1. Hedge FundsHedge Funds

2. AgendaAgenda
Hedge Funds an OverviewHedge Funds an Overview
Type of Hedge FundsType of Hedge Funds
Hedge Funds StrategiesHedge Funds Strategies
 Equity Long/ShortEquity Long/Short
 Distress SecuritiesDistress Securities
 Convertible ArbitrageConvertible Arbitrage
 Fixed Income ArbitrageFixed Income Arbitrage
 Global MacroGlobal Macro
 Merger ArbitrageMerger Arbitrage

3. Hedge Funds StrategiesHedge Funds Strategies

4. Hedge fund strategy-CategoriesHedge fund strategy-Categories

5. Relative Value strategiesRelative Value strategies
 Take advantage of relative pricing discrepanciesTake advantage of relative pricing discrepancies
between instruments such as equities, debt, optionsbetween instruments such as equities, debt, options
and futures.and futures.
 Managers may use mathematical, fundamental, orManagers may use mathematical, fundamental, or
technical analysis to arrive at valuation differences.technical analysis to arrive at valuation differences.
 Securities may be mispriced relative to theSecurities may be mispriced relative to the
underlying security, related securities, groups ofunderlying security, related securities, groups of
securities or overall market.securities or overall market.
 Many hedge funds in this category use leverageMany hedge funds in this category use leverage
and seek opportunities globally.and seek opportunities globally.

6. Event Driven strategiesEvent Driven strategies
 Investing in opportunities created by significant corporateInvesting in opportunities created by significant corporate
events, such as mergers and acquisitions, bankruptcyevents, such as mergers and acquisitions, bankruptcy
reorganisations and share buybacks.reorganisations and share buybacks.
 Leverage may be used by some managers to increaseLeverage may be used by some managers to increase
the exposure to an investment.the exposure to an investment.
 Fund managers may hedge against downside marketFund managers may hedge against downside market
risk by using derivative strategies such as purchasingrisk by using derivative strategies such as purchasing
put options or put option spreads.put options or put option spreads.

7. Directional strategiesDirectional strategies
 Buying and/or selling a security or financial instrumentBuying and/or selling a security or financial instrument
believed to be significantly under-priced or over-pricedbelieved to be significantly under-priced or over-priced
by the market, relative to its potential value.by the market, relative to its potential value.
 This discipline may concentrate on a specific company,This discipline may concentrate on a specific company,
industry or country.industry or country.
 The strategy most familiar to investors is the long/shortThe strategy most familiar to investors is the long/short
(hedged equity) strategy, which typically involves a core(hedged equity) strategy, which typically involves a core
holding of equities which the manager owns (‘longholding of equities which the manager owns (‘long
positions’) hedged at all times with short positions (salepositions’) hedged at all times with short positions (sale
of equities borrowed, not owned) giving the portfolio anof equities borrowed, not owned) giving the portfolio an
overall long or short exposure.overall long or short exposure.

8. Directional StrategyDirectional Strategy
Equity Long/ ShortEquity Long/ Short

9. Define- Equity Long/ShortDefine- Equity Long/Short
 Long/short equity is an investment strategy, which earnsLong/short equity is an investment strategy, which earns
return from stock picking, and isolates the risk (as wellreturn from stock picking, and isolates the risk (as well
as the return) of a particular stock from the risk/return ofas the return) of a particular stock from the risk/return of
the broader market or industry of which it is a part.the broader market or industry of which it is a part.
 The trade would involve purchasing the shares in one ofThe trade would involve purchasing the shares in one of
the companies (going ‘long’) and selling the competitorthe companies (going ‘long’) and selling the competitor
short.short.

