Vorlesung

Question 1

The prudent man rule

Answer 1

The prudent man rule directs trustees “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.”

Question 2

Mutual fund and broker difference to hedgefunds

Answer 2

Mutual fund: Pools money from many investors towards assets; daily pricing through the net asset value.
Difference to hedge fund: money is on the depot bank, not with the company.

Question 3

Jones Hedgefund

Answer 3

Jones, father of hedge funds: wanted to leverage, but advertising for hedge funds was forbidden. No more than 99 investors, and no publication needed.
Own investment

Question 4

Hedge fund benchmark

Answer 4

Hedgefunds do not care about benchmarks, they follow complete different strategies, To diversify the investors Portfolio.

Question 5

Payment structure of a hedgefund

Answer 5

Payment of a hedge fund managers: 2.20. 2% initial fee and 20% performance fee.

Question 6

Main Hedgefund classes

Answer 6

HFR strategy classifications: 
Equity hedge
Event driven
Micro + CTA
Relative Value
Specialty: Multimanager funds: fund of funds
in reality: not as simple.

Question 7

Beta of HF

Answer 7

HFRI annual investment returns are not correlated with the indices that much, however they are slightly correlated

Question 8

What is institutionalization

Answer 8

Institutionalization of hedge funds: large part of their assets are not any more HNWIs, however institutional investors with expertise.

Question 9

Name 4 types of funds

Answer 9

Four types of investment companies exist: mutual funds, exchange traded funds, close-end funds and unit investment trusts.

Liquid alternative funds

Question 10

Futures vs. Options for hedging

Answer 10

futures are better than options because off call them options are not as liquid and they have no linear pay off. Additional question: is the contract volatile (liquidity premium). Protection gets more expensive if we buy the put options which are further out of the money.

Problem: Delta of Option changes with decline

Please do not forget: hedging always involves opportunity costs.

Question 11

3 common features of hedgefunds (in the beginning)

Answer 11

They are three common features for the definition of hedge funds: first leverage, second short selling, third high-performance fees (2-20)

Question 12

Common features of hedgefunds today

Answer 12

Today there is no universal definition of hedge funds, however there are some characteristics:

Leverage
Shortselling
High-performance fees, 2-20
Substantial capital investments by the manager itself
Offshore structure or partnership structure
Liquidity restrictions
dynamic trading strategy
Innovation from the whole industry

Question 13

Describe services of a Prime Broker

Answer 13

Prime brokerage: services offered by investment banks to hedge funds

Global custody services (Safekeeping of assets, clearing, settlement)
Financing of leverage
Securities lending
Capital introduction
Consulting services
Additional services (risk analytics technology, office space,…)


Question 14

What is the classification problem

Answer 14

Classification Problem: Mutual funds are defined by asset classes - Hedgefunds are defined by dynamic trading strategies

Methodology (Systematic vs. Discretionary/ Opportunistic)
sectors (Equity Hedge: Energy / Basic material vs. Technology Healthcare)
Regions (Global, emerging markets, Asia)
Frequency: Monthly indices / Daily
Type: single strategy vs. Fund of Funds

“style drift” of a Hedge Fund is very bad


Question 15

Equity Hedge Equity market neutral

Answer 15

Equity Hedge Equity market neutral: Qualitative techniques of analyzing price data

Factor based: systematic analysis of common relationships between securities —> beta near 0 and a lot of leverage

Statistical arbitrage/trading: exploiting priced anomalies which may an occur as a function of expected mean reversion inherent insecurity prices; high-frequency trading; technical analysis; opportunistically to exploit new information

Characteristic: net equity market exposure no greater than 10% long or short

Question 16

Equity Hedge fundamental growth

Answer 16

Equity Hedge Fundamental growth: assessment of the valuation characteristics on the underlying companies
which are expected to have prospects for a earnings growth and capital appreciation exceeding those of the broader equity market

Companies which are experiencing or expected to experience abnormally high levels of growth in earnings, profitability, sales or marketshare

Question 17

Equity Hedge Fundamental Value

Answer 17

Equity Hedge Fundamental Value: trade evaluation metrics
by which the manager determines them to be inexpensive and undervalued when compared with relevant benchmarks

Focused on characteristics of the firms financial statements (absolute and relative)

Typically focus on equities which currently generate high cash flow, let’s trade at a discounted valuation multiples

