Case Questions for Ltcm

Case Questions for LTCM

1. Suppose the yield on a two-year Treasury note was 4%, and the yield on a five-year Treasury note was 6%. IF you expected this yield spread to widen, explain the spread trade you would execute.

a. After a year, suppose the yield on a two-year Treasury note fell to 3.5%, and the yield on a five-year note rose to 6.5%. Would you profit or lose on your trade? Explain

2. Yield spreads

a. Describe the climate of U.S. yield spreads in 1998

At the time of the Asian currency crises in late 1997 and the Russian

Crisis as well as the LTCM crisis in late 1998, drastic changes in risk preferences were observed. On these occasions, government bond yields were considerably lower than other bond yields, and the yield spread fluctuated in a highly volatile way.

b. Describe the Asian Tiger Crisis of 1997 and its impact on LTCM

Some southeast Asian countries had an unofficial fixed exchange rate on the US dollar. The appreciation of the US dollar that began in 1995, in particular against the Japanese yen, caused the South East Asian currencies to also appreciate against third-party currencies. This resulted in lost competitiveness in export markets and worsening current account deficits. Many countries

found it increasingly difficult to fund their current account deficits and it led to a domino effect of currency crisis. This crisis dropped the Dow 7.2% in 1997. The LTCM managers hedged effectively against this crisis and their investors still reached a 17.1% return that year. This was less than half of the return they got in the prior year.

c. Describe the Russian default and its impact on LTCM

Shortly after the Asian currency crisis, Russia declared it was