Beruflich Dokumente
Kultur Dokumente
What is Arbitrage?
Arbitrage, in its truest form, involves earning a riskfree profit without the outlay of any capital.
An astute investor would recognize the arbitrage opportunity here and spend
$1 to buy 1.5. They would then go to London and buy (1.5x1.4)= 2.1. They
would then go back to NY and buy ( 2.1/2)=$1.05. In the process they have
made a $0.05 risk-less profit.
5
Difference: Data alone isnt enough. One needs to process the data
into information based on complex models.
MERGER ARBITRAGE
Merger Arbitrage
May 6, 1998
Purchase Target Companys Stock
One (1) share Chrysler @ $59.88
(closing price on May 6 = $59.88)
+$66.60
- $59.88
$ 6.72
12
Annualized
Return since
inception
Correlatio
n with
MSCI
World ($)
Sharpe Ratio
7.89%
0.46
0.95
Convertible Arbitrage
(since 1994)
8.82%
0.12
1.03
6.66%
0.04
0.75
10.10%
0.36
2.1
7.71%
0.27
recent years it is likely that the use of arbitrage strategies will only
increase and in the process become less foreign to the average
investor.
14
Appendix 1
Illustration of another Arbitrage
Strategy
16
Appendix 2
17
18
19
20
Convertible Arbitrage
This strategy looks for mispricing between a convertible security
and the underlying stock. Convertible securities have a theoretical
value that is based on a number of factors, including the value of
the underlying stock. When the trading price of a convertible
moves away from its theoretical value, an arbitrage opportunity
exists. Hedge funds focusing on convertible arbitrage would
typically buy an undervalued convertible and sell the underlying
stock short in anticipation of either the stock moving down in value
to match the convertible, or the convertible moving up in value to
match the price of the stock. The movement of either the
convertible security or the underlying stock generates profit for the
hedge fund when the values of the two securities move towards
their intrinsic values, while the short sale of the underlying stock
helps to protect against stock specific and general market risk.
Certain convertible hedge fund managers make use of hedging
instruments to provide additional protection against credit risk.
21
Event Arbitrage
22
23
Mortgage-Backed Securities
Arbitrage
Mortgage-Backed Securities Arbitrage is a subset of fixed
income arbitrage. The strategy generally involves the
purchase of mortgage-backed securities and the short sale of
other fixed income securities of the same term, such as
government bonds.
24
Option Arbitrage
Option Arbitrage commonly refers to an equity trading
strategy utilizing options, such as calls, puts, and warrants.
The value of an option and the way it is priced in the market
is based on sophisticated pricing models involving a number
of variables including volatility, share price, exercise price,
time to option expiration, and the risk free rate. Volatility is a
measure of the tendency of a market price or yield to vary
over time. As volatility is usually the only variable not known
with certainty in advance, arbitrage opportunities may arise
when the theoretical and market values of volatility differ.
Volatility traders profit from the difference between the
volatility priced into an option and the volatility actually
realized in the market. The strategy involves buying options
deemed to be under priced on a volatility basis and selling
overpriced options.
25
Statistical Arbitrage
Short-term pricing misalignments in financial instruments
occur daily. These divergences are typically small and of
short duration, and the costs of execution would normally
offset the potential profit. Statistical arbitrage managers use
proprietary models to identify securities that are mispriced
relative to other securities with similar trading
characteristics. The source of return is the models ability to
use available information efficiently while maintaining very
low execution costs. By tracking a vast number of market
inefficiencies simultaneously, the aim is to exploit several
such inefficiencies to generate returns in excess of
transaction costs.
26