10. Strategy OverviewStrategy Overview
 Picking stocks which are sufficiently balanced to keepPicking stocks which are sufficiently balanced to keep
the portfolio buffered from a severe market swing.the portfolio buffered from a severe market swing.
 Baskets of long and short investments are beta neutral.Baskets of long and short investments are beta neutral.
 Market-neutral long/short equity trading balance theirMarket-neutral long/short equity trading balance their
longs and shorts in the same sector or industry.longs and shorts in the same sector or industry.
 The key to the success of this strategy is the fundThe key to the success of this strategy is the fund
manager’s ability to select a basket of long stocks thatmanager’s ability to select a basket of long stocks that
will perform better than the basket of shorts.will perform better than the basket of shorts.
 Quantitative analysis is the most common method forQuantitative analysis is the most common method for
identifying optimal long and short positions, some hedgeidentifying optimal long and short positions, some hedge
fund managers rely on fundamental analysis,fund managers rely on fundamental analysis,
systematically analyzing industries and companies tosystematically analyzing industries and companies to
find those on the brink of positive, or negative, change.find those on the brink of positive, or negative, change.

11. Strategy Overview- Contd.Strategy Overview- Contd.
 One strategy known as "One strategy known as "pairs tradingpairs trading" matches its" matches its
long and short investments one pair at a time.long and short investments one pair at a time.
 This tendency to earn small, steady gains characterizesThis tendency to earn small, steady gains characterizes
market neutral long/short equity funds in general,market neutral long/short equity funds in general,
resulting in annual returns of about 10-12 percent,resulting in annual returns of about 10-12 percent,
unlevered.unlevered.
 Strong stock-picking ability – can provide consistentlyStrong stock-picking ability – can provide consistently
good performance in any market and even excel in agood performance in any market and even excel in a
market decline, which, in today’s investment climate, ismarket decline, which, in today’s investment climate, is
an attractive feature to investors.an attractive feature to investors.
 Long/ short equity funds posted average returns of 12.6Long/ short equity funds posted average returns of 12.6
percent for three years 2003-2005 according to HFR.percent for three years 2003-2005 according to HFR.

12. Equity Long/Short – Example - 1Equity Long/Short – Example - 1
 A long/short fund manager might sell short oneA long/short fund manager might sell short one
automobile industry stock, while buying (automobile industry stock, while buying (taking a longtaking a long
positionposition) on another -- short of DaimlerChrysler, long on) on another -- short of DaimlerChrysler, long on
Ford.Ford.
 Thereafter, any general development that improves theThereafter, any general development that improves the
yield of auto industry stocks in general will help thisyield of auto industry stocks in general will help this
fund's Ford position, but will hurt its DaimlerChryslerfund's Ford position, but will hurt its DaimlerChrysler
position.position.
 The two positions are offsetting, so the portfolio isThe two positions are offsetting, so the portfolio is
hedgedhedged against developments that affect the autoagainst developments that affect the auto
industry in general.industry in general.

13. Equity Long/Short – Example - 2Equity Long/Short – Example - 2
 Imagine McDonald’s has just come out with a low-fatImagine McDonald’s has just come out with a low-fat
burger. Burger King’s new fat-free burger, on the otherburger. Burger King’s new fat-free burger, on the other
hand, is dry and tasteless, producing moans in the backhand, is dry and tasteless, producing moans in the back
seat.seat.
 So, sensing a trend here, you rush out and buy $5,000So, sensing a trend here, you rush out and buy $5,000
worth of McDonald’s stock and sell short $5,000 ofworth of McDonald’s stock and sell short $5,000 of
Burger King.Burger King.
 if the market goes up, both McDonald’s and Burger Kingif the market goes up, both McDonald’s and Burger King
positions will rise in price, but McDonald’s should risepositions will rise in price, but McDonald’s should rise
more provided the analysis is correct and is ultimatelymore provided the analysis is correct and is ultimately
recognized by other investors.recognized by other investors.
 Thus, the profit from the McDonald’s position will moreThus, the profit from the McDonald’s position will more
than offset the loss from the short position in Burgerthan offset the loss from the short position in Burger
King.King.
 As a bonus, we will receive a rebate from broker on theAs a bonus, we will receive a rebate from broker on the
short position (typically the risk-free rate of interest).short position (typically the risk-free rate of interest).

