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Fed liquidating hedge fund

With the help of Merrill Lynch, LTCM secured hundreds of millions of dollars from business owners, celebrities and even private university endowments and later the Italian central bank.

The earnings for partners in a hedge fund was taxed at the higher rate applying to income, and LTCM applied its financial engineering expertise to legally transform income into capital gains.

It did so by engaging in a transaction with UBS (Union Bank of Switzerland) that would defer foreign interest income for seven years, thereby being able to earn the more favourable capital gains treatment.

In order to maintain their portfolio, LTCM was therefore dependent on the willingness of its counterparties in the government bond (repo) market to continue to finance their portfolio.

If the company was unable to extend its financing agreements, then it would be forced to sell the securities it owned and to buy back the securities it was short at market prices, regardless of whether these were favourable from a valuation perspective.

P., collapsed in the late 1990s, leading to an agreement on September 23, 1998, among 16 financial institutions—which included Bankers Trust, Barclays, Bear Stearns, Chase Manhattan Bank, Credit Agricole, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, JP Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Paribas, Salomon Smith Barney, Societe Generale, and UBS—for a $3.6 billion recapitalization (bailout) under the supervision of the Federal Reserve. Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers.

Members of LTCM's board of directors included Myron S. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives".

The core investment strategy of the company was then known as involving convergence trading: using quantitative models to exploit deviations from fair value in the relationships between liquid securities across nations and asset classes.

In fixed income the company was involved in US Treasuries, Japanese Government Bonds, UK Gilts, Italian BTPs, and Latin American debt, although their activities were not confined to these markets or to government bonds.

At the beginning of 1998, the firm had equity of .72 billion and had borrowed over 4.5 billion with assets of around 9 billion, for a debt-to-equity ratio of over 25 to 1.

It had off-balance sheet derivative positions with a notional value of approximately

Members of LTCM's board of directors included Myron S. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives".

The core investment strategy of the company was then known as involving convergence trading: using quantitative models to exploit deviations from fair value in the relationships between liquid securities across nations and asset classes.

In fixed income the company was involved in US Treasuries, Japanese Government Bonds, UK Gilts, Italian BTPs, and Latin American debt, although their activities were not confined to these markets or to government bonds.

At the beginning of 1998, the firm had equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion, for a debt-to-equity ratio of over 25 to 1.

It had off-balance sheet derivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps.

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Members of LTCM's board of directors included Myron S. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives".The core investment strategy of the company was then known as involving convergence trading: using quantitative models to exploit deviations from fair value in the relationships between liquid securities across nations and asset classes.In fixed income the company was involved in US Treasuries, Japanese Government Bonds, UK Gilts, Italian BTPs, and Latin American debt, although their activities were not confined to these markets or to government bonds.At the beginning of 1998, the firm had equity of $4.72 billion and had borrowed over $124.5 billion with assets of around $129 billion, for a debt-to-equity ratio of over 25 to 1.It had off-balance sheet derivative positions with a notional value of approximately $1.25 trillion, most of which were in interest rate derivatives such as interest rate swaps.Whereas it is possible to construct a single set of valuation curves for derivative instruments based on LIBOR-type fixings, it is not possible to do so for government bond securities because every bond has slightly different characteristics.It is therefore necessary to construct a theoretical model of what the relationships between different but closely related fixed income securities should be.Fixed income securities pay a set of coupons at specified dates in the future, and make a defined redemption payment at maturity.Since bonds of similar maturities and the same credit quality are close substitutes for investors, there tends to be a close relationship between their prices (and yields).As a consequence, it tends to trade more expensively than less liquid older bonds, but this expensiveness (or richness) tends to have a limited duration, because after a certain time there will be a new benchmark, and trading will shift to this security newly issued by the Treasury.One core trade in the LTCM strategies was to purchase the old benchmark – now a 29.75-year bond, and which no longer had a significant premium – and to sell short the newly issued benchmark 30-year, which traded at a premium.

.25 trillion, most of which were in interest rate derivatives such as interest rate swaps.

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