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Hedge Fund Strategies (7) – Yield-Curve Arbitrage and Butterflies

Hedge Fund Strategies (7) – Yield-Curve Arbitrage and Butterflies

Our review of hedge fund trading strategies continues with a discussion of yield-curve arbitrage (YCA), a form of fixed income arbitrage. I have previously written about the yield curve, convexity, and duration.

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Copyright 2011 Eric Bank, Freelance Writer
Hedge Fund Strategies (Part 5) – Hedged Equity Short Selling

Hedge Fund Strategies (Part 5) – Hedged Equity Short Selling

Shorting a stock means selling shares you do not own in the hopes of benefiting from a decline in the price of the shares. The seller borrows shares, usually from a broker, and delivers them to a buyer in return for cash.

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Copyright 2011 Eric Bank, Freelance Writer
Capital Asset Pricing Model, Part Two – Systematic Risk

Capital Asset Pricing Model, Part Two – Systematic Risk

We are reviewing the underlying assumptions made by the Capital Asset Pricing Model (CAPM). Recall from last time the assumption that returns are distributed normally (i.e. a bell-shaped curve) and how this fails to account for skew and fat tails. Today we’ll look at CAPM’s assumption that there is but a single source of priced systematic risk: market beta.

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Copyright 2011 Eric Bank, Freelance Writer
Securties Lending, Part One

Securties Lending, Part One

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Prime brokers offer a variety of services to investors, from providing credit to clearing trades. One important service offered is known as Securities Lending. In Part One of this article, we’ll look at the contractual and collateral rules pertaining to Securities Lending.

As an investor or hedge fund, you may wish to borrow shares for a variety of reasons, such as shorting the stock or hedging a long position. An executed Securities Lending Agreement is the documentation required before shares are loaned. Continue reading “Securties Lending, Part One” »

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Copyright 2011 Eric Bank, Freelance Writer
Modern Portfolio Theory – Part Three

Modern Portfolio Theory – Part Three

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Our quest continues to find out whether hedge fund alpha really exists or is just hype. Recall from last time our documentation of the Capital Market Line (CML).  The CML represents a portfolio containing some mixture of the Market Portfolio (MP) and the risk-free rate. It is a special version of the Capital Asset Line, ranging from the risk-free rate tangentially to the Efficient Frontier at the Market Portfolio, and then extending upwards beyond the tangent point.  Modern Portfolio Theory (MPT) posits that any point on the CML has superior risk/return attributes over any point on the Efficient Frontier.  Let’s ponder that for a second – just adding some T-Bills to, say, S&P 500 baskets (our proxy for the Market Portfolio) will improve the risk/return characteristics of your portfolio.

Capital Market Line

If your entire portfolio consisted only of the cash-purchased Market Portfolio (i.e. the tangent point on the Efficient Frontier), your leverage ratio would be 1 – you are unleveraged. The points on the CML below the Market Portfolio represent deleveraging: adding cash to your portfolio.  You are lowering risk and expected return when you deleverage. If you borrowed and sold TBills, and used the proceeds to buy additional Market Portfolio, your new portfolio would be leveraged, and would be a point on the CML above the tangent. Leveraging increases your risk and expected return. If you disregard the effects of borrowing (or margin) costs, then all points on the CML share the maximum Sharpe Ratio, a popular formula for expressing risk/return. Continue reading “Modern Portfolio Theory – Part Three” »

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Copyright 2011 Eric Bank, Freelance Writer