Podcast
Questions and Answers
What is the primary objective of a pairs trading strategy in equity market-neutral investing?
What is the primary objective of a pairs trading strategy in equity market-neutral investing?
- To diversify investments across multiple volatile sectors for growth
- To invest heavily in high beta stocks for increased returns
- To maximize short-term profits from speculative trades
- To create zero or very low beta exposure while achieving alpha through stock selection (correct)
Which of the following steps is NOT part of the typical process for executing a pairs trade?
Which of the following steps is NOT part of the typical process for executing a pairs trade?
- Compile a list of possible trading pairs based on price trends
- Select pairs based on the similarity of business activities
- Review proprietary valuation models to identify mispricing
- Predict future market movements using economic indicators (correct)
Why is moderate leverage typically employed in equity market-neutral strategies?
Why is moderate leverage typically employed in equity market-neutral strategies?
- To improve liquidity in the portfolio for quick trades
- To enhance returns while controlling risk, generally less than two times capital (correct)
- To minimize transaction costs by investing larger amounts at once
- To engage in high-risk ventures that promise substantial returns
When selecting trading pairs, what factor primarily influences the decision of which securities to pair?
When selecting trading pairs, what factor primarily influences the decision of which securities to pair?
Following the execution of a pairs trade, what is the next critical step an investment manager should undertake?
Following the execution of a pairs trade, what is the next critical step an investment manager should undertake?
What is generally considered to be the expected source of return above the risk-free rate in an equity market-neutral strategy?
What is generally considered to be the expected source of return above the risk-free rate in an equity market-neutral strategy?
Which of the following best explains the concept of 'zero or low beta' in the context of pairs trading?
Which of the following best explains the concept of 'zero or low beta' in the context of pairs trading?
What is the value of the long position established in the S&P/TSX 60 futures contract during the trade initiation?
What is the value of the long position established in the S&P/TSX 60 futures contract during the trade initiation?
How many shares of RY were purchased during the trade initiation?
How many shares of RY were purchased during the trade initiation?
What was the total profit achieved from the round-trip trade?
What was the total profit achieved from the round-trip trade?
What was the price spread at which the trade reversal occurred on March 1, 2019?
What was the price spread at which the trade reversal occurred on March 1, 2019?
What was the annualized rate of return (RoR) on the initial investment of C$740,000?
What was the annualized rate of return (RoR) on the initial investment of C$740,000?
What calculation determines the number of shares Clara can convert from the bond?
What calculation determines the number of shares Clara can convert from the bond?
Which action did Clara take when initiating her trade on July 7, 2017?
Which action did Clara take when initiating her trade on July 7, 2017?
When Clara reversed her trade on October 30, 2017, what amount did she sell the convertible TSLA bond for?
When Clara reversed her trade on October 30, 2017, what amount did she sell the convertible TSLA bond for?
After Clara's trade reversal, how much did she spend on purchasing back TSLA stock?
After Clara's trade reversal, how much did she spend on purchasing back TSLA stock?
What is the total profit Clara realized from her trades?
What is the total profit Clara realized from her trades?
What is Clara's annualized rate of return (RoR) from the trade?
What is Clara's annualized rate of return (RoR) from the trade?
Which of the following was NOT a simultaneous action taken by Clara during the trade reversal?
Which of the following was NOT a simultaneous action taken by Clara during the trade reversal?
How did Clara fund her purchase of the convertible TSLA bond during the initiation of her trade?
How did Clara fund her purchase of the convertible TSLA bond during the initiation of her trade?
What mistake could a student make regarding the bond price in relation to shares converted?
What mistake could a student make regarding the bond price in relation to shares converted?
What primary skill enables bond portfolio managers to influence credit spread trades most effectively?
What primary skill enables bond portfolio managers to influence credit spread trades most effectively?
In credit risk analysis, what does the yield spread represent?
In credit risk analysis, what does the yield spread represent?
What happens to the profitability of a credit spread trade when overall market interest rates increase?
What happens to the profitability of a credit spread trade when overall market interest rates increase?
What is the preferred action taken by managers when the yield spread between a corporate bond and a government bond is considered wide?
What is the preferred action taken by managers when the yield spread between a corporate bond and a government bond is considered wide?
What is the result of reversing a credit spread trade if the yield spread narrows after opening the position?
What is the result of reversing a credit spread trade if the yield spread narrows after opening the position?
What is meant by being 'underwater' in a credit spread trade?
What is meant by being 'underwater' in a credit spread trade?
Which of the following accurately describes the correlation between credit risk and yield spread?
Which of the following accurately describes the correlation between credit risk and yield spread?
Which bond is typically purchased in a credit spread arbitrage strategy when the credit bond is deemed 'cheap'?
Which bond is typically purchased in a credit spread arbitrage strategy when the credit bond is deemed 'cheap'?
What relationship must bond portfolio managers maintain between the two bonds involved in a credit spread trade?
What relationship must bond portfolio managers maintain between the two bonds involved in a credit spread trade?
What is the primary reason that merger arbitrage returns are largely uncorrelated to the overall stock market?
What is the primary reason that merger arbitrage returns are largely uncorrelated to the overall stock market?
In the example provided, what is the implied risk arbitrage hedge ratio when acquiring XYZ shares?
