Long-Term Capital Management

Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether. Meriwether was a well-known bond trader and the former vice chairman at Salomon Brothers. After leaving the firm in 1991 following its Treasury bond scandal, he assembled a group of LTCM principals who were both academics and noted traders. Two such academicians, Myron Scholes and Robert C. Merton, were top economic theorists. In 1997, Scholes and Merton received the Nobel Memorial Prize in Economics for their work in stock options. LTCM began trading after it had received minimum investments from 80 initial investors, approximately $1.3 billion of investor capital. The fund experienced unprecedented growth, with returns as high as 40%, until its demise in 1998.

LTCM used complex quantitative models to determine the timing and estimated return of domestic and foreign bond trades. Also called convergence trades, LTCM sought bonds that were not priced accurately relative to one another. Each transaction realized a very small profit, so LTCM significantly leveraged its trades to make a profit. It would conduct a series of financial transactions that purchased lower priced bonds with long positions while selling short the more expensive, liquid bonds. LTCM used this arbitrage technique to achieve aggressive rates of return.