The biggest hedge fund that was led by John Meriwether who was the Nobel Prize winner was ‘Long-Term Capital Management’ or LTCM in short. The entire global financial system almost crumbled because of the trading strategy that is arbitrage which is a high-risk one was introduced by LTCM.
About John Meriwether
John Meriwether was one of the Salomon Brothers and also was an economist. He has also won a Nobel Prize for his work that created a boom in the financial market in the year 1998 by introducing LTCM. The LTCM was found in the year 1993 by him.
Long-term Capital Management in Depth
The focus of LTCM was trading on bonds and in its initial stage, LTCM began with assets worth just $1 billion. The trading strategies of this hedge fund were making a trading that was of convergence type and when we say convergence trading it means that the trading was done in order to take the advantages of arbitrage between the two securities. The securities involved in this type of trading are mostly not correctly priced and relatively similar to each other during trading.
An example that we can consider is that when the rate of interest changes they do not reflect appropriately on the price of the securities. When the price does not reflect adequately the traders will have a lucky chance of trading this type of securities that are at this value as it is different compared to what value it will soon have when the new rates reflect on them. The other things that LTCM dealt with were interest rate swaps. This includes exchanging a serial set of interest payments that will be done in future with another and this depends on the specific principle that is agreed upon between both counterparties. Most common interest rate swaps take place between the change that takes place at a fixed rate and the floating rate or the other way around. This will reduce exposing to any fluctuation in the interest rate that is generally available.
The leverage offered by the LTCM itself is very high since it is not widespread in arbitrage opportunity hence they make money on assets. Long-term Capital Management had roughly $5 million which controls over $100 billion and totally worth $1 trillion on the positions. During this time LTCM also took the amount that was exceeding above $120 billion in financial instruments.