14. Equity- Long/ Short- TradesEquity- Long/ Short- Trades
 Long “good stocks”/short “bad stocks” For Eg. InfosysLong “good stocks”/short “bad stocks” For Eg. Infosys
and Polarisand Polaris
 Long value/short growth – For eg. SBI and ICICILong value/short growth – For eg. SBI and ICICI
 Long small-cap/short large-cap – For eg. HLL and ITCLong small-cap/short large-cap – For eg. HLL and ITC
 Long defensive/short cyclicals – Agro and SAILLong defensive/short cyclicals – Agro and SAIL

15. Representative Funds - USRepresentative Funds - US
Top US Funds – (Source Bloomberg, Hedge FundTop US Funds – (Source Bloomberg, Hedge Fund
Research)Research)
Fund NameFund Name Hedge FundHedge Fund 3 Year3 Year
return(2003-05)return(2003-05)
JK NavigatorJK Navigator SteelheadSteelhead
PartnersPartners
71.4%71.4%
AxiomAxiom
InternationalInternational
OpportunityOpportunity
AxiomAxiom
InternationalInternational
InvestorsInvestors
44.5%44.5%
Value PartnersValue Partners Value PartnersValue Partners 33.8%33.8%

16. Representative Funds - UKRepresentative Funds - UK
Top UK Funds (Source Bloomberg, Hedge FundTop UK Funds (Source Bloomberg, Hedge Fund
Research)Research)
Fund NameFund Name Hedge FundHedge Fund 3 Year3 Year
return(2003-05)return(2003-05)
SabreSabre MathewsMathews
Capital/AustraliaCapital/Australia
108.4%108.4%
Dynamic PowerDynamic Power
HedgeHedge
Goodman & Co.Goodman & Co.
InvestmentInvestment
CounselCounsel
63.0%63.0%
SR PhoeniciaSR Phoenicia Sloane RobinsonSloane Robinson 43.0%43.0%

17. Convertible ArbitrageConvertible Arbitrage

18. Define - Convertible ArbitrageDefine - Convertible Arbitrage
Convertible arbitrage is a market neutralConvertible arbitrage is a market neutral
investment strategy often associated withinvestment strategy often associated with
hedge funds.hedge funds.
It involves simultaneous purchase ofIt involves simultaneous purchase of
convertible securities and the short sale ofconvertible securities and the short sale of
the same issuer's common stock.the same issuer's common stock.

19. Strategy OverviewStrategy Overview
 Convertible is sometimes priced inefficiently relative to theConvertible is sometimes priced inefficiently relative to the
underlying stockunderlying stock
 The number of shares sold short usually reflects a delta neutral orThe number of shares sold short usually reflects a delta neutral or
market neutral ratio. As a result, under normal market conditions,market neutral ratio. As a result, under normal market conditions,
the arbitrageur expects the combined position to be insensitive tothe arbitrageur expects the combined position to be insensitive to
fluctuations in the price of the underlying stock.fluctuations in the price of the underlying stock.
 However, maintaining a market neutral position may requireHowever, maintaining a market neutral position may require
rebalancing transactions, a process called dynamic delta hedging.rebalancing transactions, a process called dynamic delta hedging.
 When a stock declines, the associated convertible bond will declineWhen a stock declines, the associated convertible bond will decline
less, because it is protected by its value as a fixed-incomeless, because it is protected by its value as a fixed-income
instrument: it pays interest periodically (while the stock may onlyinstrument: it pays interest periodically (while the stock may only
pay a dividend, which can be suspended in bad times).pay a dividend, which can be suspended in bad times).
 At times convertible bonds declined more than the stocks into whichAt times convertible bonds declined more than the stocks into which
they were convertible, apparently for liquidity reasons (the marketthey were convertible, apparently for liquidity reasons (the market
for the stocks being much more liquid than the relatively smallfor the stocks being much more liquid than the relatively small
market for the bonds).market for the bonds).

