(Z) Regarding the Long-Term Capital Management (LTCM) incident, the so-called "financial engineering" was originally intended to effectively manage the risks of the portfolio, but now it has become the use of finance, mathematics, physics and other knowledge to handle the decomposition and synthesis of financial products.

This technique is the basis for insight into the internal risks of financial products, so portfolio risk management techniques should be an effective tool for sophisticated investment professionals.

Financial engineers can handle technical work, but many investment experts handle artistic work.

Can art and technology be perfectly combined?

It does not depend on some simple dialectical rules. Technology can be beautiful, and art can also be beautiful, but success still requires some "luck."

The story of Long-Term Capital Management in 1998 echoes an old Chinese saying: "How can you avoid getting your shoes wet if you often walk by the water?"

1. Background of Long-Term Capital Management In February 1994, John Meriwether founded the macro quantitative fund Long-Term Capital Management. The core figures at that time included: David W. Mullins (former deputy director of the Federal Reserve), Myron Scholes (1997)

Noble Economic Prize winner), Merton Miller (Noble Economic Prize winner in 1990).

At that time, the main investors of Long-term Capital Management were UBS and Merry Lynch, Europe's largest banks. When it was established, its total assets were US$1.3 billion and its investment period was no less than 3 years. That is to say,

Customers cannot redeem within three years.

The investment returns from 1994 to 1997 were: 1994 1995 1996 1997 19.9% ??42.8% 40.8% 17.1% By the end of 1997, the asset appreciation was US$7.5 billion. In December 1997, customers redeemed 27

At the end of 1997, Long-term Capital Management's actual assets under management were US$4.8 billion.

two.

Long-Term Capital Management’s Investment Strategy 1.

Fund amplification (high financial leverage) Investors always hope to use the least amount of funds to generate maximum investment returns. Therefore, for investment varieties in the interest rate market, using high financial leverage tactics is a means to achieve the above purpose.

Due to the asset manager's brand reputation and outstanding performance in previous years, LTCM has received the highest level of loan concessions from various banking institutions, and often provides 100% of the financing limit for the collateral it proposes.

That is to say, the assets acquired by LTCM in the financial product market can be 100% refinanced. This means that theoretically, the amplification factor of LTCM can be infinite, or its financing amount is almost infinite.

Therefore, although LTCM's total assets are less than US$5 billion, it has borrowed nearly US$125 billion from banks and securities firms, and the ratio of liabilities to assets is as high as more than 20 times. Finally, LTCM's financial leverage ratio is even as high as 26 times.

2.

Investment varieties and relative value arbitrage strategies LTCM uses the huge funds obtained through the above financing methods to mainly conduct risk-neutral arbitrage strategies (market neutral arbitrage) in the interest-rate swap market, that is, to buy undervalued securities.

Short selling of overvalued securities.

First, let’s take a look at the characteristics of the interest rate swap market and the arbitrage strategies in this market. Suppose a company now wants to issue a long-term floating rate bond. Since interest rates are now at a low stage, if it is expected that market interest rates may rise in the future,

The interest paid by the company will increase in the future. Obviously, the company's interest costs will increase in the future. How does the company avoid its interest rate risk?

If the company purchases an interest rate swap contract (an interest rate derivative) when issuing bonds, it can switch to paying fixed-rate interest (without having to worry about the risk of interest rate increases).

(1) Interest rate swap agreement Continuing with the above example, the company transfers the risk of rising interest rates through an interest rate swap agreement. The agreement swaps floating interest rates for fixed interest rates. This standard interest rate swap agreement is an agreement.

One party is the "fixed interest payer" and the other party is the "floating interest payer". When the two parties agree on interest, the interest payment date and the nominal principal are both agreed upon. In particular, the two parties only exchange interest and not principal.

Figure 1 below shows the cash flows of both parties to the contract. The solid line in the figure represents fixed interest payments, the dotted line represents floating interest payments, the upward arrow represents cash inflow, and the downward arrow represents cash outflow.

Figure 1: Typical cash flows of both parties (2) Risk-neutral arbitrage strategy Any of the above characteristics of the standard swap agreement can be changed, thereby creating a non-standard swap agreement.