...Characteristics of risk and return in risk arbitrage Purpose of this paper is to analyze 4750 mergers from 1963 to 1998 to characterize the risk and return in risk arbitrage. After the announcement of a merger or acquisition the target company stock typically trade at discount to the price offered by the acquiring company. The difference is known as arbitrage spread, called merge arbitrage referred to an investment strategy making profit from this spread. If merger is successful the arbitrageur will capture the arbitrage spread, if not he will lose money. Previous papers have concluded with that investors make money from this strategy. These finding suggest that financial market are not efficient in the pricing of firms. There are other to explanations one is that transaction and other practical limitations prevent investors from realizing these extraordinary returns. The second it that risk arbitrageurs receive a risk premium to compensate the risk of deal failure. Effect of transaction cost Construct to different series of risk arbitrage returns. The first series is calendar time value weighted average of return to individual mergers ignoring transaction cost and other practical limits. The second portfolio return series mimics the return from hypothetical risk arbitrage index manager. It includes transaction cost, consisting both broker commission and price impact associated with trading less than perfectly liquid securities. And include also practical constraint. When...
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...Limits to Arbitrage: Saint Leo University- Chesapeake, Virginia Corporate Finance: MBA 570 Professor Smith April 23, 2014 Abstract Arbitrage is the idea of buying asset which involves no negative cash flow and making a profit with little or no risk. Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers. This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and on the people’s preferences, given their beliefs or on how they make decisions, Thaler and Barberis (2002). In this paper, we will concentrate on the extensive literature on the Limits to Arbitrage and explain how the theory was conceived, how it evolved over time and apply a scenario to better explain the research. Limits to Arbitrage Understanding arbitrage opportunities is not the only ingredient needed to make sharp predictions. The level of irrationality need to be specified by behavior finance researchers.This is related to how they deviate from the Subjective Expected Utility theory. In order to specify the type of irrationality, researchers have turned to experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and...
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...hange "arket, 3hi!h put do3n3ard pressure on the bahts -alue. As foreign in-estors !ontinued to 3ithdra3 their funds fro" *hailand, the bahts -alue !ontinued to deteriorate. &in!e Blades has net !ash flo3s in baht resulting fro" its e+ports to *hailand, a deterioration in the bahts -alue 3ill affe!t the !o"pany negati-ely. Ben 4olt, Blades C5, 3ould like to ensure that the spot and for3ard rates Blades bank has 1uoted are reasonable. If the e+!hange rate 1uotes are reasonable, then arbitrage 3ill not be possible. If the 1uotations are not appropriate, ho3e-er, arbitrage "ay be possible. )nder these !onditions, 4olt 3ould like Blades 1q use so"e for" of arbitrage to take ad-antage of possible "ispri!ing in the foreign e+!hange "arket. Although Blades is not an arbitrageur, 4olt belie-es that arbitrage opportunities !ould offset the negati-e i"pa!t resulting fro" the bahts depre!iation, 3hi!h 3ould other3ise seriously affe!t Blades profit "argins. Ben 4olt has identified three arbitrage opportunities as profitable and 3ould like to kno3 3hi!h one of the"...
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...CHAPTER 10: FUTURES ARBITRAGE STRATEGIES END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. (Delivery Options) The U.S. Treasury bond futures contract contains several imbedded options. First, the wild card option results from a difference in the closing times of the spot and futures markets. The Treasury bond futures contract stops trading at 3:00 P.M. Eastern time. The spot market for Treasury bonds operates until 5:00 P.M. Eastern time. The wild card option is the opportunity the holder of the short futures contract has to lock in the invoice price at 3:00 P.M. and make delivery if the spot price falls below the established invoice price between 3:00 P.M. and 5:00 P.M. The option exists only during the delivery month. Second, the holder of the short position has the right to deliver any of a number of acceptable bonds, known as the quality or switching option. Sometimes the holder of the short position will be holding a bond that is not the best to deliver. A profit is sometimes possible by switching to another bond. Third, because the last day for trading a T-bond futures contract is the eighth-to-last business day of the delivery month and delivery can take place during the remaining business days, there is an end-of-the-month option. The invoice price during those final delivery days is based on the settlement price on the last trading day. Thus, during the last seven delivery days, the holder of the short position has full knowledge of the price that would be received for delivery...