20. Example – 1Example – 1
 Take a 5% convertible bond maturing in one year atTake a 5% convertible bond maturing in one year at
$1,000, exchangeable into 100 shares of non-dividend-$1,000, exchangeable into 100 shares of non-dividend-
paying common stock currently trading at $10 per share.paying common stock currently trading at $10 per share.
 An arbitrage strategy might hedge against this longAn arbitrage strategy might hedge against this long
convertible bond with a short position of 50 shares ofconvertible bond with a short position of 50 shares of
underlying common stock at $10 per share.underlying common stock at $10 per share.
 Adding to gains on the downside is the fact thatAdding to gains on the downside is the fact that
convertible bonds can only fall in value as low as theirconvertible bonds can only fall in value as low as their
"investment value" -- the value of the same company"investment value" -- the value of the same company
bond if not convertible. In this case, let's say thebond if not convertible. In this case, let's say the
investment value is $920.investment value is $920.

21. Return When No Change in Stock Price:Return When No Change in Stock Price:
Interest payments on $1,000Interest payments on $1,000
convertible bond (5%)convertible bond (5%)
$50$50
Interest earned on $500 short saleInterest earned on $500 short sale
proceeds (5%)proceeds (5%)
$25$25
Fees paid to lender of common stockFees paid to lender of common stock
(0.25% per annum)(0.25% per annum)
($1.50)($1.50)
Net cash flowNet cash flow $73.50$73.50
Annual ReturnAnnual Return 7.3%7.3%

22. Return When 25% Rise in Stock Price:Return When 25% Rise in Stock Price:
Gain on convertible bondGain on convertible bond $250$250
Loss on shorted stock (50 shares @ $2.50/share)Loss on shorted stock (50 shares @ $2.50/share) ($125)($125)
Interest payments on $1,000 convertible bondInterest payments on $1,000 convertible bond
(5%)(5%)
$50$50
Interest earned on $500 short sale proceedsInterest earned on $500 short sale proceeds
(5%)(5%)
$25$25
Fees paid to lender of common stock (0.25% perFees paid to lender of common stock (0.25% per
annum)annum)
($1.50)($1.50)
Net trading gains and cash flowNet trading gains and cash flow $198.50$198.50
Annual ReturnAnnual Return 19.85%19.85%

23. Return When 25% Fall in Stock Price:Return When 25% Fall in Stock Price:
Loss on convertible bond (only falling as low asLoss on convertible bond (only falling as low as
"investment value")"investment value")
($80)($80)
Gain on shorted stock (50 shares @ $2.50/share)Gain on shorted stock (50 shares @ $2.50/share) $125$125
Interest payments on $1,000 convertible bondInterest payments on $1,000 convertible bond
(5%)(5%)
$50$50
Interest earned on $500 short sale proceedsInterest earned on $500 short sale proceeds
(5%)(5%)
$25$25
Fees paid to lender of common stock (0.25% perFees paid to lender of common stock (0.25% per
annum)annum)
($1.50)($1.50)
Net trading gains and cash flowNet trading gains and cash flow $118.50$118.50
Annual ReturnAnnual Return 11.85%11.85%

24. Example 1 – Contd.Example 1 – Contd.
 As this example shows, if a convertible bondAs this example shows, if a convertible bond
arbitrage position is properly constructed, itarbitrage position is properly constructed, it
should profit not only from the bond couponsshould profit not only from the bond coupons
and short rebate but from changesand short rebate but from changes up or downup or down inin
the underlying equity price.the underlying equity price.
 If the stock price drops, the gain from the shortIf the stock price drops, the gain from the short
common stock position should exceed thecommon stock position should exceed the
corresponding loss on the long convertible bondcorresponding loss on the long convertible bond
and vice a versa.and vice a versa.

25. Distressed SecuritiesDistressed Securities

26. Define - Distressed SecuritiesDefine - Distressed Securities
 Distressed securities are securities ofDistressed securities are securities of
companies that are either already in default,companies that are either already in default,
under bankruptcy protection, or in distress andunder bankruptcy protection, or in distress and
heading toward such a condition.heading toward such a condition.
 Distressed Securities have also been defined asDistressed Securities have also been defined as
securities, if not in default, that have a Yield tosecurities, if not in default, that have a Yield to
Maturity in excess of 1000 basis points over theMaturity in excess of 1000 basis points over the
riskless rate of return.riskless rate of return.

