Chapter 21 Flashcards
How many general categories can Alternative investment strategies be broken down into in order of increasing expected return and risk?
- Relative value strategies (exploiting inefficiencies or differences in the pricing of related stocks, bonds, or derivatives) -> low or no exposure
- Event-driven strategies (exploit event like mergers, acquisitions, stock splits, and stock buybacks) -> medium exposure
- Directional strategies (bet on anticipated movements in the market prices) -> high exposure
What are the types of funds in RELATIVE VALUE STRATEGIES?
- Equity market-neutral
- Convertible arbitrage
- Fixed-income arbitrage
What are the types of funds in EVENT-DRIVEN STRATEGIES?
- Merger or risk arbitrage
- Distressed securities
- High-yield bonds
What are the types of funds in DIRECTIONAL STRATEGIES?
- Long/short equity
- global macro
- Emerging markets
- dedicated short bias
- Managed futures
What is An equity market-neutral strategy?
- designed to exploit inefficiencies and opportunities in the equity market by creating simultaneously long and short matched equity portfolios of approximately the same size.
- Well-designed equity market-neutral portfolios hedge out risks related to industry, sector, market capitalization,
currency, and other exposures. Moderate leverage (generally less than two times capital) is typically used to
enhance returns
What is the typical process undertaken by an equity market-neutral investment manager in executing a pairs trade?
- Review the proprietary fundamental valuation models of two companies to determine relative value
opportunities (i.e., mispricings) between related equities. - Compile a list of potential trading pairs.
- Examine the pairs in the context of the current and historical price spread relationship between the two
securities. - Choose the pairs the investment manager would like to initiate as trading pairs.
- Execute the pairs trade.
- Enter the initiated trade into a real-time portfolio management system, along with the target price spread at which the trade will be reversed to realize the target return
What does The decision as to which two securities will make up the pair is based on?
the degree of similarity between the business activities of the two companies. Typically, the companies would be head-to-head competitors with very similar business strategies
What is A convertible arbitrage strategy?
- is designed to identify and exploit mispricing between convertible securities (i.e.,convertible bonds or preferred shares) and the underlying stock.
- This strategy typically involves buying undervalued convertible securities and hedging some or all of the underlying equity risk by selling short an appropriate amount of the issuer’s common shares.
What is A fix-income arbitrage strategy?
- attempts to profit from price anomalies between related interest rate securities and their derivatives, including government and non-government bonds, mortgage-backed securities, options, swaps, and forward rate agreements.
What are The two most popular fixed-income arbitrage hedge fund strategies?
- Credit spread arbitrage
2. Yield spread arbitrage
What is credit spread arbitrage?
- manifests as yield spread for the bond, which is the difference between the market yield to maturity
(YTM) of the risky bond and that of a sovereign government bond with a similar term to maturity - short the sovereign government bond and
purchase the “cheap” credit bond when the yield spread between the two is “wide”. If the yield spread subsequently narrows, and the manager reverses the trade, a capital gain will result - Conversely, if the yield spread widens, the trade will result in an unrealized capital loss (known as being “underwater”)
What is yield spread arbitrage?
- concerned with the yield curve of a single issuer
- if the manager believes that the yield curve will flatten, they will sell the shorter-dated security and purchase the longer-dated security
