Long-Term Capital Management (LTCM) was a U.S. hedge fund which used trading strategies combined with high leverage. Despite initial enormous profits, it failed spectacularly in 1998. What most likely led to this failure? Select all that apply.
Explanation
Uncontrolled use of high leverage and the Russian Financial crisis in 1998 are two reasons that led to the collapse of LTCM in 1998. The uncontrolled use of high leverage brought about huge returns to LTCM, which then allowed many banks to extend credit to LTCM at very low interest rates. However, the Russian debt crisis widened spreads between government debt and risky debt unexpectedly in almost all the LTCM trades. LTCM lost 90% of its value and experienced a severe liquidity crisis, which led to its financial collapse.
Key Takeaway: This case illustrates the prominent example of risk potential in the hedge fund industry. When LTMC faced liquidity crisis, it could not sell billions in illiquid assets at fair prices, nor could it find more capital to maintain its position until volatility decreased and interest rate credit spreads returned to normal
