MSIN0210 Hedge Fund Strategies Practice Questions
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MSIN0210 Hedge Fund Strategies
Practice Questions
Question 1
A portfolio manager (PM) in a long/short hedge fund was allocated $50 million to build a portfolio of long and short positions in stocks. The PM ended up taking four long positions and three short positions and keeping a cash position. All positions were initiated at the same time.
The positions, the prices at which they were initiated, their most recent closing prices, and the betas of the stocks in the portfolio are summarized in the table immediately following.
|
Stock |
Number of Shares |
Price at Acquisition |
Latest Price |
Beta |
|
Avanti Holdings |
400,000 |
$27.50 |
$22.25 |
1.42 |
|
Chase Industries |
250,000 |
$42.00 |
$35.00 |
1.35 |
|
Hanover Systems |
360,000 |
$61.75 |
$47.75 |
0.98 |
|
Zapper Pharma |
90,000 |
$122.00 |
$115.50 |
0.86 |
|
Kilmony Inc. |
-320,000 |
$31.50 |
$23.00 |
1.65 |
|
Stuart Tech |
-150,000 |
$76.00 |
$61.75 |
0.74 |
|
Yarpex Foods |
-280,000 |
$53.25 |
$50.25 |
1.25 |
Required
1. Calculate the dollar amount of margin required for the portfolio the day the PM initiated the positions.
2. Calculate the amount of cash position in the portfolio after the PM initiated the positions.
3. Calculate the i) net exposure, ii) gross exposure, and iii) beta-adjusted exposure of the portfolio currently (using most recent prices).
4. Calculate the P&L of the portfolio and the percentage return.
5. Assume the PM wishes to make the portfolio market-neutral without closing any of the existing positions, and by using the Spyder (SPY) as a proxy for the market.
Describe and quantify the required trade. Within your quantification calculation assume the last price for SPY = $400.00.
Question 2
You are assisting the portfolio manager (PM) of a merger arbitrage hedge fund assess the opportunities related to two M&A deals.
1. Schroeder Integrated (SI) announced the acquisition of Barco Refining (BR) in a stock swap deal, whereby SI will pay two (2) of its shares for every three (3) BR shares. Post-announcement, SI shares were last trading at $73.25, down from $77.50, and BR shares at $42.75, up from $36.25. You can assume that a trader can get filled at these post-announcement prices.
Required
In relation to the deal described above, suppose the PM wished to do a risk arbitrage trade.
a. Describe and quantify the trade (using whole share numbers), specify the amount of cash needed to enter the trade if margin was going to be met with cash only, and clearly state the underlying bet.
b. Assuming the deal closes successfully in seven (7) months, calculate the annualized return on the portfolio. SI pays quarterly dividends of $0.75, with the next dividend payment in three (3) months. BR pays quarterly dividends of $0.50, with the next dividend in two (2) months. Ignore any interest earned on the cash position and the time value of money.
c. Compute your indifference probability of the deal closing successfully if should the deal not close, the share prices of SI and BR return to their pre-announcement levels. Assume that a potential deal failure happens in seven (7) months, similar to deal successful closing. The indifference probability is the one that leaves the PM indifferent about whether to enter the trade.
2. Columbus Pharma (CP) announced the acquisition of Trocadero Medical (TM) in a stock swap deal, whereby CP will pay 0.75 of its shares for every share of TM if CP shares are between $20 and $40 at the time of deal closing; $20 for every share of TM if CP shares are at or below $20 at the time of deal closing; and $30 for every share of TM if CP shares are at or above $40 at the time of deal closing.
Assume the shares of both CP and TM are optionable.
In relation to the deal described immediately above, suppose the PM wished to do a risk arbitrage trade.
Required
Clearly describe and quantify the trade while stating the underlying bet.
Question 3
As a portfolio manager (PM) of a fixed income arbitrage hedge fund, you are often shown deals by your analysts for your consideration. You would typically vet each deal for its potential profitability and attractiveness and pick some to execute. For the deals slated for execution, you would identify the specifics of the trade, including identifying legs, sizes, and objectives.
With the help of your analysts, you have identified a fixed income arbitrage opportunity based on the seeming mispricing of the following two US treasury bonds:
Bond A pays an annual coupon of 5.375% and is priced at 100-04; and Bond B pays an annual coupon of 4.500% and is priced at 96-00.
Both bonds mature on May 15, 2030, pay coupons semi-annually, and the prices above are clean prices as of February 15, 2023, the date of this valuation.
Your prime broker allows you to buy treasuries on margin, with a haircut of 2%. In other words, your prime broker lends you 98% of the cost of a purchase. You would put up the remaining 2% from the firm’s capital. Your broker would charge you interest on the amount lent to you. Similarly, your prime broker allows you to short treasuries, but requires you to put 2% of the proceeds from your own capital. The proceeds of the short sale, as well as the 2% top-up can be invested with the prime broker and would earn you interest.
Required
1. To help you structure the trade, and using Excel, calculate the yield to maturity of Bonds A and B.
2. Clearly explain the fixed income arbitrage opportunity related to Bonds A and B, how you would take advantage of it, and what the underlying bet is.
3. Using Excel, calculate the Val01 of each of Bonds A and B. Show your workings and the functions and values of variables used in your Excel workbook. Show your answers to four decimals places.
4. Calculate the invoice prices of Bonds A and B per $1,000 par value. Show your answers to two decimals places. The applicable day count convention is Actual/Actual.
5. Ignoring any interest paid or earned, and if you have no more than $1,000,000 of the firm capital available for this trade, calculate the size of each leg of the trade (number of bonds, rounded down to whole numbers).
6. Ignoring any interest paid or earned, and assuming price adjustment is instantaneous, calculate the percentage return (profit or loss) on the trade if the spread disappears with both legs moving an equal number of basis points.
2023-07-29