Question 18

Equity hedge Quantitative directional

Answer 18

Equity Hedge Quantitative directional: Factor based and statistical arbitrage/trading strategies

Typically maintain varying levels of net long or short equity market exposure over the various market cycles

Question 19

Equity Hedge Short Bias

Answer 19

Equity Hedge Short bias: assessment of the valuation characteristics on the underlying companies with the goal of identifying overvalued companies

Maintain consistent short exposure —> expect to outperform traditional equity managers in declining equity markets

Fundamental or technical

particular focus on the identification of overvalued companies —> expect to maintain in that short equity position over various market cycles


Question 20

Macro Active trading (general)

Answer 20

Macro Active trading: Active trading methods
Typically with high-frequency position turn over all leverage

May employ both: discretionary and systematic macro with identifiable sub strategies

Process based on systematic, quantitative evaluation of macroeconomic variables

Portfolio positioning is predicated on convergence of differentials between markets (not necessarily highly correlated)

Fundamental relationships across geographic areas (inter- and intra asset classes)

Distinct from other macro strategies in that they characteristically emphasize rapid market response to new information + High volume of turnover in liquid but frequently volatile and unstable market positions

Question 21

Macro Commodity

Answer 21

Macro commodity: systematic commodity based on mathematical, algorithmic and technical models

Trending or momentum characteristics —> highly liquid Instruments —> shorter holding period.

Expect to have greater than 35% of portfolio in dedicated commodity exposure

Discretionary commodity strategies are reliant on the fundamental evaluation of market data, relationships and influences

May trade actively in the developed and emerging markets (focusing on absolute and relative levels on equity markets, fixed income, currency, spreads trading)



Question 22

Macro Currency / Discretionary Macro Currency

Answer 22

Macro currency: discretionary and systematic — mathematical, algorithmic and technical models

Little or no influence of individuals over portfolio positioning

Trending or momentum characteristics in highly liquid assets — short holding periods — some try to employ counter-trend models

Greater than 35% of portfolio dedicated to currency exposure

Discretionary currency strategies rely on fundamental evaluation of market data, relationships and influences
Investment process most heavily influenced by top-down analysis of macro economic variables

May try to trade actively in developed and emerging markets

Question 23

Macro discretionary thematic

Answer 23

Macro discretionary thematic: relying on the evaluation of market data, relationships and influences — Group of portfolio managers

Top-down analysis of macro economic variables

Trade actively in developed and emerging markets

Positions typically are predicated on the evolution of investment themes the manager expect to materialize over the relevant time frame

Contain contrarian or volatility focused components

Question 24

Macro systematic diversified

Answer 24

Macro systematic diversified: mathematical, algorithmic and technical models

Identify opportunities in markets exhibiting trending or momentum characteristics across individual instruments

Some strategies seek to employ countertrend models —> strategies benefit most from an environment characterized by a persistent, discernible trending behavior

No greater than 35% of portfolio in either dedicated currency or commodity exposures


Question 25

Event driven Activist

Answer 25

Event driven Activists: obtain representation on the company's board of directors Impacting the firms policies or strategic directions Advocate activities such as division or asset sales, corporate divestiture, dividend or share buyback, changes in management Focused on equity companies which are engaged in the corporate transactions, security issuance/Repurchase, asset sales, division spinoffs or other catalysts Greater than 50% of the portfolio in activist positions


Question 26

Event driven credit arbitrage

Answer 26

Event driven credit arbitrage: opportunities in corporate fixed income secs Senior or subordinate claims as well as bank debt and other outstanding obligations, structuring positions with little or no road credit market exposure Limited exposure to government, silver rain, equity, combustible or other obligations —> main focus on fixed corporate obligations Fundamental credit analysis to evaluate the likelihood of an improvement in the issuers creditworthiness Difference to fixed income corporate strategies: involve more general Market Hedges, while Credit arbitrage in lieu of arbitrage positions with little or no net credit market exposure —> predicated on specific, anticipated idiosyncratic developments Management typically involved with Company management

Question 27

Event driven distressed/restructuring

Answer 27

Event driven distressed/restructuring: focused on corporate fixed income Primarily trading at significant discounts to their value at issuance or obliged as a result of formal bankruptcy or financial market perception Management typically in contact with company management or/and creditors In contrast to special situations, distressed strategies employ primarily debt (greater than 60%) but also may maintain related Equity exposure

