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When Genius Failed

In: Business and Management

Submitted By ruiyu10
Words 378
Pages 2
When Genius Failed, written by Roger Lowenstein, depicts a grappling tragic story of Long-Term Capital Management, a hedge fund setup by John Meriwether, assembling with brilliant market traders and academics as partners including two Nobel Memorial Prize winners. They initially procured incredible profit by successfully chased arbitrage opportunities, but ultimately fall to the ground due to their inaccurately judgment of market’s movement and overly manipulate of leverage, which lead to its marvelous rate of return of more than 40 percent per year in four years quickly ended by losing 4.5 billions in as short as five weeks. By analyzing and providing convincing arguments toward Long-Term Capital Management’s failure, Roger contributed to offer those greedy market traders a wake-up call and a lesson that merits attention.
On no account can we ignore the risk aroused by taking advantage of leverage. However, this is precisely one of the most significant reasons that broke Long-Term Capital Management down. As Roger mentioned, at the time they got involved into the trade of home mortgage securities, when the model indicated that “ the IO price seemed so out of whack”, they “once again” made use of a vast leverage by investing 2 billions into the trade, which is highly risky. If a person challenged this by pointing out that this group of smallest people expertise in bond trade, how would people explain the action of them by stepping in equity volatility trade and still trying to get profit by constantly increasing leverage. By the spring of 1996, Long-Term Capital Management got incredible 140 billions in asset, which was thirsty times of underlying capital. Leverage is able to bring the company huge profit, whereas, at the same time, it greatly increase the exposure of assets and put those assets into risk. When liquidity dries up in financial market, the massive leverage could cause catastrophic. Just as Seth Klarman doubted that “ how could investors be so certain that markets would always be liquid”? However, apparently, Larry Hilibrand and Victor Haghani did not take this factor into consideration. Partners’ philosophy was based on that markets were gradually getting more steadily, more liquid and more continuous, which also were the assumption behind Black-Scholes Model, their basic theory of trading strategy.…...

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