fi (convertible arbitrage)
DESCRIPTION
TRANSCRIPT
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This projector is working...
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Susanny’s Final Presentation in SMU...
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FNCE204: Analysis of Fixed IncomePrepared for Prof Thong Tiong Yang
Chris Tan Kok Yong | Kumara Velan S/O Suppiah | Kwok Kin Fei | Leonardi Susanny
A presentation by TY ‘Da Vinci’ Thong Fund...
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WHAT’S THE AGENDA?
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WHAT’S THE AGENDA?
Introduction to Convertible Bonds
Convertible DebtArbitrage Techniques
Risks Exposure
The ‘Da Vinci’ Code
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INTRODUCTION TO CONVERTIBLE BONDS
Con
vert
ible
Bon
ds
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INTRODUCTION TO CONVERTIBLE BONDS
A type of bond that allows holder to convert into shares at
conversion price
Con
vert
ible
Bon
ds
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INTRODUCTION TO CONVERTIBLE BONDS
3 outcomes of a convertible bond
At the money
In the money
Out of the moneyCon
vert
ible
Bon
ds
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WHY ISSUE CONVERTIBLE BONDS?
Con
vert
ible
Bon
ds
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WHY ISSUE CONVERTIBLE BONDS?
Minimize negative investor interpretation
Less equity dilution compared to rights issue
Lower fixed-rate borrowing costs
Increase total level of debt-gearing
1 2
3 4
Con
vert
ible
Bon
ds
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INTRO TO CONVERTIBLE DEBT ARBITRAGE
Con
vert
ible
Bon
ds
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INTRO TO CONVERTIBLE DEBT ARBITRAGE
Exploit mispricing in convertible bonds (CB)
21 French CBs were underpriced by 3%
103 US listed CBs were undervalued by 4%
Con
vert
ible
Bon
ds
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INTRO TO CONVERTIBLE DEBT ARBITRAGE
Exploit mispricing in convertible bonds (CB)
A result from the difficulty in valuing option
To price attractively to ensure demand
Con
vert
ible
Bon
ds
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NUMERICAL EXAMPLE
Con
vert
ible
Bon
ds
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NUMERICAL EXAMPLE
5% Coupon Rate, Annually1 year maturity
Convertible Ratio of 50 ABC shares ($20)Short 25 ABC shares
Share Price Unchanged Share Price Rise to $30 Share Price Drop to $10
Profit from Conversion $0 $500 $0
Profit/Loss from Short Sale $0 -$250 $250
Coupon Received $50 $50 $50
2% Interest from Short Sale $10 $10 $10
1% Interest to Broker -$5 -$5 -$5
Profit $55 $305 $305
% return 5.5% 30.5% 30.5%Con
vert
ible
Bon
ds
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Convertible Debt Arbitrage Techniques
DELTA NEUTRAL HEDGE
GAMME CAPTURE HEDGE
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DELTA NEUTRAL HEDGE
Arb
itrag
e Te
chni
ques
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DELTA NEUTRAL HEDGE
Long Convertible Bond
Short Underlying Stock at current Delta
Delta ( )CVS
=
Arb
itrag
e Te
chni
ques
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DELTA NEUTRAL HEDGE
Long Convertible Bond
Short Underlying Stock at current Delta
Delta ( )CVS
=
Yield no profit or loss from stock price movement
Capture cash flows from coupon and interest
Arb
itrag
e Te
chni
ques
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BEGINNING POSITION
Del
ta N
eutra
l Hed
ge
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BEGINNING POSITION
Position Quantity Price Value Profit / Loss
Convertible Long Position
1000 1000 $1,000,000
Short Stock Position
16000 40 -$640,000
Stock Price Moves 1%
Convertible Long Position
1000 1006.4 $1,006,400 $6,400
Short Stock Position
16000 40.4 -$646,400 -$6,400
Net Profit / Loss $ - Delta = 0.64Del
ta N
eutra
l Hed
ge
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CHANGE IN DELTA AS STOCK PRICE CHANGES
Del
ta N
eutra
l Hed
ge
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CHANGE IN DELTA AS STOCK PRICE CHANGES
Position Quantity Price Value Profit / Loss
Convertible Long Position
1000 1006.4 $1,006,400
Short Stock Position
16000 40.4 -$646,400
Stock Price Moves another 1%
Convertible Long Position
1000 1012.89 $1,012,890 $6,490
Short Stock Position
16000 40.8 -$652,800 -$6,400
Net Profit / Loss $90Delta = 0.651Del
ta N
eutra
l Hed
ge
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RE-BALANCING REQUIRED
Del
ta N
eutra
l Hed
ge
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RE-BALANCING REQUIRED
Position Quantity Price Value Profit / Loss
Convertible Long Position
1000 1006.4 $1,006,400
Short Stock Position
16225 40.4 -$655,490
Stock Price Moves 1%
Convertible Long Position
1000 1012.89 $1,012,890 $6,490
Short Stock Position
16225 40.8 -$661,980 -$6,490
Net Profit / Loss $ -Delta = 0.651Del
ta N
eutra
l Hed
ge
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GAMMA-CAPTURE HEDGE
Arb
itrag
e Te
chni
ques
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GAMMA-CAPTURE HEDGE
Long Convertible Bond
Short Underlying Stock at current DeltaSame as Delta Hedge
Arb
itrag
e Te
chni
ques
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GAMMA-CAPTURE HEDGE
Long Convertible Bond
Short Underlying Stock at current DeltaSame as Delta Hedge
However
Hedging ratio is different in order to capture Gamma
CV= Gamma ( )
S2
2
Sacrifice some cash flow for greater capital gain
Arb
itrag
e Te
chni
ques
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BULLISH-GAMMACAPTURE HEDGE
Quantity Price Value Convertible Long Position 100 950 $95,000
Short Stock Position -700 53 -$37,100
Downside Target Price Current Price Upside Current PriceStock Price $35.50 $53.00 $79.05
Convertible Price $830.00 $950.00 $1,192.50Delta 0.3 0.54 0.75
P/L Convertible -$12,000.00 $ - $24,250.00P/L Stock $12,250.00 $ - -$18,235.00Coupons $4,250.00 $4,250.00 $4,250.00
Stock Dividends $ - $ - $ -Short Credit Interest $1,394.00 $1,669.50 $2,080.00
Total P/L $5,894.00 $5,919.50 $12,345.0012 month ROI 6.20% 6.23% 12.99%
Gam
ma
Cap
ture
Hed
ge
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Risk Exposures
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NOT FOOL-PROOF!
