rahul.goyl
Member
Hi David,
This is a tough one & need test on many concepts when inter-related with one other.
Cud you plz help with this one.
On a due diligence visit, the manager of an arbitrage fixed-income fund claims that his fund has very lowrisk. He tells you that the fund invests in mortgage-backed inverse floaters issued in the The current value of the long positions of the fund is roughly USD 100 million. Typically, the fund buys inverse floaters that are undervalued and hedges them so that the position is not sensitive to interest rate changes using the nearest maturity futures contract on the 10-year T-Note. The fund captures the difference between the inverse floater and the hedge portfolio when it puts on the position. You are told that the only risk arises because the fund might have to sell the hedged position. He calls this LTCM risk. Which of the following risks not discussed by the manager can affect significantly the return of the hedge fund?
I. Model risk because the prepayment model used by the fund might be wrong.
II. Default risk because the hedging strategy assumes that the inverse floaters have no default risk.
III. Liquidity risk because the hedge fund uses the nearest futures contract on the 10-year T-Note to hedge interest rate risk and trading price impact may not be possible in that contract in times of stress.
IV. Volatility risk because shocks to interest rate volatility will affect the inverse floaters but cannot typically be hedged with the 10-year T-Note contract.
Thanks
Rahul
This is a tough one & need test on many concepts when inter-related with one other.
Cud you plz help with this one.
On a due diligence visit, the manager of an arbitrage fixed-income fund claims that his fund has very lowrisk. He tells you that the fund invests in mortgage-backed inverse floaters issued in the The current value of the long positions of the fund is roughly USD 100 million. Typically, the fund buys inverse floaters that are undervalued and hedges them so that the position is not sensitive to interest rate changes using the nearest maturity futures contract on the 10-year T-Note. The fund captures the difference between the inverse floater and the hedge portfolio when it puts on the position. You are told that the only risk arises because the fund might have to sell the hedged position. He calls this LTCM risk. Which of the following risks not discussed by the manager can affect significantly the return of the hedge fund?
I. Model risk because the prepayment model used by the fund might be wrong.
II. Default risk because the hedging strategy assumes that the inverse floaters have no default risk.
III. Liquidity risk because the hedge fund uses the nearest futures contract on the 10-year T-Note to hedge interest rate risk and trading price impact may not be possible in that contract in times of stress.
IV. Volatility risk because shocks to interest rate volatility will affect the inverse floaters but cannot typically be hedged with the 10-year T-Note contract.
Thanks
Rahul
