In referring to the collapse of the Long-Term Capital Management hedge fund in 1998, an article in the New York Times noted: Starting with just $5 billion in capital, the fund was able to get $125 billion in additional funds. Using that leverage, it took on trading positions with an estimated potential value of $1.25 trillion.
a. What is leverage? What information from this excerpt indicates that Long-Term Capital Management was highly leveraged?
b. What risks did Long-Term Capital Management’s high leverage pose to the firm? What risks did it pose to the financial system?