Question 28

Event driven merger arbitrage

Answer 28

Event driven merger arbitrage: primarily announced transactions Strategies typically have over 75% of positions in announced transactions

Question 29

Event driven special situations

Answer 29

Event driven special situations: primarily focused on opportunities in equity. Corporate transaction, security issuance/repurchase, asset sales, division spinoff or other catalysts Focusing broadly on a wide spectrum of corporate lifecycle investing Including, but not limited to distressed, bankruptcy and post bankruptcy security issuance, announced M&A, spinoffs, asset sales, etc. Impacting an individual capital structure focusing primarily on situations identified via fundamental research —> likely to result in corporate transactions through catalyst Primarily equity (greater than 60%) but also corporate debt exposure —> Post bankruptcy equity exposure & exit of restructuring proceedings


Question 30

Relative value fixed income asset backed

Answer 30

Relative value fixed income asset-backed: realization of the spread between related instruments One or multiple components of the spread is the fixed income instrument backed physical collateral or other financial obligations other than those of the specific Corporation Attractive spread given the nature and quality of the collateral, the liquidity characteristics of the underlying instruments and on the issuance and trends in collateralized fix income instruments

Question 31

Relative value fixed income convertible arbitrage

Answer 31

Relative value fixed income convertible arbitrage: realization of the spread between related instruments One or multiple components of the spread is a convertible fixed income instrument Isolate the attractive opportunities between the price of the convertible security and the price of a nonconvertible security Characteristics sensitivity to credit quality of the issuer, volatility, interest rate and valuation of the issuer

Question 32

Relative value fixed income corporate

Answer 32

Relative value fixed income corporate: realization of the spread between related instruments One or multiple components of the spread is a corporate fixed income instrument Isolate attractive opportunities between a variety of fixed income instruments, typically realizing an attractive spread between multiple corporate bonds or corporate and government bonds Fixed income corporate typically involve more general market hedges with limited fixed income market exposure, while event driven credit arbitrage typically involve arbitrage positions with little or no net credit market exposure

Question 33

Relative value fixed income sovereign

Answer 33

Relative value fixed income sovereign: one or multiple components of the spread is a sovereign fixed income instrument Isolate attractive opportunities between a variety of fixed income instruments, typically realizing an attractive spread between multiple sovereign bonds or between corporate and government bonds Quantitative and fundamental discretionary approaches — relative value arbitrage sub-strategies Significant top-down macro influences Typically minimum of 50% exposure to Global sovereign fixed income markets — typically lower net exposure and than similar strategies in macro multi strategy sub-strategy



