Alternative Investments Flashcards
Backwardation
Downward sloping curve.
Todays spot price > future price.
Bearish indicator.
Expected future spot price is lower than current spot price.
Positive calander spread, convience yield doesn’t limit slope of the curve.
Positive Roll Yield and Positive Calander Spread
Contango
Bullish indicator
Current spot prices < Future spot price.
Expected future price is higher
There is a limit to the slope of the curve due to arbitrage limit.
Negative Calander spread and negative roll yield.
Trading Strategy for Backwardation
Strategy 1: Buy short dated contract, Sell long dated contract.
Strategy 2: Buy long dated contracts.
Trading Strategy for Contango
Strategy 1: Buy Long dated contract, Sell Short dated contract.
Strategy 2: Buy short dated contracts.
Insurance Theory (Keynes)
Theory of normal backwardation
Producers will use commodity futures for insurance by locking in prices. Thereby having more predictible revenue.
This selling forward pushed down prices in the future.
Prices would have to be lower in the future to induce a buyer to take a price risk.
Hedging pressure hypothesis
Producers want to sell to hedge
End users want to buy to hedge
If hedging demand from producers and users are equal, then the future curve should be flat.
Hedging pressure hypothesis
Producers demand > Consumers Demand
Backwardation.
Future prices has to be lower to induce speculators to fill gap.
This is part of Insurance theory.
Hedging pressure hypothesis
Producers demand < Consumers Demand
Contango
Future prices will be higher
Positive Calender Spread
Backwardation
Future < Spot
Negative Calender Spread
Contango
Spot < Future
Total Return Swap
One party receives payment based on the change in the level of an index
Total Return Swap = Notional Principal (△ Commodity Price - Fixed Payment)
Basis Swap
Periodic payments are exchanged based on the values of 2 related commodity reference prices that are not perfectly correlated.
Often used between highly liqiuid futurers contract and an illiquid but related material.
Variance Swap
For a specific commodity
Volatiltiy Swap
Relative to the volatility of a reference commodity
What is Calender Yield
Future prices converge to spot prices over the term of futures contract. The difference between the futures price of a nearer maturity and the futures price of a more distant maturity is known as Calendar Spread
Positive roll yiled
Backwardation.
Formula for total return of future commodity contracts
Total Return = Spot Price Return + Roll Return + Collateral Return
Total Return = Spot Return + (Excess Return - Spot Return) + (Total Return - Excess Return)
Spot Price Returns: Usually Fluctuates
Roll Return and Collateral Return: Usually remains constant.
Variance Swap
Actual Variance > Fixed Variance
Long receives payment
Variance Swap
Actual Variance < Fixed Variance
Long makes payment
Commodity Volatility Swap
Volatility of Commodity’s Price > Expected Level of Volatility
Long receives payment
Commodity Volatility Swap
Volatility of Commodity’s Price < Expected Level of Volatility
Long makes payment
Excess Return Swap
Excess Return Swap = Notional Principal (Fixed Payment - Variable Payment).
the variable payments are based on the difference between a commodity price and a
benchmark value.
In months in which the commodity price doesn’t exceed the fixed value, no payments are
made.
Roll Return Formula
[(Near Term Future Price) - (Farther Term Future Price)]/ (Near Term Future Price) x % of position being rolled
What does a negative calander spread mean
That the near-dated futures contracts are priced lower than farther-dated ones.
Contango.
What does a Positive calander spread mean
Backwardation
That the near-dated futures contracts are priced higher than farther-dated ones.
Theory of storage
It is based on the idea that whether a futures market is in backwardation or contango, depends on the relationship between the costs of storing and the benefits of holding physical inventory of the commodity.
Futures Price = Spot Price + Storage Costs - Convenience Yield
Convenience Yield: The benefits of having physical inventory available
Real Estate Index: Appraisal Index
Member contribute information about the appraisal value of the same house every quarter.
Index is constructed by first calculating the appraisal for each proprty, then value-weighted to get a return for all index.
Return formula for Appraisal Index
NOI - Capex + (Ending Mv - Beginning MV) / Beginnign MV
Income return from Appraisal Index
NOI / Beginning MV
Cash return from Appraisal Index
(NOI - Capex) / Beginning Value
Capital return from Appraisal Index
(Ending Mv - Beginning MV) -Capex / Beginning MV
Real Estate Index: Transaction Based Index
2 types
Repated Sales index
Hedonic Index
Characteristics of REITS
More than 75% of their income comes from rents or interest.
Very stable and reoccuring reported incomes
REITS payout more than 90% of their taxable accounitng net income as dividends
They offer frequent secondary equity offerings.Becuase they pay so much of their income in taxes, they need to raise new equity. Which may dulute EPS.
Hedonic Index
Part of transaction based index
Does not require repeat sales of the same property, only 1 sale.
Uses Regression analysis with many IV, such as age, size, quality of construction, and other variables.
REOC
Real Estate Operating Company
Companies that develop and sell real estate.
Primary source of income is from the sale of properties developed by them.
Does not have the Tax advantage as a REIT.
Net lease
Tenates pay operating expense.
Gross lease
Owner pays operating expense
Triple net lease
Tenants will pay common area, repairs, property taxes ect.
