David's ProTip: Typologies vary, but with this final question I structured the hedge fund strategy (AIMs) into three groups.
AIMs: Describe the underlying characteristics, sources of returns and risk exposures of various event-driven and opportunistic hedge fund strategies including: distressed securities, merger arbitrage, global macro, Regulation D, Managed futures, and Fund of Funds.
Questions:
6.1. Each of the following is a typical or common feature of distressed securities hedge fund strategy EXCEPT:
a. Relatively illiquid investments due to uncertain event horizons and lack of regular secondary markets
b. May engage in capital structure arbitrage
c. While skill (alpha) predominate, strategy is exposed to systemic risk factors
d. Significant reliance on quantitative factor trading models and statistical algorithms
6.2. Immediately on the announcement of a merger, the stock price of the target company jumps 30% but remains below (at a discount to) the announced merger price. A merger arbitrage (aka, risk arb) hedge fund takes a short position in the acquirer and a long position in the target company. The net payoff profile, to the merger arbitrageur, most resembles which option payoff profile?
a. Long a call option on a successful deal close
b. Short a call option on a successful deal close
c. Long a put option on a successful deal close
d. Short a put option on a successful deal close
6.3. A Regulation D hedge fund negotiates an investment in a small, risky company in the form of a debenture convertible, upon registration with the SEC, at a floating 20% discount to the stock price (i.e., a protected discount). Which of the following risks is LEAST acute to the hedge fund manager?
a. Liquidity risk
b. Credit risk
c. Price (market) risk
d. Risk of "flight to quality" in the overall market
6.4. A global macro hedge fund underperformed its absolute return hurdle for the year. During a meeting, an investor was overheard to make the following criticisms of the global macro managers:
I. "You, the fund managers, committed style drift and I did not expect style drift." (And, in truth, the fund did shift from strategy to strategy)
II. "Markets were down, which revealed the fund to have significant beta exposures, but I expected low to no exposure to systematic risk factors." (And, in truth, the fund did have beta exposures)
III. "The fund should have been seeking to exploit opportunities in less efficient, less liquid markets." (And, in truth, the fund did avoid illiquid markets)
Which of the above criticism(s) is VALID of the global macro hedge fund?
a. None of them
b. I. only
c. II. and III.
d. All of them
Answers:
- Directional: deliberate common factor (beta) exposures. For example, the difference between equity long/short and equity market neutral is that the former retains deliberate equity beta but the latter wants to zero out equity beta.
- Relative value (aka, convergence): in general, non-directional and seeking to exploit a price inefficiency. For example, volatility, capital structure. Note how many of these strategies require or imply two trades to exploit the expected convergence or reversion.
Here is a way to think about this group: they should not be able to add value (skill-based alpha) if the strong form of EMH is true.
- Event-driven & opportunistic (the rest): by definition, uncorrelated (low beta, except for global macro) with high skill (e.g., distressed)
AIMs: Describe the underlying characteristics, sources of returns and risk exposures of various event-driven and opportunistic hedge fund strategies including: distressed securities, merger arbitrage, global macro, Regulation D, Managed futures, and Fund of Funds.
Questions:
6.1. Each of the following is a typical or common feature of distressed securities hedge fund strategy EXCEPT:
a. Relatively illiquid investments due to uncertain event horizons and lack of regular secondary markets
b. May engage in capital structure arbitrage
c. While skill (alpha) predominate, strategy is exposed to systemic risk factors
d. Significant reliance on quantitative factor trading models and statistical algorithms
6.2. Immediately on the announcement of a merger, the stock price of the target company jumps 30% but remains below (at a discount to) the announced merger price. A merger arbitrage (aka, risk arb) hedge fund takes a short position in the acquirer and a long position in the target company. The net payoff profile, to the merger arbitrageur, most resembles which option payoff profile?
a. Long a call option on a successful deal close
b. Short a call option on a successful deal close
c. Long a put option on a successful deal close
d. Short a put option on a successful deal close
6.3. A Regulation D hedge fund negotiates an investment in a small, risky company in the form of a debenture convertible, upon registration with the SEC, at a floating 20% discount to the stock price (i.e., a protected discount). Which of the following risks is LEAST acute to the hedge fund manager?
a. Liquidity risk
b. Credit risk
c. Price (market) risk
d. Risk of "flight to quality" in the overall market
6.4. A global macro hedge fund underperformed its absolute return hurdle for the year. During a meeting, an investor was overheard to make the following criticisms of the global macro managers:
I. "You, the fund managers, committed style drift and I did not expect style drift." (And, in truth, the fund did shift from strategy to strategy)
II. "Markets were down, which revealed the fund to have significant beta exposures, but I expected low to no exposure to systematic risk factors." (And, in truth, the fund did have beta exposures)
III. "The fund should have been seeking to exploit opportunities in less efficient, less liquid markets." (And, in truth, the fund did avoid illiquid markets)
Which of the above criticism(s) is VALID of the global macro hedge fund?
a. None of them
b. I. only
c. II. and III.
d. All of them
Answers:
