Chapter 19

  1. anticipated volatility
    Anticipated volatility is the future level of volatility expected by a market participant.
  2. asset-backed securities
    Still another subset of fixed-income arbitrage trades is asset-backed securities (ABS), which are securitized products created from pools of underlying loans or other assets.
  3. busted convertibles
    Bonds with very high conversion premiums are often called busted convertibles, as the embedded stock options are far out-of-the-money.
  4. carry trades
    Carry trades attempt to earn profits from carrying or maintaining long positions in higher-yielding assets and short postitions in lower-yielding assets without suffering from adverse price movements.
  5. classic convertible bond arbitrage trade
    The classic convertible bond arbitrage trade is to purchase a convertible bond that is believed to be undervalued and to hedge its risk using a short position in the underlying equity.
  6. classic dispersion trade
    The classic dispersion trade is a market-neutral short correlation trade, popular among volatility arbitrage practitioners, that typically takes long positions in options listed on the equities of single companies and short positions in a related index option.
  7. classic relative value strategy trade
    The classic relative value strategy trade is based on the premis that a particular relationship or spread between two prices or rates has reached an abnormal level and will therefore tend to return to its normal level.
  8. complexity premium
    A complexity premium is a higher expected return offered by a security to an investor to compensate for analyzing and managing a position that requires added time and expertise.
  9. components of convertible arbitrage returns
    The components of convertible arbitrage returns include interest, dividends, rebates, and capital gains and losses.
  10. convergence
    Convergence is the return of prices or rates to relative values that are deemed normal.
  11. convertible bonds
    Convertible bonds are hybrid corporate securities, mixing fixed-income and equity characteristics into one security.
  12. correlation risk
    Correlation risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of correlation between market prices or rates.
  13. correlations go to one
    The term correlations go to one means that duing periods of enormous stress. stocks and bonds with credit risk decline simultaneously and with somewhat similar magnitudes.
  14. delta
    Delta is the change in the value of an option (or a security with an implicit option) with respect to a change in the value of the underlying asset (i.e., it measures the sensitivity of the option price to small changes in the price of its underlying asset).
  15. delta-neutral
    A delta-neutral position is a position in which the value-weighted sum of all deltas of all positions equals zero.
  16. dilution
    Dilution takes place when additional equity is issued at below-market values, and the per-share value of the holdings of existing shareholders is diminished.
  17. duration
    Duration is a measure of the sensitivity of a fixed-income security to a change in the general level of interest rates.
  18. duration-neutral
    A duration-neutral position is a portfolio in which the aggregated durations of the short positions equal the aggregated durations of the long positions weighted by value.
  19. dynamic delta hedging
    Dynamic delta hedging is the process of frequently adjusting positions in order to maintain a target exposure to delta, often delta neutrality.
  20. effective duration
    Effective duration is a measure of the interest rate sensitivity of a position that includes the effects of embedded option characteristics.
  21. equity-like convertible
    An equity-like convertible is a convertible bond that is far in-the-money and therefore has a price that tracks its underlying equity very closely.
  22. fixed-income arbitrage
    Fixed-income arbitrage involves simultaneous long and short positions in fixed income securities with the expectation that over the investment holding period, the security prices will converge toward a similar valuation standard.
  23. gamma
    Gamma is the second derivative of an option's price with respect to the price of the underlying asset - or, equivalently, the first derivative of the delta with respect to the price of the underlying asset.
  24. general collateral stocks
    General collateral stocks, which are stocks not facing heavy borrowing demand, may earn a 2% rebate when Treasury bill rates are at 2%, whereas stocks on special may earn zero rebates or even negative rebates, wherein borrowers must pay the lenders money in addition to the interest that the lender is earning on the collateral.
  25. hybrid convertibles
    Convertible bonds with moderately sized conversion ratios have stock options closer to being at-the-money and are called hybrid convertibles.
  26. implied volatility
    The implied volatility of an option or an option-like position - in this case, the implied volatility of a convertible bond - is the standard deviation of returns that is viewed as being consistent with an observed market price for the option.
  27. intercurve arbitrage positions
    There are also intercurve arbitrage positions, which means arbitrage (hedged positions) using securities related to different yield curves.
  28. interest rate immunization
    Interest rate immunization is the process of eliminating all interest rate risk exposures.
  29. intracurve arbitrage positions
    These are examples of intracurve arbitrage positions because they are based on hedged positions within the same yield curve.