Real Estate relationship with interest rates
Inverse relationship
High interest rates push down real estate prices and credit avalibaility
Net Asset Value Per Share
(MV Asset - MV Liabilities) / Shares outstanding
[Tangible assets + (Net income / Cap Rate) - Liabilites] / Shares outstanding
Hedge Fund Strategy: Equity
Long Short Equity
Market Neutral
Short Biased
Hedge Fund Strategy: Event Driven
Merger Arbitrage
Distress Securities
Highest correlated with the equity market
Hedge Fund Strategy: Relative Value
Fixed Income Arbitrage
Convertible Bond Arbitrage
Hedge Fund Strategy: Oppertunistic
Global Macro
Managed Future
Hedge Fund Strategy: Specialist
Volatility Strategy
Reinsurance Strategies
Relative Valuation between two or more securites. Exposed to credit & Liquidity Risk
Hedge Fund Strategy: Muli-Manager
Multi Strategy
Funds of Funds
Characteristics of Equity long-Short
Reliance on Fundamental research
Diverse Investment style
40-60% Exposure to Net long positions
Gross long exposure 70-90%.
Some managers are able to add alpha by timing the market. Few are successful though.
Variable Leverage
High volatility
Positive beta exposure
Absolute valuation approach
Concertrated position size
Leverage levels are negativly related to the level of risk factors exposure the portfolio has.
Characteristics of Short Biased
Dedicated to short only position
60-120% Short position at all times
30-60% net short position
Bottom up approach
Takes short position, then present market research
Attempts to deliver returns that are negativly correlated with the market.
- Low Leverage
- High Volatility
- Negative Beta exposure
- Absolute Valuation approach
- Concentrated positioning sizes
Successful short only fund manager: Increasily positive market returns as the market declines and Risk-free-Rate when the markets increases
Characteristics of Market Neutral
Modest return profile
Aim is to be market neutral
High levels of diversification and liquidity
Purely quantitative managers
Not useful in upward trending markets
High leverage
Low volatility
Beta Exposure is neutral (0)
Relative Valuation approach
Diverse Position Sizing.
Characteristics of Merger Arbitrage
Relativly liquid strategy
Moderate to high level of leverage
Soft Catalyst Approach: Trade in the anticipation of an event
Hard Catalyst Approach: Trade in the reaction of an event.
Typically trades are done using common stock.
Cash for stock deal: Buy Target Company shares.
Stock For Stock Deal: Buy target and sell aquirer.
Relative high Sharpe Ratio
Low correlation to market return.
Uncorrelated source of Alpha.
Characteristics of Event Driven: Distress Securities
Return profile investing typically at the high end of event driven strategies with more volatility.
Usually Long biased, subjected to security specific outcomes, still impacted by the health of the macro-economy.
Liquidation: Assets are sold and paid out according to the capital strucutre.
Reorganization: Capital Strucutre Arbitrage, buy securities that would survive. Long Senior Debt, short junior debt or equity.
Moderate or low levels of leverage.
Long Lock up periods.
Characteristics of Relative Value: Fixed Income Arbitrage
Risk/return profile is derived from the high correlation found across different securities.
High amounts of leverage.
The more correlated, the lower the risk of the leverage involved.
Pricing inefficinies are small, but high correlated between securities.
Characteristics of Relative Value: Convetible Bond Arbitrage
Strive and benefit from strucutally cheap source of implied volatility.
Embedded options trade at lower volatility levels compared to the underlying asset, making the calls cheap.
Must accept or hedge away interest rate, credit and market risk.
High levels of leverage
works best during times of high convertiblility insurance, moderate volatility, and reasonable market liquidity.
Characteristics of Oppertunistic Strategies: Global Macro
Wide range of asset classes.
Focus on theme or regions.
Top-Down Fundamental approach
Fiarly hemogenous
High leverage -6-7 times leverage
Mean reverting
mean-reverting low volatility markets offer few oppertunities
highly liquid
Characteristics of Oppertunistic Strategies: Managed Futures
Uncorrelated with stocks and bonds
Returns tend to be positivly skewed
85-90% of assets are invested in short term government debt.
Time Series Momentum: Trend following. Long assets that are rising in price, and short assets that are dropping.
Cross-sectional Momentum: Same as TSM but a group of large positions against a group of short positions.
highly liquid
Characteristics of Specialist Strategies: Volatility Trading
Long volatility position exhibits positive convexity, which can be useful for hedging strategies.
Relative value volatility arbitrage (buy cheap volatility, and sell more expensive volatility).
Long short VIX futures, Options, or swaps.
Characteristics of Specialist Strategies: Reinsurance/Life Settlement
Insurance company has to much risk exposure for a specific event and at a geographical areas.
Sells a bit of the risk to a reinsurance.
uncorrelated with other assets classes.
Life settlement: Policy holder surrender their policy by selling it to a fund.
Characteristics of Specialist Strategies: Multi-Manager Strategies
Designed to offer steady low-volatility returns via strategy diversification.
Mullti-Manager have outperfomed Funds of Funds.
Multi-Strategie offers potentially faster tatical asset allocation and improved fee strucutre.
Funds of Funds offer potentially offer more diverse strategy mix, and slower tatical reaction time.
Mulit-Strategy uses more leverage than Funds of Funds.