Risk
Exp
osur
es
Source: Dow Jones Hedge Fund Strategy Benchmarks : Convertible Arbitrage Fact Sheet
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NOT FOOL-PROOF!
Risk
Exp
osur
es
Source: Dow Jones Hedge Fund Strategy Benchmarks : Convertible Arbitrage Fact Sheet
-30
-22.5
-15
-7.5
0
7.5
1/02 7/02 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 7/07 1/08 7/08
Monthly Returns After Fees(%)
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NOT FOOL-PROOF!
Risk
Exp
osur
es
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NOT FOOL-PROOF!
Risk
Exp
osur
es
Default Risk1
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NOT FOOL-PROOF!
Risk
Exp
osur
es
Default Risk1
Unwinding their positions prior to realizing bond’s fundamental
values
2
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit
Equity Market
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
Liquidity
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
Currency
Liquidity
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TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Execution
Equity Market
Interest Rate
Currency
Liquidity
Sunday, July 11, 2010
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The ‘Da Vinci’ Code
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Carryt
current income of delta neutral position
financing cost of delta neutral position
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
current income of delta neutral position financing cost of delta neutral position
(Bt*Cyt)+(deltat*Bt*OBRt- s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
(Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
(Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
Current yield of bond at time t
Short financing charge
Capital base required to
establish position
Price of convertible bond at time t
Overnight bank rate
Dividend compensation paid to stock lender as percentage of Bt
Leverage rate
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0
::Condition for starting the carry strategy::
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POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0
::Condition for starting the carry strategy::
Position is held until this condition is rendered
void!
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CALCULATING RETURNS
The
‘Da
Vin
ci’ C
ode
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CALCULATING RETURNS
The
‘Da
Vin
ci’ C
ode
Vt = Bt - SStMarked-to-market
portfolio value for day t deltat*Bt
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CALCULATING RETURNS
The
‘Da
Vin
ci’ C
ode
Vt = Bt - SStMarked-to-market
portfolio value for day t deltat*Bt
Rt = ((Vt - Vt - 1) + (SSt-1*OBRt – s – dyt)-(Bt-1-Capt-1)*Lt-1)
Capt-1
::Therefore::
Daily return on the positive carry trade
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OPTIMIZING
The
‘Da
Vin
ci’ C
ode
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OPTIMIZING
The
‘Da
Vin
ci’ C
ode
CFDs as proxies for shorting
(deltat*Bt*OBRt – s – dyt)
((0.9*deltat*Bt*OBRt)-dyt)
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OPTIMIZING
The
‘Da
Vin
ci’ C
ode
Minimizing Lt
(Capt*OBRt + (Bt – Capt)*Lt)
Bt*OBRt
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OPTIMIZING
The
‘Da
Vin
ci’ C
ode
Maximizing OBRt
((0.9*deltat*Bt*OBRt)-dyt)
(20(0.9*deltat*Bt*OBRt) – dyt)
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REAL LIFEAPPLICATION
The
‘Da
Vin
ci’ C
ode
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REAL LIFEAPPLICATION
The
‘Da
Vin
ci’ C
ode
Issue Date 16 October 2009
Conversion Price $3.0853/share
Min. Denomination US$100,000
Issue Price 1.0 Par
Board Lot Size US$200,000
Fixed Exchange Rate S$1.440=US$1.00
Conversion Ratio 93,345.8659
Overnight Bank Rate 0.2796%
Singapore Prime rate 5%
Delta 0.6
Capital Base 15% of long position
Olam 6% CB 15102016
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REAL LIFEAPPLICATION
(RESULTS)
The
‘Da
Vin
ci’ C
ode
Carryt
OCt
Return
Fund Management Fees (20/2)
-$23,241.8
$87,400
58.26%
$148,172
Sunday, July 11, 2010
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REAL LIFEAPPLICATION
(RESULTS)
The
‘Da
Vin
ci’ C
ode
Carryt
OCt
Return
Fund Management Fees (20/2)
-$23,241.8
$87,400
58.26%
$148,172
BOOMZ!
Sunday, July 11, 2010
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Q & A
Sunday, July 11, 2010
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Q & A
A presentation by TY ‘Da Vinci’ Thong Fund...
Sunday, July 11, 2010