Question 34

Relative value volatility

Answer 34

``` Relative value volatility: trade volatility as an asset class Employing arbitrage, directional, market neutral or a mix strategy ``` Exposures can be long, short, neutral or variable Include both listed and unlisted instruments Isolate opportunities between the price of multiple options or instruments containing implicit optionailty Characteristic sensitivity to volatility, interest rate and issuers equity

Question 35

Relative value yield alternatives

Answer 35

Relative value yield alternatives: one or multiple components of the spread contain derivatives, equity, real estate, MLP or a combination. Quantitatively driven to measure existing relationship between instruments Isolate opportunities in the youth oriented securities Yield alternative contain primarily in non-fixed income securities (in contrast to income arbitrage) and the investment thesis is more predicated on the yield realized then on price appreciation (in contrast to Equity hedge)

Question 36

Problem with length of data

Answer 36

Length of data: unlike for equity and bond indices, there are no long-term time series for hedge funds

Question 37

Problem with frequency of data

Answer 37

Frequency of data: monthly price and return data in database vendors

Question 38

Deviation from normality

Answer 38

Deviation from normality: return distributions of hedge funds exhibit negative skewness and positive kurtosis —> hedge funds generate extreme returns much more often than the normal distribution suggests

Question 39

Instant history or backfilling bias

Answer 39

Instant history or backfilling bias: when the hedge funds report return information for the first time, Data vendors usually include the complete history of the database

Question 40

Survivorship bias:

Answer 40

Survivorship bias: data vendors usually only include the returns of hedge funds currently reporting information (survivors) —> the main reason for high survivorship bias is the high attrition rate

Question 41

Selection bias

Answer 41

Selection bias: a selection of hedge funds in the database is not necessarily representative for the complete universe of hedge funds

Question 42

Markowitz modern portfolio theory

Answer 42

Markowitz: paper: modern portfolio theory, normative mean variance theory of portfolio management which shows what investors should do under certain assumptions.

Question 43

CAPM

Answer 43

William F.sharpe: CAPM; positive general equilibrium theory for the pricing of financial assets

Question 44

Risk

Answer 44

Risk: measurable uncertainty; uncertainty: unmeasurable one

Question 45

Markowitz optimal portfolio

Answer 45

Markowitz optimal portfolio call set of portfolios with: 1. Maximum expected return for varying levels of risk and 2. Minimal risk for varying levels of expected return. This set of portfolios is known as the Efficient frontier

Question 46

How to select an optimal portfolio

Answer 46

How Can investors select an optimal portfolio: determine the efficient frontier and select portfolio with the desired target return E. The purpose of this is to determine the optimal portfolio weights W* (mathematically: minimize portfolio variance with constraints: C1 : target return equals E. C2: some of weight equals one, which means 100% is invested

Question 47

Creating CML

Answer 47

When a risk-free investment is available in addition to risky assets, the shape of the frontier changes dramatically. It become the line. Therefore all investors prefer portfolios which are a combination of the risk-free asset in the portfolio M (two fund separation). This line is called the capital market line (CML).

Question 48

Efficient frontier

Answer 48

Efficient frontier: There must be one portfolio that is the efficient combination of all available securities, because if 2 securities have the same return for different amounts of risk than the one with the greater risk will be avoided by risk-averse investors

Question 49

Difference in risk between SML and CML:

Answer 49

Difference in risk between SML and CML: the CML uses the standard deviation of the returns on the market portfolio as the risk measure where as the CAPM uses the covariance of the returns on the security with those on the market portfolio as the risk measure. Key conclusion of the CAPM is that portfolio of all assets, held in proportion of their outstanding market values, is an extremely attractive investment choice.

Question 50

Market neutral

Answer 50

Statistical definition: the portfolio is market neutral, if the beta of the factor model used are zero

Question 51

Asset based style factor model Expansion

Answer 51

Asset-based style factor model Risk of Hedge fund depends on style → non-linear ⇒ Option like returns (Fungh/hsieh 2001) Additional risk/return characteristics: Spread, volatility, option based, rule based factors Mitchell/Polvino (2001): 1: Merger arbitrage are uncorrelated in flat or appreciating markets, but positively correlated with depreciating markets & 2. Returns are similar to an option strategy, which sells uncovered index put options


Question 52

Cash merger

Answer 52

Cash merger: Offer of cash for company assets Strategy: Buy company stocks below public M&A price and sell it for M&A price. Additionally take offered dividends. Opportunity cost of capital: Capital frozen until final merger Main risk: Deal failure

Question 53

Stock Merger

Answer 53

Stock merger: Company offers stocks to buyout target Strategy: Buy targets stocks and short the aquirers stock. Profit is difference between price of the acquirer and target company. Dividends of the target (but pay dividends of aquirer) + Interest income on the proceeds of the short sale Main risk: Deal Failure

