Sample Paper

Hedge Fund Strategies – Final Examination (Prof. Vedpurisar)

Total Marks: 50 Marks

Time Allocated: 2 Hours (February 4, 2011)

Open Notes, Laptop, Internet

Part A (Applied Theory): 20 Marks

Question 1 - GDP growth, inflation and unemployment data are what global macro hedge fund traders keep studying very closely. Visualize different scenarios for the global economy, given today’s situation and explain how they will affect the commodity, bond and stock markets. If you are a hedge fund trader, what kind of strategies would make sense? Please answer in not more than 10 sentences. (10 Marks)

Question 2 - Hedge funds try to generate superior returns by combining alpha and alternatives beta. In the process, they assume many risks which must be managed carefully. Mention briefly the key learnings from the failure of:

ü Amarnath (5 Marks)

ü LTCM (5 Marks)

Your answer must not exceed 5 sentences for each part.

Part B (Problems): 30 Marks

Question 1 – Consider a hedge fund trader who is long on the following portfolio. The delta of a put is currently 0.4 while that of a call is 0.3. What should the trader do to make it a market neutral portfolio? Will any risk still remain? (4 Marks)

Type	Quantity
Long	200 Shares
Long	40 Put Options
Short	150 Call Options
Long	60 Call Options

Question 2 – Based on a stock’s daily closing prices (in $) for the past 6 month, you established the daily volatility to be 0.2. A call option on the stock with a daily implied volatility of 0.03 is trading. Is there a possibility to do volatility arbitrage? (5 Marks)

Question 3 – A trader embarks on an arbitraging strategy in the fixed income market. The 1 year treasury bond is yielding 3.50% while the repo rate is 3.25%. In the inter-bank interest rate swap market, the quote is 3.85%/3.95% vs LIBOR. The LIBOR is currently quoting 3.75%. What kind of position can the trader take? (5 Marks)

Question 4 – The 3 month T-Bill instrument is yielding 3.5% while the 6 month one is yielding 4.5%. At the same time, the 3 month T Bill futures, maturing 3 months from now are currently quoting 4%. IS there any possibility of arbitrage for a hedge fund trader? How much the bets change if the futures were quoting 6%? (5 Marks)

Question 5 – A convertible bond which will fetch 4 shares each on conversion is currently quoting 98. The shares are quoting 35. What would be a typical arbitraging strategy? If after 3 months, the bond is converted and the prices are as follows, what is the profit in the following situations? (6 Marks)

ü Bond 105, Stock 36.5

ü Bond 90, Stock 32

Question 6 – After a merger has been announced, the target company’s stock price rises to 40 from the level of 30 before the announcement. If the bid price is 45, what is the probability of the merger succeeding as per the markets? If a risk arbitrageur decides to profit from the opportunity, what would be the strategy? (5 Marks)