Hedge Fund Investors course phần 5 ppsx

$5 million in capital. What are the limits on leverage for this com- pany? 6.8 A hedge fund has positions (long and short) in stocks, index fu- tures, commodity futures, and currencies. The fund’s prime broker finances all the cash positions and carries all the futures positions. To what extent can SPAN margin rules reduce the margin required for the positions? 6.9 How can a hedge fund exceed the limit of 50 percent margin required on cash stock positions? 6.10 Your hedge fund has long positions in U.S. Treasury securities total- ing $50 million and short positions worth $35 million. You pay an average repo rate of 4.5 percent to finance your longs and receive an average reverse repo rate of 4 percent on your cash collateral cover- ing your short positions. You post haircuts averaging 0.25 percent on the long positions and 0.5 percent on the short positions. What amount of capital is tied up in haircuts? 6.11 How levered is the Treasury part of the portfolio in question 6.10? 6.12 A hedge fund has $100 million in capital levered approximately 20:1. It maintains a position of long notes and bonds roughly equal to its position in short bonds. The financing rate on the long positions av- erages about 0.5 percent (50 basis points) higher than the rate on the short positions. How much does the fund need to make trading (an- nually) to break even after financing costs? 6.13 You borrow 25,000 shares of XYZ common and deliver the shares to satisfy a short sale. While you are carrying the short, the stock pays a dividend of $1 per share. Who receives the dividend? 6.14 You borrow 25,000 shares of XYZ common and deliver the shares to satisfy a short sale. While you are carrying the short, the stock splits 2:1. How does this affect the stock loan transaction? 6.15 You borrow 25,000 shares of XYZ common and deliver the shares to satisfy a short sale. While you are carrying the short, a proxy fight develops over control of the company. How do you restore the vote to the lender of the shares? 6.16 What is the tax treatment of a Treasury coupon or stock dividend re- ceived as a replacement payment from a securities borrower? 6.17 Why might it be reasonable to allow a hedge fund greater leverage for risky positions held as outright futures (long or short) than for levered positions in the underlying cash instruments? 6.18 Why would the U.S. Federal Reserve Bank want to limit the amount of leverage possible on securities loans? Hedge Fund Leverage 103 ccc_mccrary_ch06_87-106.qxd 10/6/04 1:43 PM Page 103 6.19 A hedge fund has $10 million in marginal positions and has loans to- taling $8 million. The fund is subject to maintenance margin of at least 30 percent. How much new cash would the hedge fund need to deposit to satisfy a margin call? 6.20 If the hedge fund in question 6.19 chose to liquidate positions rather than deposit additional margin, how much would need to be liqui- dated? 6.21 A hedge fund buys a six-month call on a common stock at a price of $5. The strike of the option is $102. The current price of the stock is $100. The short-term rate of interest is 5 percent. The current value of the call is $5.25. How much margin must the hedge fund put up to carry the call? 6.22 What margin would the hedge fund need to post if it wrote (sold) an option like that described in question 6.21? Assume the sale is a naked short sale (i.e., you have no position in the stock). 6.23 What is the standard deviation of the return on a hedge fund port- folio that is 100 percent invested in stock A and also carries an equal amount of stock B on leverage. Stock A has a standard devia- tion of return equal to 22 percent. Stock B has a standard deviation of return equal to 25 percent. The two stocks have a correlation of 75 percent. 6.24 What is the expected return on the leveraged portfolio in Question 6.23 if the expected return on each stock is 20 percent (unleveraged) and the risk-free rate is 5 percent? 6.25 What is the probability of loss for the portfolio in questions 6.23 and 6.24? 6.26 What is the probability of losing 25 percent or more for the portfolio in questions 6.23 and 6.24? NOTES 1. “Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management: Report of the President’s Working Group on Financial Markets, April 1999,” www.ustreas.gov/press/releases/reports/hedgfund.pdf. 2. For additional reading on options, see John Hull, Options, Futures, and Other Derivatives, 5th Edition, Pearson Education, 2002. 