27. Strategy OverviewStrategy Overview
 Securities often trade at discounts to a rationalSecurities often trade at discounts to a rational
assessment of their risk-adjusted value for a variety ofassessment of their risk-adjusted value for a variety of
reasons.reasons.
 Distressed securities are stocks, bonds, and trade orDistressed securities are stocks, bonds, and trade or
financial claims of companies in, or about to enter or exit,financial claims of companies in, or about to enter or exit,
bankruptcy or financial distress.bankruptcy or financial distress.
 The prices of these securities fall in anticipation of theThe prices of these securities fall in anticipation of the
financial distress when their holders choose to sell ratherfinancial distress when their holders choose to sell rather
than remain invested in a financially troubled company.than remain invested in a financially troubled company.
 Investment professionals who specialize in researchingInvestment professionals who specialize in researching
distressed securities and who understand the true risksdistressed securities and who understand the true risks
and values involved can scoop up these securities orand values involved can scoop up these securities or
claims at discounted prices, seeing the glow beneath theclaims at discounted prices, seeing the glow beneath the
tarnish.tarnish.

28. Strategy Overview- Contd.-1Strategy Overview- Contd.-1
 A distressed opportunity typically arises when a company, unable toA distressed opportunity typically arises when a company, unable to
meet all its debts, files for Chapter 11 (reorganization) or Chapter 7meet all its debts, files for Chapter 11 (reorganization) or Chapter 7
(liquidation) or bankruptcy.(liquidation) or bankruptcy.
 As companies get into financial trouble, there is usually theAs companies get into financial trouble, there is usually the
opportunity to buy at steep discounts from people to whom money isopportunity to buy at steep discounts from people to whom money is
owed who don’t want to or can’t wait for the reorganization to beowed who don’t want to or can’t wait for the reorganization to be
completed.completed.
 The investor, if he’s employing this strategy wisely, will not onlyThe investor, if he’s employing this strategy wisely, will not only
know everything about the company and its financials but will haveknow everything about the company and its financials but will have
studied the creditors involved in the reorganization as well.studied the creditors involved in the reorganization as well.
 Their numbers, their willingness to compromise, and the complexityTheir numbers, their willingness to compromise, and the complexity
of their claims help indicate how long the reorganization will last,of their claims help indicate how long the reorganization will last,
what the asset distributions will be, and whether the expectedwhat the asset distributions will be, and whether the expected
returns are worth the wait.returns are worth the wait.

29. Strategy Overview- Contd.-2Strategy Overview- Contd.-2
 Investment Manager will buy up enough of the company’s debt orInvestment Manager will buy up enough of the company’s debt or
trade claims so as to earn a seat on the creditor committee andtrade claims so as to earn a seat on the creditor committee and
have an influence in the distribution process.have an influence in the distribution process.
 Distressed securities investing allows the investor who has gainedDistressed securities investing allows the investor who has gained
adequate knowledge through his research and due diligence to limitadequate knowledge through his research and due diligence to limit
the downside of his investment by effectively buying $1 for 50 centsthe downside of his investment by effectively buying $1 for 50 cents
 Average return 20 percent during the three years (2003-2005)Average return 20 percent during the three years (2003-2005)

30. How to determine a distressedHow to determine a distressed
company is worth investing in?company is worth investing in?
 Study the events driving down the value of a company’sStudy the events driving down the value of a company’s
securities.securities.
 Do calculations to determine if the purchase price of theDo calculations to determine if the purchase price of the
security is below not only its potential value but its bare-security is below not only its potential value but its bare-
bones liquidation value.bones liquidation value.
 Understanding the different kinds of claims involved in aUnderstanding the different kinds of claims involved in a
reorganization or bankruptcy, as not all are paid backreorganization or bankruptcy, as not all are paid back
evenly and at the same time.evenly and at the same time.

