Finance Ministry Notifies Changes In Exim Policy

The collapse of Long-Term Capital Management, the US hedge fund, was one of those crises that come from nowhere to shake the financial system.

One can view the sega from a number of angles: as a tale of Wall Street's finest meeting their nemesis at the hands of the markets: a case study in the dangers of hedge funds (and derivatives); or simply the latest chapter in a long history of speculative crises.

Inventing Money seizes on the involvement of two Nobel prize winners, Robert Merton and Myron Scholes, to trace the intellectual and financial market developments that led to the collapse.

This is background filling with a vengeance; LTCM does not even start trading until the book is two-thirds over. But it does transform the typical over-detailed, hour-by-hour account of corporate collapse into a primer for those interested in the world of financial theory.

Forty years ago, the world of finance was much simpler: currencies were fixed against each other (and ultimately gold) under the Bretton Woods system. The down-fall of the Bretton Woods system, the inflationary turmoil of the 70s and the liberalisation of financial markets changed all that. Risk was everywhere and the smart commodity traders in Chicago spotted an opportunity, they duly intorduced exchange-traded futures and options. A family of derivative instruments grew from this base.

In the world of derivatives, the standard traders' approach to pricing - stick a finger in the wind to see how market sentiment is moving - was no longer appropriate. The value of these instruments was literally "derived" from something else. Black and Scholes came up with their formula for pricing options, that helped the latter get a Nobel prize. As the instruments grew more sophisticated, WallStreet called in a battalion of PhDs, dubbed rocket scientists, to do the maths.

Pricing anomalies did occur. With the right brains and enough capital, it would be possible to make almost risk-free profits by arbitrage; buying the underpriced security and selling short the overpriced one until the anomaly disappared. That was the theory. John Meriwether, LTCM's founder, had made a great success fo the approach at Salomon Bothers, the investment bank. When he set up on his own, a hedge fund was the ideal v