3. The cumulative probability is the area under the curve. This value can be calcu- lated using the Excel function NORMDIST(Threshold Return, Expected Re- 104 HEDGE FUND COURSE ccc_mccrary_ch06_87-106.qxd 10/6/04 1:43 PM Page 104 turn, Standard Deviation of Return, TRUE or 1). {=NORMDIST(0%, 15%, 18%, 1)} returns 20.2 percent. 4. (=NORMDIST(0%, 25%, 36%, 1)} returns 24.4 percent. 5. (=NORMDIST(0%, 25%, 30.12%, 1)} returns 20.3 percent. 6. The cash generated by the short sale is also reinvested at the short-term rate of return equal to 5 percent. 7. (=NORMDIST(0%, 6%, 8.05%, 1)} returns 22.8 percent. Hedge Fund Leverage 105 ccc_mccrary_ch06_87-106.qxd 10/6/04 1:43 PM Page 105 ccc_mccrary_ch06_87-106.qxd 10/6/04 1:43 PM Page 106 CHAPTER 7 Performance Measurement C ompetitive investors seek attractive returns. Beauty remains in the eye of the beholder, though. Clearly, higher returns are better than lower returns. Investors would prefer to accept less risk to achieve a given return. It is important to understand performance measurement. First the reader may be called upon to conduct a performance return. Second, the reader should be able to review critically the performance measurement calculated by others. Finally, the hedge fund returns are not directly com- parable to the yields on alternative assets. 1 However, hedge fund returns can be readily adjusted to facilitate comparison to bond and money mar- ket returns. CALCULATING RETURNS Investors commit funds to a particular investment for a variety of reasons. The return on the investment is usually very important. Yet return is calcu- lated many different ways to serve different purposes. Investors need to know how return is calculated to properly understand the investment re- sults they receive. Nominal Return The nominal return is the simplest type of return calculation and is a com- ponent of most of the other return measures. To calculate nominal return, divide the gain in value by the starting value of the investment. (7.1) Nominal Return Gain Initial Investment Value = 107 ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 107 Restating equation (7.1) slightly: (7.2) This simplifies to: (7.3) Sometimes, this nominal return is modified slightly to acknowledge that the return shown in the numerator increases the investment base in the denominator as in equation (7.4): (7.4) In equation (7.4), the return is divided by the average value of the invest- ment. Annualized Return It is difficult to compare the nominal returns of different assets. Clearly, higher returns are better than lower returns, but it also matters how long it takes to achieve a particular return. Without some adjustment for time, it is not possible to compare returns. Generally, nominal returns are adjusted to a period equal to one year. (7.5) Incorporating equation (7.1): (7.6) This method of converting a nominal return to an annual return presumes that you can repeat an investment over and over successively, until a year Annualized Return Nominal Return Fraction of Year = Annualized Return Gain Initial Investment Value Fraction of Year =× 1 Nominal Return Final Investment Value (Initial Investment Value Final Investment Value) = + − /2 1 Nominal Return Final Investment Value Initial Investment Value =−1 Nominal Return Final Investment Value Initial Investment Value Initial Investment Value = − 108 HEDGE FUND COURSE ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 108 has passed. The return earned in a full year is the sum of the returns earned in all the subperiods of the year. In its simplest form, returns partway through the year are not available for reinvestment during the period. This annualized return can be compared with simple interest rates on invest- ment alternatives. Compound Returns Many investments pay interest regularly during the life of the investment. Investors prefer to receive frequent partial payments of interest because this interest is then available for reinvestment. Compound returns account for this potential to earn interest on interest. Also, compound returns cal- culated from hedge fund returns that may not make periodic payments are important because this return can be compared directly with other invest- ment alternatives. Semiannual Compound Return Most bonds pay periodic interest pay- ments during the life of the investment. In the United States, most gov- ernment and corporate bonds pay half the annual income in two installments per year. Interest from first payments can be reinvested in the second period, so the gain to the investor is greater than in stated coupon rate. Consider the following specific example. A bond pays 10 percent inter- est and repays principal at the end of one year. The repayment in