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...2003 3:04 PM Economy and Society Volume 32 Number 3 August 2003: 349–380 Long-Term Capital Management and the sociology of arbitrage Donald MacKenzie Abstract Arbitrage is a key process in the practice of financial markets and in their theoretical depiction: it allows markets to be posited as efficient without all investors being assumed to be rational. This article explores the sociology of arbitrage by means of an examination of the arbitrageurs, Long-Term Capital Management (LTCM). LTCM’s 1998 crisis is analysed using both qualitative, interview-based data and quantitative examination of price movements. It is suggested that the roots of the crisis lay in an unstable pattern of imitation that had developed in the markets within which LTCM operated. As the resulting ‘superportfolio’ began to unravel, arbitrageurs other than LTCM fled the market, even as arbitrage opportunities became more attractive, causing huge price movements against LTCM. Three features of the sociology of arbitrage are discussed: its conduct by people often personally known to each other; the possibility and consequences of imitation; and the limits on the capacity of arbitrage to close price discrepancies. It is suggested that by 1998 imitative arbitrage formed a ‘global microstructure’ in the sense of Knorr Cetina and Bruegger. Keywords: arbitrage; economic sociology; imitation; Long-Term Capital Management (LTCM); globalization; risk. Introduction Of all the contested boundaries...
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...5/7 (0.05) PL = $0.09 Question 2 T = [1,0] PT = $0.60 U = [0,1] PU = $0.70 V = [4,3] PV = $4.30 Use simultaneous equation: Equation 1: T = 4 Equation 2: U = 3 4T + 3U = V Therefore, 4 [1,0] + 3 [0,1] = [4,3] The fair value of V given the replication portfolio: 4 (PT) + 3 (PU) = Pv 4 (0.60) + 3 (0.70) = Pv Pv = $4.50 It is undervalued in the market ($4.50 > $4.30). Therefore, an arbitrage exists. To take advantage of the arbitrage we would sell the replication portfolio for $4.50 and simultaneous buy security V at Pv = $4.30 Arbitrage is the difference: $4.20 - $4.50 = - $0.20 Since, this is money today - $0.20 with no negative liability in the future this is a type 2 arbitrage. Portfolio | Position Value (t=0) | If State 1 (t+1) | If State 2 (t+2) | (Buy) V | 4.30 | 4 | 3 | (Sell) T | 4(0.60) = -2.4 | -4(1) = -4 | -4(0) = 0 | (Sell) U | 3(0.70) = -2.1 | -3(0) = 0 | -3(1) = -3 | Portfolio: [V – 4T + 3U] | 4.30 – 4.50 | -4 + 0 + 4 = 0 | 0 – 3 +3 = 0 | Total | -0.20 | 0 | 0 | This payoff table shows the arbitrage as breakdown of payoffs at...
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...American Finance Association Limited Arbitrage in Equity Markets Author(s): Mark Mitchell, Todd Pulvino, Erik Stafford Source: The Journal of Finance, Vol. 57, No. 2 (Apr., 2002), pp. 551-584 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2697750 Accessed: 08/01/2010 15:26 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association...
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...pound sterling to dollars is $2.00 per pound sterling. What will be the forward exchange rate in dollars/pound for a forward contract maturing six months later? (10 marks) 4. Options Trading Strategies a. Explain how a long stock and long put strategy equals the cash flow from a long call strategy. (5 marks) b. Why is a straddle position considered a speculation on the asset’s volatility? (5 marks) c. Can a butterfly spread ever be constructed to have zero initial premium? Why or why not? (5 marks) d. Explain in simple terms why a call option on a non-dividend paying stock should never be exercised early. (5 marks) 5. Consider an index futures arbitrage opportunity. a. What is the effect of dividend uncertainty on the no-arbitrage window and why? (5 marks) b. What is the effect of marking to market cash flows on the no-arbitrage window and why? (5 marks) c. Why and...