  30. marking-to-market
    Marking-to-market refers to the use of current market prices to value instruments, positions, portfolios, and even the balance sheet of firms.
  31. marking-to-model
    Marking-to model refers to valuation based on prices generated by pricing models. The pricing models generally involve two components.
  32. modified duration
    Modified duration is equal to traditional duration divided by the quantity [1+(y/m)], where y is the stated annual yield, m is the number of compounding periods per year, and y/m is the periodic yield.
  33. moneyness
    Moneyness is the extent to which an option is in-the-money, at-the-money, or out-of-the-money.
  34. mortgage-backed securities arbitrage
    Mortgage-backed securities arbitrage to generate low-risk profits through the relative mispricing among MBS or between MBS and other fixed-income securities.
  35. net delta
    The net delta of a position is the delta of long positions minus the delta of short positions.
  36. option-adjusted spread
    A key concept in pricing fixed income securities with embedded prepayment options is the option-adjusted spread (OAS), which is a measure of the excess of the return of a fixed-income security containing an option over the yield of an otherwise comparable fixed-income security without an option after the return of the fixed-income security containing the option has been adjusted to remove the effects of the option.
  37. parallel shift
    A parallel shift in the yield curve happens when yields of all maturities shift up or down by equal (additive) amounts.
  38. portfolio insurance
    Portfolio insurance is any financial method, arrangement, or program for limiting losses from large adverse price movements.
  39. price transparency
    Price transparency is information on the prices and quantities at which participants are offering to buy (bid) and sell (offer) an instrument.
  40. pricing risk
    Pricing risk is the economic uncertainty caused by actual or potential mispricing of positions.
  41. realized volatility
    Realized volatility is the actual observed volatility (i.e., the standard deviation of returns) experienced by an asset - in this case, the underlying stock.
  42. rebate
    A rebate is a payment of interest to the securities' borrower on the collateral posted.
  43. riding the yield curve
    The process of holding a bond as its yield moves up or down the yield curve due to the passage of time is known as riding the yield curve.
  44. rolling down
    Rolling down the yield curve is the process of experiencing decreasing yields to maturity as an asset's maturity declines through time in an upward-sloping yield curve environment.
  45. short correlation
    The classic dispersion trade is referred to as a short correlation trade bacause the trade generates profits from low levels of realized correlation and losses from high levels of realized correlation.
  46. short squeeze
    A short squeeze occurs when holders of short positions are compelled to purchase shares at increasing prices to cover their positions due to limited liquidity.
  47. sovereign debt
    Sovereign debt is debt issued by national governments.
  48. special stock
    A special stock is a stock for which higher net fees are demanded when it is borrowed.
  49. tail risk
    Tail risk is the potential for very large loss exposures due to very unusual events, especially those associated with widespread market prices declines.
  50. term structure of interest rates
    Sometimes the term structure of interest rates is distinguished from the yield curve because the yield curve plots yields to maturity of coupon bonds, whereas the term structure of interest rates plots actual or hypothetical yields of zero-coupon bonds.
  51. theta
    Theta is the first derivative of an option's price with respect to the time to expiration of the option.
  52. variance notional value
    The variance notional value of the contract simply scales the size of the cash flows in a variance swap.
  53. variance swaps
    Variance swaps are forward contracts in which one party agrees to make a cash payment to the other party based on the realized variance of a price or rate in exchange for receiving a predetermined cash flow.
  54. vega
    Vega is a measure of the risk of a position or an asset due to changes in the volatility of a price or rate that helps determine the value of that position or asset.
  55. vega notional value
    The vega notional value of a contract serves to scale the contract and determine the size of the payoff in a volatility swap.
  56. vega risk
    Vega risk is the economic dispersion caused by changes in the volatility of a price, return, or rate.
  57. volatility arbitrage
    Volatility arbitrage is any strategy that attempts to earn a superior and riskless profit based on prices that explicitly depend on volatility.
  58. volatility risk
    Volatility risk is dispersion in economic outcomes attributable to changes in realized or anticipated levels of volatility in a market price or rate.
  59. volatility swap
    A volatility swap mirrors a variance swap except that the payoff of the contract is linearly based on the standard deviation of a return series rather than the variance.
  60. yield curve
    A yield curve is the ralationship between the yields of various securities, usually depicted on the vertical axis, and the term to maturity, usually depicted on the horizontal axis.
Card Set
Chapter 19
Relative Value Hedge Funds