CAIA - 27 - Hedge Funds: Relative Value Strategies Flashcards
___ ___strategies aim to exploit deviations from stable relationships.
Relative value strategies aim to exploit deviations from stable relationships.
Put-Call Parity Equation
Call + Bond = Put + Stock
___ ___refers to opportunities that involve limited risk with the potential for large positive returns relative to the amount of risk taken.
Risk arbitrage refers to opportunities that involve limited risk with the potential for large positive returns relative to the amount of risk taken.
___ ___ is related to an unexpected change in an asset’s fundamental value resulting in a loss.
Fundamental risk is related to an unexpected change in an asset’s fundamental value resulting in a loss.
___ ___are investors who trade securities for reasons unrelated to the fundamental value of securities.
Noise traders are investors who trade securities for reasons unrelated to the fundamental value of securities.
When traders overestimate their ability to make predictions, it is a symptom of ___ ___.
When traders overestimate their ability to make predictions, it is a symptom of overconfidence bias.
Investors who make decisions in situations using past experiences from similar situations are exhibiting ___ ___.
Investors who make decisions in situations using past experiences from similar situations are exhibiting representativeness bias.
___ refers to investors relying too heavily on an initial piece of information when making decisions.
Anchoring refers to investors relying too heavily on an initial piece of information when making decisions.
When investors have stronger reactions to losses and tend to hold on to losing stocks for too long but sell winning stocks too soon, they are exhibiting ___ ___.
When investors have stronger reactions to losses and tend to hold on to losing stocks for too long but sell winning stocks too soon, they are exhibiting loss aversion.
___ ___refers to a levered fund that suffers temporary losses having its line of credit reduced or eliminated by its lender.
Leverage risk refers to a levered fund that suffers temporary losses having its line of credit reduced or eliminated by its lender.
___ ___are barriers to costless trading that can make implementation of some arbitrage strategies too costly or too risky.
Market frictions are barriers to costless trading that can make implementation of some arbitrage strategies too costly or too risky.
An ___ ___refers to asset owners hiring agents to manage their assets and, as a result, incurring costs associated with agents not serving the owners’ interests or the owners having to audit or monitor the agents.
An agency relationship refers to asset owners hiring agents to manage their assets and, as a result, incurring costs associated with agents not serving the owners’ interests or the owners having to audit or monitor the agents.
The ___ ___strategy is a relative value strategy that aims to exploit the relative mispricing of an issuers’ convertible bonds and stocks.
The convertible arbitrage strategy is a relative value strategy that aims to exploit the relative mispricing of an issuers’ convertible bonds and stocks.
Convertible arbitrage typically involves ___ convertible bonds and ___the equity.
Convertible arbitrage typically involves buying convertible bonds and shorting the equity.
3 steps to convertible arbitrage:
- ___ convertible bond
- Determine ___ ___
- Manage ___
3 steps to convertible arbitrage:
- Value convertible bond
- Determine hedge ratio
- Manage risks
Issuing convertible bonds has 2 advantages over issuing equity:
- Does not ___
- Markets don’t ___ ___
Issuing convertible bonds has 2 advantages over issuing equity:
- Does not dilute
- Markets don’t react negatively
The ___ ___represents the number of shares into which each bond can be converted.
The conversion ratio represents the number of shares into which each bond can be converted.
The ___ ___ is the effective price at which the shares are acquired through the convertible bond.
The conversion price is the effective price at which the shares are acquired through the convertible bond.
Conversion Price (Equation)
Face Value of Convertible Bond / Conversion Ratio
When an issuer can call a bond at a pre-fixed price regardless of other circumstances, it is call a ___ ___.
When an issuer can call a bond at a pre-fixed price regardless of other circumstances, it is call a hard call.
When the issuer can only call a bond if the equity price has increased above some hurdle rate, it is called a ___ ___.
When the issuer can only call a bond if the equity price has increased above some hurdle rate, it is called a soft call.
___ is the total value of the shares into which the bond can be converted.
Parity is the total value of the shares into which the bond can be converted.
Parity (equation)
(Stock Price x Conversion Ratio) / Face Value
A convertible bond with parity greater than its face value is said to be ___-___-___
A convertible bond with parity greater than its face value is said to be in-the-money
The ___ ___is the difference between the convertible bond price and parity and is expressed as a percentage of ___.
The conversion premium is the difference between the convertible bond price and parity and is expressed as a percentage of parity.
___-___convertible bonds are issued at a deep discount to par and are redeemable at par.
Zero-coupon convertible bonds are issued at a deep discount to par and are redeemable at par.
___ ___ ___ ___ are zero-coupon convertible bonds that are both callable and putable.
Liquid Yield Option Notes are zero-coupon convertible bonds that are both callable and putable.
___ ___ ___ are convertibles that are required to convert to equity at some point.
Mandatory conversion securities are convertibles that are required to convert to equity at some point.
A ___ ___ ___ ___ stock is a mandatory preferred convertible with a pre-set cap level, above which the conversion ratio is adjusted to keep the total return payoff constant.
