Explain the causes of the Asian Tiger Crisis and how it affected LTCM

Question

What will be an ideal response?

Answer 1

The Asian Tiger Crisis started in Thailand in 1997 and spread to other East Asian countries, such as the Philippines, Malaysia, South Korea, Indonesia, and Hong Kong. The source of the 1997 problem was the Asian countries had long pegged their currencies to the U.S. dollar, but their exchange rates had become unsustainably overvalued. Speculators, sensing that devaluations were imminent, sold the Asian Tiger currencies and bought safer currencies like the U.S. dollar. The central banks of these Asian nations supported their fixed exchange rates by selling foreign currencies (i.e., purchasing their own currencies) until they ran out of international reserves. The reduction in domestic money supplies caused by central bank intervention and the increased investment risk resulted in sharp increases in Asian Tiger interest rates.
The Asian Tiger crisis hurt LTCM because the company invested in these nations' fixed income securities, expecting their interest rates to fall and the value of their currencies to
be maintained by the central banks. When interest rates rose and the bottom fell out from under their exchange rates, LTCM's losses mounted.