Question 54

Problem in HF and CAPM/3factor model Merger Arbitrage option strategy Dangers for MA

Answer 54

CAPM/3-factor Fama-French Model DO NOT capture risk of merger arbitrage —> excess return is not necessarily alpha but the risk premium not captured by the linear factor models (—> missing risk factor/non linear relation?) IF markets are flat or appreciating: generating alpha (in excess of beta & r) However, if markets DECLINE, Beta increases to 0.5 —> High positive correlation between the returns (negative) Merger arbitrage is similar to a strategy writing uncovered index put options Mergers are often canceled or postponed when equity markets fall

Question 55

Hedge ratio

Answer 55

Portfolio Value / Contract Value

Question 56

Future Value

Answer 56

Value per point * Actual index value

Question 57

ROE

Answer 57

Profit margin * asset turnover * financial leverage (Net income / average equity) = (net income / net sales) * (net sales / average assets) * (average assets / average equity)

Question 58

FCFF

Answer 58

Free Cashflow to the firm EBIT(1-t) + D&A - Capex - ∆WC +- Adj

Question 59

EBIT

Answer 59

Earnings before interest and taxes Rev - COGS - SG&A - R&D - Others

Question 60

D&A

Answer 60

Depreciation and Amortization

Question 61

Capex

Answer 61

Capital expenditures

Question 62

∆WC

Answer 62

Change in working capital ∆Current assets - ∆Current liabilities

Question 63

COGS

Answer 63

Cost of good sold

Question 64

SG&A

Answer 64

Selling, General & Administrative

Question 65

WACC

Answer 65

r(1-t) * [MV(D) / MV(D) + MV(E)] + r * [MV(E) / MV(D) + MV(E)]

Question 66

CAPM

Answer 66

i = rf + beta(rm - rf)

Question 67

Present Value of a company

Answer 67

1. : Calculate FCFF 2. : Calculate WACC 3. : Calculate Present Value of Firm PV = (FCFF / 1+WACC) + (FCFF2 / 1+WACC^2) ..... = SUM(FCFF / 1+WACC) + TV TV = (FCFF / WACC-g) / 1+WACC^T 4. : PV - MV(D) +- Adj. 5. : Value of 1 share = PV(E) / Number of shares outstanding

Question 68

Differences of Liquid alternatives to Hedgefunds

Answer 68

Ownership: Mutual Fund -- Private/Offshore Corp Regulation: UCITS/Inv. Comp. Act of 1940 -- AIFMD/Sec. Act of 1933 Daily Liquidity/Daily rebalancing possible: Yes -- No Investor qualification: None -- Accredited Investor Investment Minimum: Low -- High Transparency: Sales prospectus -- Private placement/Subscription doc. No Marketing allowed Custody of assets: Commercial Bank -- Brokerage Firm/Prime Broker Illiquidity Premium: No -- Yes Restrictions on leverage: yes -- no

Question 69

Hedge Ratio

Answer 69

Portfolio / Value of Future = Number of needed futures

Question 70

Value of future:

Answer 70

Contract Value = Value of 1 point * Price of underlying

Question 71

Small Caps

Answer 71

Stocks with small market capitalizations

Question 72

Large caps

Answer 72

Stocks with high market capitalizations

Question 73

Value Stocks

Answer 73

High book to market ratio

Question 74

Growth stocks

Answer 74

Low book to market ratio

Question 75

Selection bias

Answer 75

Selection bias: Hedge funds in the observable portfolio are not representative of the universe of hedge funds —> Probably means, that a vendors database may not provide the true picture of the performance of all funds available for investment

Question 76

Instant history bias:

Answer 76

Instant history bias: Database vendors backfill a hedge funds performance when they add a new fund into their database

Question 77

Survivorship bias:

Answer 77

Survivorship bias: Funds dropped out of database, because of performance(!) reasons —> Upward bias

Question 78

Market portfolio of hedgefunds

Answer 78

Market portfolio of hedgefunds is not practical —> Hedgefunds minimum investment way to high Use fund of funds —> does not contain survivorship, instant history & selection bias (they are a good proxy for the hedgefund universe --> Tells us how much the management of a hedgefund portfolio costs)

Question 79

Downward bias of fund of funds

Answer 79

They have to hold cash (redemptions) which is in the performance do not contain survivorship, instant history & selection bias

Question 80

Lookback straddle:

Answer 80

Lookback straddle: Straddle of Lookback put & call —> Buy/sell at minimum and buy back at maximum —> Shows the maximal possible return

Question 81

PMTS:

Answer 81

PMTS: Primitive Market timing strategy: Enter trade in anticipation of a price move Long standard straddle

Question 82

PTFS:

Answer 82

PTFS: Primitive Trend Following strategy: Trade after certain price moves Long lookback straddle

Question 83

2 Main characteristics of CTAs in a portfolio

Answer 83

Trend followers, although they have systematic risk(1), can reduce the volatility of a typical stock/bond portfolio during extreme market downturns(2).

Question 84

Asset based hedge fund style factor:

Answer 84

Asset based hedge fund style factor: Asset-based style factors link returns of hedge fund strategies to observed market prices They provide an explicit description of how various styles of hedge funds add to portfolio diversification rather than relying on peer Group averages of historical hedge funds returns.

Question 85

Managers with the same strategy can differ in:

Answer 85

Managers with the same strategy can differ in: Leverage —> differences in their beta Trade execution —> differences in their alpha Choice of securities —> differences in alpha and beta

Question 86

Hedgefund strategy has 3 elements:

Answer 86

Hedgefund strategy has 3 elements: Strategy: How long and shorts are combined Location: To which assets is the strategy applied Style: How are the positions leveraged and managed