A preferred equity redemption cumulative stock is a mandatory preferred convertible with a pre-set cap level, above which the conversion ratio is adjusted to keep the total return payoff constant.
Value of bond using component approach (equation)
Convertible Bond = Straight Bond + Call Option on Stock
The component approach to valuing a convertible bond has 3 main drawbacks.
- It uses ___-___, which only works on ___options.
- It does not account for ___ ___
- It does not account for ___
The component approach to valuing a convertible bond has 3 main drawbacks.
- It uses black-scholes, which only works on European options.
- It does not account for credit risk
- It does not account for covenants
The ___ ___prices an option using a lattice for the asset’s value.
The binomial model prices an option using a lattice for the asset’s value.
up/down factors in binomial stock price model (equation)
probability of stock price movement up in binomial model (equation)
Stock price under risk-neutral probability (equation)
Call option value of discounted risk-neutral stock price
Convertible bond price using binomial model (equation)
Max (Parity, Par + Coupon Payment)
A junk convertibles parity is usually ___-___% of face value
A junk convertibles parity is usually 0-30% of face value
A bond-like (busted) convertibles parity is usually ___-___% of face value.
A bond-like (busted) convertibles parity is usually 30-80% of face value.
A Hybrid convertible’s parity is usually ___-___% of the face value.
A Hybrid convertible’s parity is usually 80-120% of the face value.
An equity-like convertible’s parity is typically above ___% of the face value.
An equity-like convertible’s parity is typically above 120% of the face value.
Convertible arbitrageurs generally prefer ___ convertibles.
Convertible arbitrageurs generally prefer hybrid convertibles.
The ___ of the convertible measures its sensitivity to changes in the value of the underlying asset.
The delta of the convertible measures its sensitivity to changes in the value of the underlying asset.
Delta of convertible (Equation), assuming the conversion ratio equals 1.
Delta of convertible with respect to parity (equation)
At-the money options tend to have deltas of about ___. Deep in the money convertibles have a delta of ___. Deep out of the money options have a delta of ___.
At-the money options tend to have deltas of about 0.5. Deep in the money convertibles have a delta of 1. Deep out of the money options have a delta of 0.
Gamma as a 1st partial derivative (equation)
Gamma as a 2nd partial derivative (equation)
Gamma is ___ for at-the-money convertibles
Gamma is largest for at-the-money convertibles
A convertible bond strategy that uses deep-in-the-money convertibles is similar to a ___ ___and is also called a ___-___strategy.
A convertible bond strategy that uses deep-in-the-money convertibles is similar to a synthetic put and is also called a cash-flow strategy.
A strategy that uses at-the-money convertibles applies ___ ___.
A strategy that uses at-the-money convertibles applies volatility trading.
In additional to equity risk, convertible bond arbitrage strategies need to manage non-equity risks:
- ___ risk
- ___ ___ risk
- ___risk
- ___ ___ risk
In additional to equity risk, convertible bond arbitrage strategies need to manage non-equity risks:
- Credit risk
- Interest rate risk
- Event risk
- Crowding effect risk
The ___ ___risk is demonstrated when numerous hedge funds try to liquidate their positions at the same time.
The crowding effect risk is demonstrated when numerous hedge funds try to liquidate their positions at the same time.
Returns from pairs trading are expected to have ___ correlation to equity markets.
Returns from pairs trading are expected to have low correlation to equity markets.
A ___ ___portfolio has equal long and short exposures to a specific currency.
A monetary neutral portfolio has equal long and short exposures to a specific currency.
A ___ ___portfolio generates returns uncorrelated with the market risk associated with a specified beta.
A beta neutral portfolio generates returns uncorrelated with the market risk associated with a specified beta.
A ___ ___portfolio generates returns uncorrelated with economic sectors.
A sector neutral portfolio generates returns uncorrelated with economic sectors.
Most often, a pairs trading strategy is ___ neutral and ___neutral.
Most often, a pairs trading strategy is monetary neutral and sector neutral.
A popular approach used to identify candidate pairs for a pairs trading strategy is the ___-___approach, which is a statistical technique that indicates the relationship between non-stationary variables over time.
A popular approach used to identify candidate pairs for a pairs trading strategy is the co-integration approach, which is a statistical technique that indicates the relationship between non-stationary variables over time.
Cointigration test (equation)
___ ___risk is performance dispersion resulting from idiosyncratic trading
Noise traders risk is performance dispersion resulting from idiosyncratic trading
___ risk is the idiosyncratic risk that refers to the spread between the two stocks becoming permanent.
Fundamental risk is the idiosyncratic risk that refers to the spread between the two stocks becoming permanent.
___ risk refers to the risk that market participants are slow to react to divergence between two stock prices.
Synchronization risk refers to the risk that market participants are slow to react to divergence between two stock prices.
___-___risk refers to the risk that investors are forced to cover their short positions.
Short-sale risk refers to the risk that investors are forced to cover their short positions.
