How did John Meriwether get his start with the investment firm Salomon Brothers? What role did Meriwether play in forming LTCM?<\/p>\n\n\n\n
In When Genius Failed<\/em>, Roger Lowenstein writes that hedge fund manager and arbitrage expert John Meriwether was pivotal in the conception and formation of LTCM. He formed the arbitrage group at the investment firm Salomon Brothers, where he had previously worked.<\/p>\n\n\n\n Let’s look at the rise of John Meriwether, Salomon Brothers’ hand in LTCM’s creation, and how they set the stage for LTCM’s rise and fall.<\/p>\n\n\n\n\n\n\n\n Lowenstein writes that, at Salomon Brothers, John Meriwether began his journey by learning the intricate art of arbitrage, a strategy that would become the linchpin of his success<\/strong>. Meriwether\u2019s arbitrage strategy<\/a> at Salomon Brothers enabled him to exploit price discrepancies, turning them into substantial profits. <\/p>\n\n\n\n At its core, notes Lowenstein, Meriwether’s strategy was rooted in the concept of convergence.<\/strong> He believed that differences in price between nearly identical financial securities would eventually equalize. By structuring his trades to bet on these convergences, he consistently emerged richer at Salomon Brothers, far more often than he faced losses.<\/p>\n\n\n\n Since it\u2019s such a key concept to understanding the book, let\u2019s take some time to illustrate arbitrage with an example. <\/p>\n\n\n\n Suppose Company A is listed on both the New York Stock Exchange (NYSE) and the London Stock Exchange (LSE). On the NYSE, Company A’s stock is trading at $100 per share. On the LSE, Company A’s stock is trading at \u00a380 per share. Assume the exchange rate between the US Dollar (USD) and the British Pound (GBP) is 1 USD = 0.75 GBP. Given this exchange rate, Company A’s stock should <\/em>theoretically be trading at approximately \u00a3133.33 on the LSE to be equivalent to its $100 price on the NYSE. Instead, an arbitrage opportunity exists because it\u2019s underpriced on the LSE.<\/p>\n\n\n\n To execute the arbitrage trade, a trader buys <\/em>Company A’s stock on the LSE for \u00a380. She simultaneously sells <\/em>an equivalent number of Company A’s shares on the NYSE for $100 each. So she buys 1,000 shares on the LSE for \u00a380,000 (1,000 shares x \u00a380\/share). At the same time, she sells 1,000 shares on the NYSE for $100,000 (1,000 shares x $100\/share).<\/p>\n\n\n\nMeriwether’s Career at Salomon Brothers<\/strong><\/h2>\n\n\n\n
Example: Arbitrage Strategy Across Two Stock Exchanges<\/h3>\n\n\n\n