Long-Term Capital Management - LTCM


DEFINITION of 'Long-Term Capital Management - LTCM'

A large hedge fund led by Nobel Prize-winning economists and renowned Wall Street traders that nearly collapsed the global financial system in 1998 as a result of high-risk arbitrage trading strategies.

The fund formed in 1993 and was founded by renowned Salomon Brothers bond trader John Meriwether.

BREAKING DOWN 'Long-Term Capital Management - LTCM'

LTCM started with just over $1 billion in initial assets and focused on bond trading. The trading strategy of the fund was to make convergence trades, which involve taking advantage of arbitrage between securities that are incorrectly priced relative to each other. Due to the small spread in arbitrage opportunities, the fund had to leverage itself highly to make money. At its height in 1998, the fund had $5 billion in assets, controlled over $100 billion and had positions whose total worth was over a $1 trillion.

Due to its highly leveraged nature and a financial crisis in Russia (i.e. the default of government bonds) which led to a flight to quality, the fund sustained massive losses and was in danger of defaulting on its loans. This made it difficult for the fund to cut its losses in its positions. The fund held huge positions in the market, totaling roughly 5% of the total global fixed-income market. LTCM had borrowed massive amounts of money to finance its leveraged trades. Had LTCM gone into default, it would have triggered a global financial crisis, caused by the massive write-offs its creditors would have had to make. In September 1998, the fund, which continued to sustain losses, was bailed out with the help of the Federal Reserve and its creditors and taken over. A systematic meltdown of the market was thus prevented.

  1. Hedge Fund

    An aggressively managed portfolio of investments that uses leveraged, ...
  2. Systematic Risk

    The risk inherent to the entire market or entire market segment. ...
  3. Arbitrage

    The simultaneous purchase and sale of an asset in order to profit ...
  4. Leverage

    1. The use of various financial instruments or borrowed capital, ...
  5. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic ...
  6. Flight To Quality

    The action of investors moving their capital away from riskier ...
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