Managing Hedge Fund Risk and Financing: Adapting to a New Era

Relative value Strategies

Relative value strategies seek to profit from mis-pricings of related securities. These mis-pricings may be identified based on a theoretical arbitrage free formula, statistical analysis of historical relationships, or fundamental analysis. These strategies are engineered to profit when a particular set of securities return or move to their historical or theoretically correct comparative value relationship. Relative value strategies seek to have little or no exposure to the underlying equity or bond markets. They tend to be market- or beta-neutral. Below we present analysis of a variety of such strategies.

Convertible Arbitrage Strategies

These funds manage positions in convertible instruments and their issuers' underlying equity to create portfolios that tend to be equity market neutral. Convertible instruments are typically convertible bonds, warrants or convertible preferred shares which are most often exchangeable into common stock of the issuer. The plain vanilla convertible arbitrage strategy involves taking a long position in a convertible bond and shorting the issuer's stock. It is possible to reverse this strategy (go long on the underlying and short on the bond), but this is less common. The latter is also often fairly expensive, even when the opportunity does arise to use it, because it is likely to have a negative carrying cost.

One goal of this strategy is neutralize the equity sensitivity inherent in the option that is embedded within this ...