31. ExampleExample
 El Paso Electric underwent a Chapter 11 reorganizationEl Paso Electric underwent a Chapter 11 reorganization
 Dickstein Partners, which specializes in distressed investments,Dickstein Partners, which specializes in distressed investments,
bought junior bonds in the utility that had fallen to 50 cents on thebought junior bonds in the utility that had fallen to 50 cents on the
dollar, expecting additional profits from shares parceled out as partdollar, expecting additional profits from shares parceled out as part
of the reorganization plan.of the reorganization plan.
 Companies in the process of reorganizing their debts often issueCompanies in the process of reorganizing their debts often issue
new shares to the junior creditors when they can’t repay them in full.new shares to the junior creditors when they can’t repay them in full.
 Such shares are commonly referred to as orphan equities when theSuch shares are commonly referred to as orphan equities when the
issuer (the company) has no Wall Street coverage.issuer (the company) has no Wall Street coverage.
 First issued at $5 a share, the stock dropped initially as lessFirst issued at $5 a share, the stock dropped initially as less
knowledgeable (or less patient) former creditors, stuck with anknowledgeable (or less patient) former creditors, stuck with an
unwanted investment, hastily sold their new holdings.unwanted investment, hastily sold their new holdings.
 Seeing the opportunity, Dickstein purchased additional equity fromSeeing the opportunity, Dickstein purchased additional equity from
these sellers and watched as the stock steadily climbed over thethese sellers and watched as the stock steadily climbed over the
next two years to over $9 a share.next two years to over $9 a share.

32. Representative Funds - USRepresentative Funds - US
Top US Funds – (Source Bloomberg, Hedge FundTop US Funds – (Source Bloomberg, Hedge Fund
Research)Research)
Fund NameFund Name Hedge FundHedge Fund 3 Year3 Year
return(2003-05)return(2003-05)
York CreditYork Credit
OpportunitiesOpportunities
Dinan Mgmt.Dinan Mgmt. 33.10%33.10%
Jolly RogerJolly Roger Pirate CapitalPirate Capital 32.30%32.30%
Highland CrusaderHighland Crusader Highland CapitalHighland Capital
Mgmt.Mgmt.
31.0%31.0%

33. Representative Funds - UKRepresentative Funds - UK
Top UK Funds (Source Bloomberg, Hedge FundTop UK Funds (Source Bloomberg, Hedge Fund
Research)Research)
Fund NameFund Name Hedge FundHedge Fund 3 Year3 Year
return(2003-05)return(2003-05)
VR ArgentinaVR Argentina
RecoveryRecovery
VR DistressedVR Distressed
AssetsAssets
42.9%42.9%
Millennium GlobalMillennium Global
High YieldHigh Yield
Millennium GlobalMillennium Global
InvestmentInvestment
38.6%38.6%
VR DistressedVR Distressed
AssetsAssets
VR DistressedVR Distressed
AssetsAssets
32.0%32.0%

34. Fixed Income ArbitrageFixed Income Arbitrage

35. Define – Fixed Income ArbitrageDefine – Fixed Income Arbitrage
 Hedge Funds take offsetting positions in Fixed Income securitiesHedge Funds take offsetting positions in Fixed Income securities
and their derivatives in order to exploit mispricings between Interestand their derivatives in order to exploit mispricings between Interest
rates securities.rates securities.
 Fixed income arbitrage is an investment strategy generallyFixed income arbitrage is an investment strategy generally
associated with hedge funds, which consists of the discovery andassociated with hedge funds, which consists of the discovery and
exploitation of inefficiencies in the pricing of bonds, i.e. instrumentsexploitation of inefficiencies in the pricing of bonds, i.e. instruments
from either public or private issuers yielding a contractually fixedfrom either public or private issuers yielding a contractually fixed
stream of income.stream of income.
 Fixed-income arbitrage speculates on the widening or narrowing ofFixed-income arbitrage speculates on the widening or narrowing of
a spread between similar or closely related fixed income securitiesa spread between similar or closely related fixed income securities
based on mathematical models of their respective yield curves.based on mathematical models of their respective yield curves.
 Most arbitrageurs who employ this strategy trade globally.Most arbitrageurs who employ this strategy trade globally.

