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To: robnhood who wrote (8355)	10/9/1998 9:49:00 PM
From: Joseph G.	Read Replies (2) \| Respond to of 86076

<<CHICAGO, Oct. 9 (Reuters) - A former Soros Fund managing director said on Friday that the troubled hedge fund Long-Term Capital Management (LTCM) hurt the United States by raising doubts about the country's financial market system. ''(LTCM founder) John Meriwether did the United States a real disservice,'' Robert Johnson told a conference on the Asia crisis organized by the Federal Reserve Bank of Chicago. "The scale (of the damage) to the U.S. and U.S.-type system is very, very large. ''The United States is becoming quite isolated...Other countries...are not quite in love with markets as we are.'' Johnson expressed surprise that Meriwether remained at LTCM after his firm was rescued on September 23 by 14 financial institutions with an oversight committee to run the hedge fund. ''(Investor) Warren Buffett would have fired him,'' Johnson said, referring to Buffett's offer this summer to buy LTCM. Johnson also forecast a marked U.S. economic slowdown in 1999, as well as a deepening of the recession in Japan, in part due to the financial turmoil now affecting many countries. >>

To: robnhood who wrote (8355)	10/12/1998 12:25:00 PM
From: Joseph G.	Read Replies (1) \| Respond to of 86076

<<LONDON, Oct 12 (Reuters) - Billions of dollars have been lost in the most tumultuous weeks in recent history because financial markets refuse to conform with the old adage that history repeats itself. Financial analysts say billions more may be at risk because computerised trading models, so-called black boxes, used by investors fail to take into account the impact of chaos in world markets. A recent high-profile casualty of the belief that history repeats itself is Long-Term Capital Management (LTCM), a hedge fund which used statistical laws that have either permanently or temporarily become defunct, analysts say. The U.S.-based fund said last month it had suffered losses of $4 billion because of market volatility. Since then, markets have been gripped by concern that more funds may face huge losses because their black boxes have misguided them. LAW OF AVERAGES Although the precise methodology used in black-box trading is still under debate, analysts pinpoint at least one strategy which has definitely gone wrong -- the law of averages. A principle behind some of these models is that yield differentials between government and corporate bond markets revert over time to their historical averages. "If there is deviation from the average, the smart thing would be to assume that deviation is going to be ironed out. Buy the security that looks cheap, sell the one that looks dear," said Stephen Lewis, chief economist at Monument Derivatives. Specifically, a favourite trade has been to sell U.S. government bonds and buy bonds issued by U.S. companies on the basis that the yield difference -- or spread -- between the two will converge towards an historic average. "Some models are more vicious. The further they are from the average, the bigger the bet they recommend," said Lewis. In recent months these spreads have refused to narrow, widening progressively as investors worried about global financial turmoil rushed for cover in domestic government bond markets and out of increasingly risky corporate debt. "These models could not price in the global crisis or credit risk as in the probability of a company being unable to meet its contractual monetary obligations," said Claudio Piron, treasury economist at Standard Chartered Bank. "They apparently didn't take into account the fact that the crisis could contaminate the local U.S. financial market." Piron said the yield difference between 10-year U.S. sovereign and corporate bonds was around 2.157 percent on September 30, nearly double the 1.172 percent on July 1. "Last September it was around 1.05 percent. For around two years before July the norm was about 1.09 percent. But I think LTCM kept betting on the spread narrowing," Piron said. LEVERAGING To further compound the problem, some trades were then leveraged to magnify potential gains or in some cases losses. Leveraging or gearing can be achieved in one of two ways. The first is to leave a deposit or collateral with a bank which in return will extend credit facilities based on a multiple estimated to range between 10 and 20 for hedge funds. For example, a deposit of $10 million on a multiple of 10 would allow a hedge fund to take a $100 million bet. If that $100 million lost value to $95 million the bank can offset that loss against the deposit -- this is known as margin trading. The other way to leverage would be via options -- the right to buy or sell a specific financial instrument or commodity at a set price and time in the future at a cost known as the premium. So, for example, $10 million could be used to buy the option which in turn allows the holder to sell a much larger amount of the government to corporate bond yield spread at, say, 2.2 percent in three months' time. If all goes well and the spread narrows to 1.1 percent, the holder of the option has gained 1.1 percent. But if the spread widens to 3.3 percent, the holder loses the $10 million premium. VOLATILITY Michael Metcalfe, currency strategist at Natwest Global Markets, believes that one of the variables -- volatility -- which contributes to the value of an option is no longer functioning as it should. "Recent moves of some financial instruments have fallen out of the range estimated by volatility given a worst case scenario," Metcalfe said. As defined in option trading models, volatility will estimate a range or a band within which 95 percent of all possible outcomes -- or prices in the case of financial commodities -- would be expected to fall. The debate in the case of volatility centres around the variation of a price around an average. Has the average been displaced to some significantly higher or lower level or is the price action throwing out temporary aberrations? David Smith, UK analyst at Williams de Broe, said the unforeseen effect of emerging market turmoil has had an impact in terms of a statistical shock which has "But the other thing is that with short-term views you miss the big picture and that's what they've done. They worked on a very short time frame," he said. In the longer term, maybe over a period of years, yield spreads between government and corporate bonds in the United States could gravitate back towards the average, analysts say. HISTORY AND EFFICIENT MARKETS For some, the argument goes back to the 1960s when switching between gilts -- British government bonds -- with different coupons and maturities to pick up extra yield was popular. "This sort of trade did not apparently increase risk. It worked on the basis that market inefficiencies created price anomalies which could be taken advantage of," Smith said. More recently, over the past 10 to 15 years, financial deregulation and floating exchange rates have increased opportunities and allowed many to take views on the future price movements of financial instruments. "This sort of trade takes an implicit view about the future of a yield curve, for example on the basis of changes in inflation, interest rates or other factors," Smith said. >>