Question #17

Adding a 20% allocation to a hedge fund strategy in a traditional portfolio typically leads to the portfolio having lower volatility, higher risk-adjusted return as measured as a Sharpe ratio or Sortino ratio, and lower maximum drawdown. It does not typically increase the overall return of the portfolio. (Module 34.4, LOS 34.i) Leigh Winstanton is a relative value hedge fund manager. She is currently analyzing government bond and swaps markets for pricing discrepancies, collating the data displayed as follows: 5-year Treasury Inflation-Protected Securities (TIPS) coupon rate: 1% (priced at par) 5-year Treasury bond coupon rate: 3% (priced at par) 5-year inflation swap fixed rate: 1.5% Winstanton also engages in convertible bond arbitrage trades. She collates data on a potential convertible arbitrage trade in the securities of Triste, Inc. (TST), a medium-sized manufacturer of agricultural equipment, displayed as follows: TST has in issue a 2-year 4% annual coupon convertible bond, priced at 115 The conversion ratio of the TST convertible bond is 25 shares per USD 1,000 par Current price of TST shares is USD 50 per share Borrowing costs are USD 0.60 per year, per share Dividend per share is expected to be USD 1 per year, per share Winstanton is investigating whether there is an immediate arbitrage opportunity from buying the convertible bond and converting into shares. Winstanton is also interested in how carrying this convertible bond arbitrage position through time will likely affect the profitability of the trade. Winstanton is looking to hire a volatility trader to execute trades with the objective of hedging the exposure of the fund's existing relative value positions to large, unexpected movements in spreads and prices in times of market stress.