36. Type of securitiesType of securities
 In pursuit of their goal of both steady returns andIn pursuit of their goal of both steady returns and
low volatility, the arbitrageurs can focus upon:low volatility, the arbitrageurs can focus upon:
 Interest rate swaps,Interest rate swaps,
 US non-US government bond arbitrage,US non-US government bond arbitrage,
 US Treasury security,US Treasury security,
 Forward yield curves,Forward yield curves,
 Mortgage-backed securities.Mortgage-backed securities.

37. Investment ApproachInvestment Approach
 Fixed Income Arbitrage strategies vary widelyFixed Income Arbitrage strategies vary widely
followed and include:followed and include:
 Exploiting anomalies between one issuer debtExploiting anomalies between one issuer debt
securitiessecurities
 Exploiting anomalies between debt securities ofExploiting anomalies between debt securities of
different issuersdifferent issuers
 Exploiting dislocations between emerging marketExploiting dislocations between emerging market
securities and U.S. debt securitiessecurities and U.S. debt securities

38. GLOBAL MACRO STRATEGYGLOBAL MACRO STRATEGY

39. Global MacroGlobal Macro
 This Strategy aims to make profit from changes in global economies.This Strategy aims to make profit from changes in global economies.
 Global macro managers carry long and short positions in any of theGlobal macro managers carry long and short positions in any of the
world's major capital or derivative markets. These positions reflectworld's major capital or derivative markets. These positions reflect
their views on overall market direction as influence by majortheir views on overall market direction as influence by major
economic trends and/or events.economic trends and/or events.
 Focuses on macro-economic opportunities across numerousFocuses on macro-economic opportunities across numerous
markets and instruments with the hopes of profiting from macromarkets and instruments with the hopes of profiting from macro
events.events.
 Macro events are changes in global economies and the macroMacro events are changes in global economies and the macro
investors anticipate such events and shifts and make profit byinvestors anticipate such events and shifts and make profit by
investing in financial instruments whose prices are most directlyinvesting in financial instruments whose prices are most directly
influenced by these trend. Eg: Interest Rate,Inflation,Economicinfluenced by these trend. Eg: Interest Rate,Inflation,Economic
policies etc.policies etc.

40. Global Macro – Cont.Global Macro – Cont.
 Participates in all major markets - equities, bonds, currencies andParticipates in all major markets - equities, bonds, currencies and
commodities - though not always at the same timecommodities - though not always at the same time..
 Uses leverage and derivatives to accentuate the impact of market moves.Uses leverage and derivatives to accentuate the impact of market moves.
 If a huge deficit is accompanied by an expansionary fiscal policy (higherIf a huge deficit is accompanied by an expansionary fiscal policy (higher
government spending and taxation) and tight monetary policy (highergovernment spending and taxation) and tight monetary policy (higher
interest rates to stem borrowing), the theory has it that the country'sinterest rates to stem borrowing), the theory has it that the country's
currency will actually rise.currency will actually rise.
 Stanley Druckenmiller went long on the Deutsche mark to the tune of $2Stanley Druckenmiller went long on the Deutsche mark to the tune of $2
billion after the Berlin Wall came down in 1989. Seeing that West Germanybillion after the Berlin Wall came down in 1989. Seeing that West Germany
was about to run up a huge budget deficit to finance the rebuilding of Eastwas about to run up a huge budget deficit to finance the rebuilding of East
Germany and that the Bundesbank was not going to tolerate any inflation,Germany and that the Bundesbank was not going to tolerate any inflation,
Druckenmiller predicted - quite correctly and lucratively - that the price of theDruckenmiller predicted - quite correctly and lucratively - that the price of the
Deutsche mark would rise.Deutsche mark would rise.

