Explanation:
Statement D is incorrect because moral hazard played a significant role. Lenders and counterparties were overly willing to extend massive leverage to LTCM with minimal collateral, haircuts, or disclosure. They relaxed their normal risk management standards because they assumed LTCM's management (which included Nobel laureates) was infallible, effectively relying on reputation rather than sound counterparty risk measures.
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Q.92 The failure of Long Term Capital Management almost brought the financial markets to a standstill and has since become a marker buoy to show just how far certain risk management safeguards can go to alleviate the risk of failure. Which of the following statements about LTCM’s failure is incorrect?
A
LTCM relied too much on theoretical market risk models and too little on stress testing, gap risk, and liquidity risk.
B
LTCM scantily disclosed its positions and exposures, and counterparties had few ways to find out LTCM’s exposure to other counterparties.
C
In most of its repo and swap transactions’ LTCM did not pay an initial margin as would other non-bank counterparties.
D
There was no moral hazard at play in the run-up to LTCM’s failure.
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