General Finance and AM Flashcards
Leverage
Measures the relative size of long and short positions in risky assets compared to the size of the portfolio. A true company with zero leverage is 100% cash.
- Leverage debt to adjusted EBITDA
- but not just debt, need to take into account deal based calculations, Credit agreement.
Leverage is provided to HF through a prime broker. Federal Reserve Board’s Regulation T (Reg T) allows investors to borrow up to a maximum 50% of a position on margin (which leads to a maximum level of exposure equal 1/0.5 = 2). For a short position, Reg T requires that short sale accounts hold collateral of 50% of the value of the short implying a maximum short exposure of two.
By establishing offshore investment vehicles, hedge funds can obtain “enhanced leverage” higher than levels than allowable by Reg T. Prime brokers have established facilities overseas in less restrictive jurisdictions in order to provide this service. Another way to obtain higher leverage than allowed by Reg T is “portfolio margining” which is another service provided by prime brokers. Portfolio margining was approved by the SEC in 2005 and allows margins to be calculated on a portfolio basis, rather than on a security by security basis.
Derivatives and options, have embedded leverage in addition to the leverage available from external financing. The highest leverage is available in Treasury, foreign exchange, and derivatives security markets such as interest rate and foreign exchange swaps. These swap transactions are over the counter and permit much higher levels of leverage than Reg T. These securities enable investors to have large notional exposure with little or no initial investment or collateral
traditional are not the best managers of leveraged funds, often will request 0 IA
if rated BBB- assume double BB and thrown a bone
Assets under management
cash plus delta of long and short positions
difference between AUM between traditional and Alt is the concept of committed capital. Day one is not necessarily funding of investment but commitment to fund the investments.
PE does not call for capital on day one? reduced duration and boost return in equities. Will not draw capital if no ability to deploy right away. Metric is Internal Rate of Return.
Net Asset Value
AUM divided by the number of shares
Gross Leverage
sum of long and short exposure per share divided by NAV
- This definition implicitly treats both the long and short positions as separate sources of profits in their own right, as would be the case for many long-short equity funds
- Overstates risk if the short position is used for hedging and does not constitute a separate active bet.
Net Leverage
difference between long and short exposure per share expressed as a proportion of NAV. The net leverage measure captures only the long positions representing active positions which are not perfectly offset by short hedges, assuming the short positions represent little risk by themselves.
Hedge funds
- Relatively high and sophisticated use of leverage to obtain notional exposure at levels greater than their capital base to achieve large returns.
- exclusive and limited partnership for high net worth individuals (200K per year after two years) or institutions that use pooled funds to achieve a high alpha for investors
- Unregulated = typically offshore due to the tax benefit
- Not regulated by the SEC = ability to invest in anything unique strategy
- the managers are typically people with pedigree and skin in the game
- Assets typically not easily accessible as they are with mutual funds
- 20 / 2 the managers take 20% of profits and 2% goes to the HF
- High water marks are used to protect investors by preventing fees from being applied to the same transaction
- Main buckets of strategies:
- Long / short
- Macro
- Relative
Debt Capital Markets
type of market where companies raise funds by trading debt securities like corporate and government bonds. When a company raises debt, it means that it borrows funds and pays interest on those funds. This is different than equity because there is no decrease in ownership.
Equity Capital Markets
Selling ownership in exchange for cash.
The Equity Capital Market group can be broken down into three subgroups:
- Equity Origination: This group pitches companies on raising capital and financing deals such as IPOs.
- Syndicate: This team works with other banks to execute the deal. This is necessary as most of the equity deals involve multiple banks.
- Convertible Bonds: Convertible bonds are debt issuances that convert into equity once a company’s stock price reaches a certain number. So, this group works with companies to raise capital using convertible bonds.
S&P 500
preferred index given its depth and breadth, representative of U.S. equity marketsbecause it comprises more stocks across all sectors (500 versus the Dow’s 30 Industrials).
Furthermore, the S&P 500 uses a market capitalization weighting method, giving a higher percentage allocation to companies with the largest market capitalizations, while the DJIA is a price-weighted index that gives companies with higher stock prices a higher index weighting. The market capitalization-weighting structure is more common than the price-weighted method across U.S. indexes.
Book Value Per Share
Green light to value investors, when a stock trades below its book value could be trading at a discount
(Shareholders’ Equity - Preferred Equity) / Total Outstanding Common Shares
balance sheet, you’ll find the accumulated depreciation of corporate assets, which aids in getting the most accurate outcome when it comes to book value per share
a company’s market value is significantly stronger than its book value, it’s a bull market scenario
Mutual Fund
actively managed fund that uses pooled assets of investors to trade on stocks, bonds, money market instruments so it can take on larger positions
Continuously offered, closed-end funds
Investors can buy into these funds each day at the fund’s net asset value (NAV).
