations.Due to the small spread in arbitrage opportunities, LTCM had to leverage itself highly to make money.
High leverage, along with financial crisis in Russia (i.e. the default of government bonds), resulted in massive losses and was in danger of defaulting on its own loans. This made it difficult for LTCM to reduce its losses in its positions taken.