one year (per $100 bond) is $100 principal plus $10 ($100 × 10 percent) or a total of $110. This value is sometimes called the future value. Equation (7.7) shows the future value of an annual-pay bond: Future Value = Principal + (Principal × r) (7.7) which factors down to: Future value = Principal × (1 + r) (7.8) = $100 × (1.10) = $110 (7.9) If the bond paid half the coupon after six months, the investor could reinvest that amount for the second half of the year. The future value of the semiannual bond will slightly exceed the future value of the annual bond. Performance Measurement 109 ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 109 Suppose for simplicity that the coupon could be reinvested in an identical bond. The future value is given by equation (7.9): (7.10) (7.11) (7.12) Using Excel: = 1.05^2*100 produces $110.25 The semiannual bond has the same future value as an annual-pay bond with a 10.25 percent coupon. This means that a 10 percent semiannual bond has an effective annual yield of 10.25 percent. Daily Compounding In the 1970s, savings institutions used this interest-on- interest effect to pay a higher effective rate than the allowable ceiling. If a bank paid 10 percent interest compounded daily, the investor would have a balance (future value) of $110.5156 at the end of one year. The formula for daily compounding is shown in equation 7.13: (7.13) (7.14) (7.15) Future Value =+       ×+       ×+       +       =+       =+       ×= 1 365 1 365 1 365 1 365 1 365 1 10 365 100 110 5156 365 365 rrrr r K % $$. Future Value Principal Principal =+       ×+       ×         =+       × =×= 1 2 1 2 1 2 1 05 100 110 25 2 2 rr r (. ) $ $ . 110 HEDGE FUND COURSE ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 110 Using Excel: = (1 + 10%/365)^365*100 produces $110.5156 Therefore, a 10 percent interest rate paid daily is equivalent to an annual payment of 10.5156 percent. Continuous Compounding The logical limit to compounding in an account- ing system is daily. Most interest accrual systems don’t break down a year any finer than daily. However, mathematicians followed this progression from annual to semiannual to daily to the mathematical extreme. If interest could be paid every infinitesimally small fraction of a second and that in- terest was available for immediate reinvestment, the formula for the future value is given by equation (7.16): Future Value = e rT (7.16) where T is the time until repayment in years. Future Value = 2.71828 10%×1 × $100 = $100.5171 (7.17) Using Excel: = exp(10%)*100 produces $100.5171 Notice that nearly all the benefit of interest on interest has already been re- alized under daily compounding. Monthly and Quarterly Compounding Hedge fund performance is generally reported monthly or quarterly. The mathematics follows the same pattern as already described. See equations (7.18) to (7.21) for details: Quarterly: (7.18) (7.19) Future Value =+       =+       ×= 1 4 1 10 4 100 110 3813 4 4 r % $$. Performance Measurement 111 ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 111 Monthly: (7.20) (7.21) Using Excel: = (1+ 10%/4)^4*100 produces $110.3813 = (1+ 101%/12)^12*100 produces $110.4713 Finding Equivalent Interest Rates for Different Compounding Frequencies It should be clear that a particular rate can imply different economic returns, depending on the frequency of compounding. For this reason, it is not pos- sible to compare rates of different compounding frequencies without fur- ther analysis. Fortunately, it is possible to convert a rate using one compounding frequency to the equivalent rate using any other frequency. In the previous examples, a 10 percent rate was converted to the annual equivalent. The examples that follow find the rates required to attain the same effective annual rate. For example, suppose that a hedge fund has been providing an annu- alized monthly return of 10 percent. To find a semiannual rate that is equivalent, find a rate that creates the same future value after one year. Equations (7.22) to (7.25) derive the equivalent rate relative to equal fu- ture values. Find the future value from the monthly return: (7.22) Find the semiannual rate giving the same future value: (7.23) 1 104713 1 2 2 . =+       r Semiannual Future Value =+       =1 10 12 1 104713 12 % . Future Value =+       =+       ×= 1 12 1 10 12 100 110 4713 12 12 r % $$. 112 HEDGE FUND COURSE ccc_mccrary_ch07_107-126.qxd 10/7/04 1:35 PM Page 112 [...]... August September October November December 1 .50 % –3.00% 3. 75% 7 .50 % 7.20% 9.00% 5. 80% 1.80% 6.90% –1.80% 0.20% 5. 