The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

APPLICATIONS OF OTC EQUITY DERIVATIVES

The array of OTC derivative-based equity portfolio management strategies cuts across the two primary categories of investment philosophy—active and passive management. We consider several strategies in this section, which are listed in Exhibit 15.1, together with the purpose of using an OTC derivatives and a product candidate.

Exhibit 15.2 summarizes various OTC equity derivative structures in terms of the role of derivatives for long-term investors and hedgers.²⁶⁹ A broad spectrum of equity investment activities emanating from the role of derivatives can benefit from these three basic categories of OTC equity derivative structures: options and exotics, equity-linked notes and equity swaps.

EXHIBIT 15.1 The Use of OTC Derivatives for Equity Strategies

Equity Strategy		Purpose	Product Candidate
Return-enhancement strategies		Outperform benchmark	Equity swap
Hedging strategies		Risk management	Exotics, swaps, debta
Spread strategies		Risk management	Equity swaps, exotics
Market access strategies		Reduce costs	Swaps, debt, warrants, exotics
Changing equity exposure		Reduce costs
Index funds		Outperform benchmark	Swaps, debt, exotics
Standard	Swaps, debt
Enhanced
Style
Asset allocation		Risk management	Swaps
Active manager transition		Cost management	Swaps, exotics
aDebt refers to equity-linked debt products.

Creation of Structured Product Solutions

One of the most important applications of derivative securities is in the creation of structured product solutions to the ...