Answer-first summary for fast verification
Answer: LTCM failed to account properly for the illiquidity of its largest positions in its risk calculations.
The correct answer is D. LTCM failed to account properly for the illiquidity of its largest positions in its risk calculations. A major contributing factor to the collapse of LTCM was its inadequate consideration of the liquidity risk associated with its largest positions. LTCM relied on valuation reports from dealers who were only aware of a small portion of LTCM's total position in specific securities, leading to an underestimation of the true liquidity risk. When the Russian debt crisis unfolded in August 1998 and another firm decided to liquidate large positions similar to LTCM's, the illiquidity of LTCM's positions forced the firm into a precarious situation. LTCM was reluctant to sell due to the potential for exacerbating the adverse market impact, even as its equity was rapidly deteriorating. To prevent a complete collapse, LTCM's creditors intervened, providing an additional USD 3.65 billion in liquidity to allow the firm to maintain its positions through the turbulent market conditions of the fall of 1998. However, this intervention resulted in investors and managers at LTCM, excluding the creditors, losing nearly all of their investment in the fund.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
No comments yet.
In the context of the collapse of Long-Term Capital Management (LTCM), which statement best illustrates the firm's approach to risk management?
A
LTCM had no active risk reporting.
B
LTCM's stress testing became a risk management department exercise that had little influence on the firm's strategy.
C
LTCM's use of high leverage is evidence of poor risk management.
D
LTCM failed to account properly for the illiquidity of its largest positions in its risk calculations.