10% Wealth Relative High-Water Mark 1.0 150 0.9846 1.02 15 1.0981 1.1771 1.2831 1.2087 1.2304 1.3 153 1.2916 1.2942 1.2282 1.0 150 1.0 150 1.02 15 1.0981 1.1771 1.2831 1.2831 1.2831 1.3 153 1.3 153 1.3 153 1.3 153 Drawdown 0.00% –3.00% 0.00% 0.00% 0.00% 0.00% 5. 80% –4.10% 0.00% –1.80% –1.60% –6.62%... curve is, in fact, a map of probabilities of such outcomes.4 4 .50 0 4.000 Portfolio 1 µ = 10% σ = 10% 3 .50 0 Probability 3.000 2 .50 0 2.000 Portfolio 1 Probability of Loss = 15. 9% 1 .50 0 Portfolio 2 µ = 15% σ = 20% 1.000 0 .50 0 Portfolio 2 Probability of Loss = 22.7% 0.000 –100% – 75% 50 % – 25% 0% Return FIGURE 7.1 Normal Distributions 25% 50 % 75% 100% 119 Performance Measurement Other Statistical Models of... may be accurate 114 HEDGE FUND COURSE AVERAGING RETURNS Hedge fund investors generally want to know how well a fund has performed over a period of time, so that the return is not overly influenced by short-term performance This performance may be the basis of comparison between two hedge funds of the same strategy or between two hedge fund strategies, or comparison of a hedge fund against a benchmark... (i.e., one hedge fund) Some managers sponsor more than one hedge fund In particular, a 130 HEDGE FUND COURSE manager may have mirror funds in the United States and offshore that carry nearly identical positions Some managers may also run separate accounts for certain investors with positions that closely resemble the hedge fund managed in parallel These relationships could require a hedge fund manager... contrast, investors in an exempt hedge fund are only protected from fraud, and managers are charged with few duties beyond honesty and fairness Not surprisingly, hedge fund managers avoid being classified as managers of plan assets If plan assets comprise 25 percent or more of a hedge fund, the hedge fund is deemed to be plan assets and the manager and the fund are controlled by ERISA Hedge funds monitor... still provide useful information about the risk of a hedge fund portfolio Hedge fund practitioners have developed several alternative measures of hedge fund portfolio risk 120 HEDGE FUND COURSE Largest Losing Month and Drawdown This measure calculates the largest cumulative loss on a hedge fund portfolio In the example in Table 7.1, the largest loss was 5. 8 percent Usually, these loss statistics are calculated... Wealth Relative January February March April May June July August September October November December 1 .50 % –3.00% 3. 75% 7 .50 % 7.20% 9.00% 5. 80% 1.80% 6.90% –1.80% 0.20% 5. 10% 1.0 150 0.9846 1.02 15 1.0981 1.1771 1.2831 1.2087 1.2304 1.3 153 1.2916 1.2942 1.2282 (7.30) (7.31) (7.32) 116 HEDGE FUND COURSE Using Excel: = 1.2282^(1/12) – 1 (Monthly) produces 1.73% Notice that the geometric average is lower... CHAPTER 8 Hedge Fund Legislation and Regulation he laws and regulations affecting a hedge fund represent one of the most complex topics addressed in this course book One law firm that sets up hedge funds and provides legal services to hedge funds created a handbook1 for its clients totaling 56 3 pages, with promises to produce at least a second volume to complete the tutorial In contrast, this course book... 10 11 12 1 .50 % –3.00% 3. 75% 7 .50 % 7.20% 9.00% 5. 80% 1.80% 6.90% –1.80% 0.20% 5. 10% Total Arithmetic Average 22. 15% 1. 85% 1 15 Performance Measurement Calculating the Geometric Mean Return Table 7.2 extends the monthly performance from Table 7.1 The “Wealth Relative” column represents a $1 investment in the fund with reinvestment At the end of one year, $1 grows to $1.2282 Obviously, the fund has produced... AND CONCLUSION Hedge funds are intensely interested in performance measurement Because fees are high in hedge funds, funds are pressured to perform well Some investors may be willing to experience high levels of risk with their hedge fund assets, but all investors want to get as high a return as possible for the amount of risk assumed Performance is the largest motivator influencing investors to make . of such outcomes. 4 118 HEDGE FUND COURSE FIGURE 7.1 Normal Distributions 4 .50 0 4.000 3 .50 0 3.000 2 .50 0 2.000 1 .50 0 1.000 0 .50 0 0.000 –100% – 75% 50 % – 25% 0% 25% 50 % 75% 100% Probability Return Portfolio. =+       ×+       ×+       +       =+       =+       ×= 1 3 65 1 3 65 1 3 65 1 3 65 1 3 65 1 10 3 65 100 110 51 56 3 65 3 65 rrrr r K % $$. Future Value Principal Principal =+       ×+       ×         =+       × =×= 1 2 1 2 1 2 1 05. average (1. 85 percent) is also called the simple average or un- weighted average. 114 HEDGE FUND COURSE TABLE 7.1 Monthly Hedge Fund Performance Month Return 1 1 .50 % 2 –3.00% 3 3. 75% 4 7 .50 % 5 7.20% 6