fi (convertible arbitrage)
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Sunday, July 11, 2010
Sunday, July 11, 2010
Susanny’s Final Presentation in SMU...
Sunday, July 11, 2010
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...
Sunday, July 11, 2010
WHAT’S THE AGENDA?
Sunday, July 11, 2010
WHAT’S THE AGENDA?
Introduction to Convertible Bonds
Convertible DebtArbitrage Techniques
Risks Exposure
The ‘Da Vinci’ Code
Sunday, July 11, 2010
INTRODUCTION TO CONVERTIBLE BONDS
Con
vert
ible
Bon
ds
Sunday, July 11, 2010
INTRODUCTION TO CONVERTIBLE BONDS
A type of bond that allows holder to convert into shares at
conversion price
Con
vert
ible
Bon
ds
Sunday, July 11, 2010
INTRODUCTION TO CONVERTIBLE BONDS
3 outcomes of a convertible bond
At the money
In the money
Out of the moneyCon
vert
ible
Bon
ds
Sunday, July 11, 2010
WHY ISSUE CONVERTIBLE BONDS?
Con
vert
ible
Bon
ds
Sunday, July 11, 2010
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
Sunday, July 11, 2010
INTRO TO CONVERTIBLE DEBT ARBITRAGE
Con
vert
ible
Bon
ds
Sunday, July 11, 2010
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
Sunday, July 11, 2010
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
Sunday, July 11, 2010
NUMERICAL EXAMPLE
Con
vert
ible
Bon
ds
Sunday, July 11, 2010
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
Sunday, July 11, 2010
Convertible Debt Arbitrage Techniques
DELTA NEUTRAL HEDGE
GAMME CAPTURE HEDGE
Sunday, July 11, 2010
DELTA NEUTRAL HEDGE
Arb
itrag
e Te
chni
ques
Sunday, July 11, 2010
DELTA NEUTRAL HEDGE
Long Convertible Bond
Short Underlying Stock at current Delta
Delta ( )CVS
=
Arb
itrag
e Te
chni
ques
Sunday, July 11, 2010
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
Sunday, July 11, 2010
BEGINNING POSITION
Del
ta N
eutra
l Hed
ge
Sunday, July 11, 2010
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
Sunday, July 11, 2010
CHANGE IN DELTA AS STOCK PRICE CHANGES
Del
ta N
eutra
l Hed
ge
Sunday, July 11, 2010
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
Sunday, July 11, 2010
RE-BALANCING REQUIRED
Del
ta N
eutra
l Hed
ge
Sunday, July 11, 2010
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
Sunday, July 11, 2010
GAMMA-CAPTURE HEDGE
Arb
itrag
e Te
chni
ques
Sunday, July 11, 2010
GAMMA-CAPTURE HEDGE
Long Convertible Bond
Short Underlying Stock at current DeltaSame as Delta Hedge
Arb
itrag
e Te
chni
ques
Sunday, July 11, 2010
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
Sunday, July 11, 2010
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
Sunday, July 11, 2010
Risk Exposures
Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk
Exp
osur
es
Source: Dow Jones Hedge Fund Strategy Benchmarks : Convertible Arbitrage Fact Sheet
Sunday, July 11, 2010
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(%)
Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk
Exp
osur
es
Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk
Exp
osur
es
Default Risk1
Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk
Exp
osur
es
Default Risk1
Unwinding their positions prior to realizing bond’s fundamental
values
2
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit
Equity Market
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
Liquidity
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Equity Market
Interest Rate
Currency
Liquidity
Sunday, July 11, 2010
TYPES OF RISKS INVOLVED
Risk
Exp
osur
es
Risks
Credit Leverage
Execution
Equity Market
Interest Rate
Currency
Liquidity
Sunday, July 11, 2010
The ‘Da Vinci’ Code
Sunday, July 11, 2010
POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Carryt
current income of delta neutral position
financing cost of delta neutral position
Sunday, July 11, 2010
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)
Sunday, July 11, 2010
POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
(Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt)
Sunday, July 11, 2010
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
Sunday, July 11, 2010
POSITIVE CARRY MODEL
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
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::
Sunday, July 11, 2010
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!
Sunday, July 11, 2010
CALCULATING RETURNS
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
CALCULATING RETURNS
The
‘Da
Vin
ci’ C
ode
Vt = Bt - SStMarked-to-market
portfolio value for day t deltat*Bt
Sunday, July 11, 2010
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
Sunday, July 11, 2010
OPTIMIZING
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
OPTIMIZING
The
‘Da
Vin
ci’ C
ode
CFDs as proxies for shorting
(deltat*Bt*OBRt – s – dyt)
((0.9*deltat*Bt*OBRt)-dyt)
Sunday, July 11, 2010
OPTIMIZING
The
‘Da
Vin
ci’ C
ode
Minimizing Lt
(Capt*OBRt + (Bt – Capt)*Lt)
Bt*OBRt
Sunday, July 11, 2010
OPTIMIZING
The
‘Da
Vin
ci’ C
ode
Maximizing OBRt
((0.9*deltat*Bt*OBRt)-dyt)
(20(0.9*deltat*Bt*OBRt) – dyt)
Sunday, July 11, 2010
REAL LIFEAPPLICATION
The
‘Da
Vin
ci’ C
ode
Sunday, July 11, 2010
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
Sunday, July 11, 2010
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
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
Q & A
Sunday, July 11, 2010
Q & A
A presentation by TY ‘Da Vinci’ Thong Fund...
Sunday, July 11, 2010