Redemptions, however, are made via monthly or quarterly tenders rather than each day. To ensure they can meet redemptions, many of these funds, as well as daily-access funds, set up lines of credit to cover withdrawals above and beyond cash reserves
401K plans used by corporate America equate to $6.2 trillion with $4 trillion in mutual funds
Subject to regulation under the Investment Company Act of 1940 (“40 Act”)
A mutual fund is a type of investment where the money of a number of investors is pooled together and used by the fund manager to invest in underlying securities in line with the objectives of the mutual fund strategy
By structure, mutual fund strategies can be classified as open-ended or closed-ended mutual funds
On the basis of investing in asset classes, mutual funds can be broadly divided into three categories: Equity, Debt and Hybrid
Asset coverage requirement (“ACR”) for borrowing is 3.0x. (ACR is the ratio, which the value of the total assets of a given Borrower less all liabilities and indebtedness of the Borrower not represented by senior securities bears to the aggregate amount of all senior securities representing indebtedness of the Borrower)
Accounting: Must carry investments on balance sheet at fair value. Net adjustment to the fair value of the portfolio results in an unrealized gain or loss recognized on the income statement.
Reporting: Required to comply with 40 Act disclosure requirements (quarterly, semi-annual and annual filings, material events filings and fact sheets)
Shareholder Rights:
An investment company must abide by certain shareholder rights. The following activities are prohibited unless approved by a majority shareholder vote:
A mutual fund company may not borrow money, make loans, buy or sell real estate, or underwrite securities issued by other companies
A mutual fund company may not change its investment objectives
A mutual fund company may not change the nature of its business and cease acting as an investment company
A mutual fund company cannot change from a diversified form to an undiversified one
Failure to maintain >3.0x asset coverage
Unable to incur additional indebtedness
A fund’s failure to maintain its status as a mutual fund under the 1940 Act constitutes an event of default
- unlike stocks, no voting rights for shareholders but similarly buying ownership of “company”
- Price does not vary intraday like stocks, NAV calculated at the end of each day by dividing total value of securities by outstanding shares
- Investors make $ from dividends, capital gain (selling when increase in value), or when selling shares after holdings increase
- MF make $ from 1–3% in commission, redemption fees
- Structurally - trust (legal entity) - series with different share classes - each have sep liabilities.
- Strategies: Equity, Fixed Income (gov’t debt, corporate) index fund (stocks which correspond to index), money market (short term debt)
- 50-80% mutual funds fail to meet their objective. 23% of all active funds surpassed the average of their passive rivals over the 10-year period ended June 2019. Long-term success rates were generally higher among foreign-stock funds and bond funds and lowest among U.S. large-cap funds. Passively managed ETFs have a better track record.
- ACR 3.0x the value of the total assets of a given borrower - all liabilities and indebtedness
mimic the s&p 500 index of leading American stocks. An index fund holds stocks in proportion to their market capitalisation. Because the fund owns all the stocks in the index, it is diversified. Above all, it is cheap to run. It has no need for expensive analysts. Turnover costs are trivial. You buy stocks when they join the index, and sell them when they leave. In between you just hold them
One charge is that index investing adds to stockmarket volatility and inflates bubbles. This misunderstands the nature of a market-cap index. It weights each stock by its value. If a faddish stock’s price goes up rapidly, its weight in the index increases accordingly, and its value in the indexed portfolio increases automatically. No additional purchase is needed. If anything, index funds make markets less volatile. In panics they have generally been more stable than active funds.
Yield curve
comparing two interest rates of products with different maturity but similar credit quality.
- used as a litmus test to indicate the economy’s health
- When 0, loaning $ becomes a losing proposition. Credit tightens.
- The past 9 recessions were preceded by the inverted yield curve
LIBOR
London interbank offered rate = rate that a bank pays to borrow from another bank. represents $350TR in loans. LIBOR was used by several large banks to rig their trader’s positions. Now will be replaced in 2021.
Derivatives
a contract between two parties or more for stocks, commodities, bonds or interest rates
Futures
- Small movements in assets of underlying futures can cause disproportionately larger losses to the fund. Generally more liquid than other derivatives but are less liquid than stocks, bonds, or other investments.
- price of a futures contract depends to only on the price of the underlying asset but also other factors. more volatile than equity and bonds.
- subject to temporary distortions including lack of liquidity in the markets, government intervention which can result in volatile and unpredictable prices