The Rise and Fall of Long-Term Capital Management by Roger Lowenstein

Finance Book Report: Summary and Critical Analysis
Name
Institutional Affiliation
Finance Book Report: Summary and Critical Analysis
Introduction
Financial books are interesting pieces because they are eye-openers to the actual realities of the financial world. Authors are keener to analyze financial information and present genuine information in this course. They are much aware that the free market rewards quality products and neglects the less insightful. In the same line of thought, When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein and Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar are two books that aim to offer the reader an overview of how the financial world operates. The two books focus on nature and the degree to which financial decisions affect the firm. In the first book, When Genius Failed: The Rise and Fall of Long-Term Capital Management, the authors highlight the effect of an individual firm’s financial decisions on the entire industry. In the second, Barbarians at the Gate: The Fall of RJR Nabisco concentrates on the greediness of corporate bosses and their role in the decline of the firm to extreme levels.
Summary
When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein
Lowenstein begins his book addressing the quiet environment around the Federal Reserve Bank of New York, which is in the heart of Wall Street. Usually, the place is overwhelmed with traders, brokers, and investment bankers who are anxiously on the rush to close the next deal. The source of this rather quiet moment is the fall of Long-Term Capital Management (LTCM). LTCM is a hedge fund with its headquarters in Greenwich, Connecticut. The firm comprises hotshot bond traders, a former central banker, and exceptional financial academics including Nobel Prize winners. LTCM manages funds for only one hundred investors. The intriguing thing about the firm is that within five years, it had risen to prominence and still, exited the market in the most embarrassing way possible.
Credit where it is due because within this period they turned a billion dollars into 4.5 billion dollars. It is devastating to note that the firm lost all this value in a few months and more importantly, the situation almost carried the entire financial sector with it. LCTM never took into account their leverage ratio, which at some point was at 30:1 and grew even larger, the moment the firm began to collapse. This fact is highlighted in the fact that they only had 4 billion in an equity fund, but were controlling about 120 billion dollars (Lowenstein, 2000). They were over-reliant on mathematical models and failed to notice the more complicated derivatives. The Black-Scholes mathematical model was used for pricing options. This model was developed by Scholes who worked at the firm. Although the model relied on the efficiency of the market, there were concerns about how the firm colluded with high-ranking bankers to influence these deals and alter the foresaid efficiency. However, its collapse was unforeseen. The firm’s lifespan comprised of two black swan events and could have used the first one to learn a very crucial lesson. The first was fav...