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When Genius Failed Case Solution

Compare the merits and limitations of a strategy mentioned in the book that was used by LTCM

LTCM has the strategy to generate profit from the arbitrage, which means earning profit without bearing any risk. The book talks about numerous ways to make the difference mean spread as profit while bearing no risk in the market. Furthermore, the strategy has merits that it could generate profit from the market by identifying the arbitrages opportunities in the market, while taking no risk in the market. Thu, the purchase of the bond with less demand in the market, and taking short position, while maintaining the long position, similarly the difference of prices would be profitable. However, long-term (LTCM) failed to realize that if the market turns against them, they would be less liquid to change their position in the market, meanwhile, the risk of losing capital would also increase in this case.

Is there anything that LTCM could have done in order to avoid their disastrous end?

For every dollar of the investment in the fund, long-term had borrowed twenty to thirty dollars to place the bets. Similarly, numerous loans to the long-term had been achieved by the signature loans. In simple words long-term had used large amount of leverage in the capital. On the other hand, the long-term has the low-liquidity in case if the market turns against them. Furthermore, they had not traded as in open market trades are carried, indeed they traded their own customized options. On the other hand, long-term had invested huge amount around more than half of their capital in the interest swaps, and equity volatility bets. However, during the disastrous end, long-term could not change their position due to its positions in illiquid markets.

How do you evaluate the course of actions taken by the regulator in trying to solve the crisis?

Regulatory authority has been trying to solve the crises by supporting the long-term, because, if the long-term had collapsed, then it would have negative impact on the market, and especially on the banks, which would have crashed the market as well as other investment banks and institutions that were counterparties to the long-term. However, McDonough, the president of the New York fed, has been in meeting with the Wall Street intuitions, for making arguments to save the long-term. Furthermore, on the various meetings, McDonough’s efforts worked, and they brought a bailout for the long-term to sustain its position in the market. It was anticipated that long-term would not only collapse, but also lead market into the financial distress.

After reading the book, what's your opinion on the current quantitative models used in finance?

Finance is all about what you think about the future, based on the past outcomes. However, in finance we have history, and based on the facts and figures that have affected the market in the past, a model can be applied to predict the future outcomes. On the other hand, the market reacts to the many changing variables, similarly it does not matter how good models are there, as no one will always win, and there would be conditions that would have positive, negative relationship with each other. However, today, we have various models that predict the future outcomes, based on some inputs that generate the outputs. However, as compared to the past, we have more knowledge, and information related to the key drivers of the market..............................

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