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...75) Therefore, funds flow from US to Canada. If an arbitrageur can borrow up to $1,000,000 (or CD1,250,000), formulate a covered interest arbitrage. Make sure to explain your steps in detail (just writing out three random calculations does not count). Determine the amount of arbitrage profit. 1. Borrow $1,000,000 at the US interest rate of 2.5%. Will owe $1,000,000(1.025) = $1,025,000 after 90-days. 2. Sell dollars at the spot exchange rate of $0.80/CD, buy CD1,250,000 (=1,000,000/0.80) 3. Invest the CD 1,250,000 at the Canadian interest rate of 4%. After 90 days, will yield, CD1,250,000(1.04) = CD 1,300,000. 4. Simultaneously with the investment, sell forward the CD1,300,000 at the 90-day forward rate of $0.79/CD to lock in the exchange rate. Will have 1,300,000(0.79) = $1,0.27,000. 5. In 90-days, take the CD1,300,000 from the Canadian investment, deliver for the forward contract, take the $1,027,000 from the forward contract, pay off the US bank loan of $1,025,000. Will be left with an arbitrage profit of $1,027,000-$1,025,000 = $2,000. For interest rate parity (IRP) to hold, what should the correct forward exchange rate be? 1.025 F (0.80) * (1.025) F $0.7885 1.04 0.80 (1.04) PROBLEM II: (20 points) Given the following information, is triangular arbitrage possible? If so detail the steps necessary to carry out triangular arbitrage and compute the profit from this strategy if the...
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...natural gas futures contracts with a variety of maturity dates. Their trades were very risky from both a market risk perspective and a liquidity perspective. Background: Amaranth Advisors LLC: Amaranth was a multi-strategy hedge fund headquartered in Greenwich, Connecticut. Nicholas Maounis, a former convertible bond trader, founded Amaranth in September 2000.Amaranth’s initial assets under management of $600 million had grown to between $7.2 billion and $7.5 billion by the end of 2005, which translated to an average annual return of 15%, almost double the average return of other multi-strategy funds over the same period. The Primary strategies employed by the fund included convertible arbitrage, statistical arbitrage, energy trading, merger arbitrage, long/short trading and credit arbitrage. DAAS Capital Advisors: DAAS was a multi-strategy hedge fund, headquartered in the heart of Manhattan. It was founded in 2002 by Ali Armstrong, after he had spent several years as managing director at a major Wall Street investment bank. DAAS had achieved an average annual return of 18.2% since its inception and had grown its assets under management to approximately...
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...For a Sociology of Worth David Stark Columbia University and the Santa Fe Institute Department of Sociology Columbia University 1180 Amsterdam Ave New York, NY 10027 dcs36@columbia.edu Forthcoming in Vando Borghi and Tommaso Vitale, editors, Le convenzioni del lavoro, il lavoro delle convenzioni, numero monografico di Sociologia del Lavoro, n. 102, Milano: Franco Angeli. For a Sociology of Worth David Stark Columbia University and the Santa Fe Institute Parsons’ Pact Arguably, the founding moment of the field of economic sociology took place more than a half-century ago at Harvard, where Talcott Parsons was developing his grand designs for sociology. Parsons’ ambitions were imperial, but there was one field that Parsons maneuvered around instead of claiming outright. That field was hegemonic in his time and is considerably hegemonic still – the discipline of economics. Parsons, therefore, made overt signals to his colleagues in the Economics Department at Harvard alerting them to his ambitious plans and assuring them that he had no designs on their terrain (see Camic 1987). Basically, Parsons made a pact: in my gloss – you, economists, study value; we, the sociologists, will study values. You will have claim on the economy; we will stake our claim on the social relations in which economies are embedded. What have been the effects of Parsons’ Pact? First, by limiting its range, this jurisdictional division of the social sciences placed constraints on sociology...
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...Risk Arbitrage: Abbott Labs & Alza 1) How does risk arbitrage work? What are the risks and opportunities associated with this strategy? Risk arbitrage, or merger and acquisition arbitrage, is one of three types of arbitrage strategies. Two types of mergers are possible: a cash merger and a stock merger. Cash Merger Opportunities Acquirer proposes to purchase the shares of the target for a certain price in cash. Until the acquisition is completed, the stock of the target usually trades below the purchase price. An arbitrageur buys the stock of the target and makes a gain if the acquirer ultimately buys the stock. Stock-for-Stock Merger Opportunities Acquirer proposes to buy the target by exchanging its own stock for the stock of the target. An arbitrageur my then short sell the acquirer and buy the stock of the target. This is called “setting a spread.” After the merger is completed, the target’s stock will be converted into stock of the acquirer based on the exchange ratio determined by the merger agreement. The arbitrageur delivers the converted stock into his/her short position to complete the arbitrage. Risks Associated with M/A Arbitrage Risks arise from the possibility of deals failing to go through. Obstacles may include either party's inability to satisfy conditions of the merger, a failure to obtain shareholder approval, or failure to receive antitrust and other regulatory clearances. 2) Green circle shorted 312,000 Abbott shares and longed 260,000 Alza...