In the example provided, what is the implied risk arbitrage hedge ratio when acquiring XYZ shares?
What characteristic defines a deal as dilutive for the acquiring firm?
What characteristic defines a deal as dilutive for the acquiring firm?
What are high-yield bonds often referred to as?
What are high-yield bonds often referred to as?
Which of the following is NOT a common characteristic of high-yield bonds?
Which of the following is NOT a common characteristic of high-yield bonds?
How does a risk arbitrage fund typically seek to enhance its returns?
How does a risk arbitrage fund typically seek to enhance its returns?
What is the annualized return expected from the merger arbitrage scenario described?
What is the annualized return expected from the merger arbitrage scenario described?
What might indicate that a merger will be considered accretive for the acquiring firm?
What might indicate that a merger will be considered accretive for the acquiring firm?
What is the primary strategy of managers dealing with high-yield bonds?
What is the primary strategy of managers dealing with high-yield bonds?
What typical time frame does the risk arbitrage strategy in the example suggest for the transaction to completion?
What typical time frame does the risk arbitrage strategy in the example suggest for the transaction to completion?
Flashcards
Pairs Trading
Pairs Trading
An equity market-neutral strategy that identifies and trades pairs of related stocks with mispriced valuations.
Low Beta
Low Beta
A portfolio with minimal directional exposure to the overall market.
Market-Neutral Portfolio
Market-Neutral Portfolio
A portfolio that hedges against several risks, such as industry, market, or sector risk.
Fundamental Valuation Models
Fundamental Valuation Models
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Trading Pairs
Trading Pairs
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Price Spread
Price Spread
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Equity Market Neutral Strategy
Equity Market Neutral Strategy
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Convertible Bond
Convertible Bond
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Conversion Price
Conversion Price
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Conversion Ratio
Conversion Ratio
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Shorting a Stock
Shorting a Stock
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Longing a Bond
Longing a Bond
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Simultaneous Actions
Simultaneous Actions
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Realized Value
Realized Value
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Reversal
Reversal
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RoR
RoR
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Credit Spread
Credit Spread
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Credit Spread Arbitrage
Credit Spread Arbitrage
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What is the primary factor influencing bond prices?
What is the primary factor influencing bond prices?
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Yield to Maturity (YTM)
Yield to Maturity (YTM)
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How do portfolio managers use credit spreads in trading?
How do portfolio managers use credit spreads in trading?
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What happens when the yield spread widens?
What happens when the yield spread widens?
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What happens when the yield spread narrows?
What happens when the yield spread narrows?
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What is the goal of credit spread arbitrage?
What is the goal of credit spread arbitrage?
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Why is it important to match the maturities of the bonds in credit spread arbitrage?
Why is it important to match the maturities of the bonds in credit spread arbitrage?
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What is fundamental analysis in the context of credit spread arbitrage?
What is fundamental analysis in the context of credit spread arbitrage?
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Trade Initiation
Trade Initiation
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Trade Reversal
Trade Reversal
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Price Spread Target
Price Spread Target
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Net Financial Result
Net Financial Result
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Annualized RoR
Annualized RoR
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Merger Arbitrage
Merger Arbitrage
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Risk Arbitrage
Risk Arbitrage
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Hedge Ratio
Hedge Ratio
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Dilutive Merger
Dilutive Merger
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Accretive Merger
Accretive Merger
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High-Yield Bonds
High-Yield Bonds
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Credit Strategy
Credit Strategy
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Capital Appreciation
Capital Appreciation
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Traditional Investment Grade Credit
Traditional Investment Grade Credit
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Junk Bonds
Junk Bonds
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Study Notes
Alternative Investments: Strategies and Performance
- Alternative investment strategies include relative value, event-driven, and directional strategies
- Relative value strategies attempt to profit by exploiting inefficiencies or differences in the pricing of related stocks, bonds, or derivatives, and have low or no exposure to the market
- Event-driven strategies seek to profit from unique corporate events such as mergers, acquisitions, stock splits, and buybacks, and have medium exposure to the market
- Directional strategies bet on changes in market prices (equity, debt, currency, and commodities) and have high exposure to the market
- Equity market-neutral strategies create long and short matched equity portfolios to generate returns unaffected by market direction
- Convertible arbitrage strategy identifies and exploits mispricing between convertible bonds or preferred shares and underlying stock
- Fixed-income arbitrage strategy leverages arbitrage opportunities in the pricing of related interest rate securities
- Credit spread arbitrage exploits differences in the market yield to maturity of risky bonds and sovereign government bonds
- Yield spread arbitrage trades on differences in the yield curve of bonds across different terms of maturity
Key Terms
- Absolute risk: total variability or volatility of returns
- Maximum drawdown: largest peak-to-trough decline in a given period, expressed as a percentage
- Time to recovery: number of months required to recover peak-to-trough decline
- Sharpe ratio: measures excess returns generated above the risk-free rate
- Skew: tendency of a distribution to be tilted toward negative or positive returns
- Kurtosis: measures a distribution's tendency to collect around the average or tail values
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Description
Test your knowledge on equity market-neutral investing and pairs trading strategies. This quiz covers the objectives and processes involved in executing these strategies, along with the use of leverage. Perfect for finance students and professionals looking to sharpen their understanding.