41. Global Macro – Cont.Global Macro – Cont.
 Historical patterns also helps in identifying trends andHistorical patterns also helps in identifying trends and
inflection points.inflection points.
 For example, in late 1989, Druckenmiller turned bearishFor example, in late 1989, Druckenmiller turned bearish
on the Japanese stock market in part because the Nikkeion the Japanese stock market in part because the Nikkei
index had reached a point of overextension that in allindex had reached a point of overextension that in all
previous instances had led to sell-offs.previous instances had led to sell-offs.
 The speed with which capital is capable of movingThe speed with which capital is capable of moving
means that any economy can be disrupted bymeans that any economy can be disrupted by
international capital flows due to external considerations.international capital flows due to external considerations.
This understanding is a cornerstone of macro investmentThis understanding is a cornerstone of macro investment
strategies.strategies.

42. MERGER ARBITRAGEMERGER ARBITRAGE
(RISK ARBITRAGE)(RISK ARBITRAGE)

43. Merger Arbitrage(RiskMerger Arbitrage(Risk
ArbitrageArbitrage))
 Invest in shares of a company that is in theInvest in shares of a company that is in the
process of a merger or acquisition.process of a merger or acquisition.
 Involve simultaneous purchase of stock inInvolve simultaneous purchase of stock in
companies being acquired, and the sale of stockcompanies being acquired, and the sale of stock
in its acquirer, hoping to profit from the spreadin its acquirer, hoping to profit from the spread
between.between.
 It starts when a news release appears on aIt starts when a news release appears on a
trading screen such as Bloomberg or Reuterstrading screen such as Bloomberg or Reuters
announcing that a bidder wishes to buy theannouncing that a bidder wishes to buy the
stock in a company.stock in a company.

44. Merger Arbitrage – Cont.Merger Arbitrage – Cont.
 After a company announces an intent to acquire another,After a company announces an intent to acquire another,
the price of the target company's stock predictably goesthe price of the target company's stock predictably goes
up while the acquiring company's stock will sell at aup while the acquiring company's stock will sell at a
discount to its value at the merger's closing.discount to its value at the merger's closing.
 The merger arbitrageur seeks to lock in this spread.The merger arbitrageur seeks to lock in this spread.
 A manager takes a long position in the equity of theA manager takes a long position in the equity of the
target company, with the expectation of being able totarget company, with the expectation of being able to
exchange the stock for cash or securities of the acquiringexchange the stock for cash or securities of the acquiring
company when the acquisition is complete. At the samecompany when the acquisition is complete. At the same
time, the manager sells short the stock of the acquiringtime, the manager sells short the stock of the acquiring
company, expecting it to drop before the deal is finalized.company, expecting it to drop before the deal is finalized.

45. Merger Arbitrage Strategy:Merger Arbitrage Strategy:
Buy 1 share of target Company B at $100;Buy 1 share of target Company B at $100;
Sell short 1 share of acquirer Company A at $105Sell short 1 share of acquirer Company A at $105
Scenarios AfterScenarios After
MergerMerger
Gain (Loss)Gain (Loss)
on Longon Long
Position ofPosition of
$100$100
Gain (Loss)Gain (Loss)
on Shorton Short
Position ofPosition of
$105$105
Total GainTotal Gain
(Loss(Loss
Rise inRise in
Company ACompany A
Stock to $120Stock to $120
$20$20 ($15)($15) $5$5
Fall inFall in
Company ACompany A
Stock to $80Stock to $80
($20)($20) $25$25 $5$5

46. Merger Arbitrage - cont.Merger Arbitrage - cont.
 To hedge against collapsed deals, some fundTo hedge against collapsed deals, some fund
managers supplement their long positions in themanagers supplement their long positions in the
target company withtarget company with puts on the company'sputs on the company's
stockstock - but only when the spread is such that- but only when the spread is such that
the potential profit well offsets the cost of thethe potential profit well offsets the cost of the
buying the put.buying the put.
 Other alternative -Other alternative - To short the target'sTo short the target's
stockstock. Eg:, Paulson Partners shorted the stock. Eg:, Paulson Partners shorted the stock
of AEL Industries Inc. on the reports ofof AEL Industries Inc. on the reports of
acquisition plans to be on shaky ground.acquisition plans to be on shaky ground.

47. Thank YouThank You