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...POTENTIAL INDIRECT EFFECT OF THIS CATEGORY INVESTOR FAILURE? 7 DOES THE RESCUE OF INSTITUTIONS LABELLED “TOO BIG TO FAIL” 9 Strengthen the long term stability of financial services sector? If so, how? 9 Encourage excessive risk taking in the knowledge of an implicit “safety net”? If so, explain why 9 WAS THIS A CASE OF CRONY CAPITALISM? 10 REFERENCES: 11 WHAT ARE HEDGE FUNDS? Hedge funds are private investment funds that aim to make profits for their shareholders by trading securities. Hedge fund utilises a variety of financial instruments to reduce risks, enhance returns and minimise the correlation with equity and bond markets. They are flexible in their investment options and can use short selling, leverage, derivatives and arbitrage. Hedge funds are defined by their freedom from regulatory controls, stipulated by the Investment Company Act of 1940 or the Security Exchange Commission. Hedge funds do not have to disclose their activities to third parties, they offer a high degree of privacy for their investors and generally they take significant risks. They are actively managed investment portfolios holding position in publicly trading securities and...
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...Nobel prize-winning economists Myron Scholes and Robert Merton. These were all experts in investing in derivatives to make aboveaverage returns and outperform the market. Investors paid $10 million to get into the fund. They were not allowed to take the money out for three years, or even ask about the types of investments LTCM used. Despite these restrictions, investors clamored to get in, thanks to LTCM's spectacular annual returns of 42.8% in 1995 and 40.8% in 1996. This was after management took 27% off the top in fees. LTCM successfully hedged most of the risk from the 1997 Asian currency crisis, giving its investors a 17.1% return that year. Trading Strategies: LTCM used complex mathematical models to take advantage of fixed income arbitrage deals usually with U.S., Japanese, and European government bonds. Price differences between a 30 year treasury bond and a 29 and three quarter year old Treasury bond is very minimal. However, small discrepancies arise between the two bonds because of a difference in liquidity. By a series of financial transactions, essentially amounting to buying the cheaper 'off-the-run' bond (the 29 and three quarter year old bond) and shorting the more expensive, but more liquid, 'on-the-run' bond (the 30 year bond just issued by the Treasury), it would be...
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...TA-Session 1 Triangular Arbitrage in real life: | BID | ASK | USD/GBP | 1,5322 | 1,5431 | USD/EUR | 1,2647 | 1,2649 | | | | GBP/USD | 0,6480 | 0,6527 | EUR/USD | 0,7906 | 0,7907 | a) Converting EUR into GBP: EUR1000 x USD1,2647/EUR = USD1264,7 USD1264,7 x GBP0,6480/USD = GBP819,5256 Reverse, convert back into EUR: GBP 819,5256 x USD1,5322/GBP * 0,7906 EUR/USD = 992,78 Percentage loss = 0.722% b) S(GBP/EUR)BID =S(USD/EUR)BID x S(GBP/USD)BID = 1,2647 x 0,6480 = 0,8195 S(GBP/EUR)ASK =S(GBP/USD)ASK x S(USD/EUR)ASK = 0,6527 x 1,2649 = 0,8256 S(EUR/GBP)BID = 1/S(GBP/EUR)ASK = 1/0,8256 = 1,2112 S(EUR/GBP)ASK = 1/S(EUR/GBP)ASK = 1/0,8195 = 1,2203 Ratio: S(GBP/EUR)BID- S(GBPEUR)ASKS(GBPEUR)ASK= 0,8195-0,82560,8256=-0,00739 c) We would ask for the quotes of EUR/GBP from another bank. d) EUR/GBPBID = 1,3612 EUR/GBPASK = 1,3698 Yes, there is an arbitrage opportunity. We can buy USD, sell USD and buy GBP, sell GBP and buy EUR. EUR1000000*USD1.2647/EUR*1/USD1.5431/GBP*EUR1.3612/GBP = EUR1115617.68 Arbitrage profit = EUR115617.68 e) implied bid < bank’s ask ; bank’s bid < implied ask The Forward Market Effective interest rates: i(CHF) = 0,08 x180360 = 0,04 i(EUR) = 0,10 x180360 = 0,05 Investing in EUR deposits: EUR10 000 000 x (1+i(EUR)) = EUR10 000 000 x (1 + 0,05) = EUR10 500 000 Investing in covered CHF deposits: 1S(EURCHF)x (1+iCHF x F(EURCHF)) EUR100000001,1960x 1+0,04 x 1,2024=EUR10 455 652,17 The payoff...
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