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Sunday, July 11, 2010
Sunday, July 11, 2010
Susanny’s Final Presentation in SMU...




Sunday, July 11, 2010
A presentation by        TY ‘Da Vinci’ Thong Fund...
    FNCE204: Analysis of Fixed Income
    Prepared for Prof Thong Tio...
WHAT’S THE
              AGENDA?




Sunday, July 11, 2010
WHAT’S THE
              AGENDA?

                                                        The ‘Da Vinci’ Code


          ...
Convertible Bonds
        INTRODUCTION TO
       CONVERTIBLE BONDS




Sunday, July 11, 2010
Convertible Bonds
        INTRODUCTION TO
       CONVERTIBLE BONDS




              A type of bond that allows
          ...
Convertible Bonds
        INTRODUCTION TO
       CONVERTIBLE BONDS




                                                   ...
Convertible Bonds
          WHY ISSUE
      CONVERTIBLE BONDS?




Sunday, July 11, 2010
Convertible Bonds
          WHY ISSUE
      CONVERTIBLE BONDS?



                                   1                    ...
Convertible Bonds
    INTRO TO CONVERTIBLE
       DEBT ARBITRAGE




Sunday, July 11, 2010
Convertible Bonds
    INTRO TO CONVERTIBLE
       DEBT ARBITRAGE



             Exploit mispricing in convertible bonds (...
Convertible Bonds
    INTRO TO CONVERTIBLE
       DEBT ARBITRAGE



             Exploit mispricing in convertible bonds (...
Convertible Bonds
       NUMERICAL EXAMPLE




Sunday, July 11, 2010
Convertible Bonds
       NUMERICAL EXAMPLE

                                                5% Coupon Rate, Annually
     ...
DELTA NEUTRAL HEDGE




  Convertible Debt Arbitrage Techniques


                        GAMME CAPTURE HEDGE




Sunday, ...
Arbitrage Techniques
           DELTA NEUTRAL HEDGE




Sunday, July 11, 2010
Arbitrage Techniques
           DELTA NEUTRAL HEDGE


             Long Convertible Bond

             Short Underlying St...
Arbitrage Techniques
           DELTA NEUTRAL HEDGE


             Long Convertible Bond

             Short Underlying St...
Delta Neutral Hedge
                  BEGINNING POSITION




Sunday, July 11, 2010
Delta Neutral Hedge
                  BEGINNING POSITION



                           Position        Quantity    Price  ...
Delta Neutral Hedge
          CHANGE IN DELTA
      AS STOCK PRICE CHANGES




Sunday, July 11, 2010
Delta Neutral Hedge
          CHANGE IN DELTA
      AS STOCK PRICE CHANGES

                           Position        Qua...
Delta Neutral Hedge
                  RE-BALANCING
                    REQUIRED




Sunday, July 11, 2010
Delta Neutral Hedge
                  RE-BALANCING
                    REQUIRED

                           Position      ...
Arbitrage Techniques
              GAMMA-CAPTURE
                 HEDGE




Sunday, July 11, 2010
Arbitrage Techniques
              GAMMA-CAPTURE
                 HEDGE

             Long Convertible Bond
              ...
Arbitrage Techniques
              GAMMA-CAPTURE
                 HEDGE

             Long Convertible Bond
              ...
Gamma Capture Hedge
                  BULLISH-GAMMA
                  CAPTURE HEDGE

                                     ...
Risk Exposures




Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk Exposures




                              Source: Dow Jones Hedge Fund Strategy Benchmarks :
      ...
NOT FOOL-PROOF!
Risk Exposures

                          (%)                       Monthly Returns After Fees
           ...
NOT FOOL-PROOF!
Risk Exposures




Sunday, July 11, 2010
NOT FOOL-PROOF!
Risk Exposures


                             1
                        Default Risk




Sunday, July 11, ...
NOT FOOL-PROOF!
Risk Exposures


                             1
                        Default Risk




                 ...
TYPES OF RISKS
Risk Exposures
                   INVOLVED




                                  Risks




Sunday, July 11,...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                              Credit




                      ...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                              Credit




                      ...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                              Credit           Leverage




   ...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                              Credit           Leverage




   ...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                                    Credit           Leverage

...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                                    Credit           Leverage

...
TYPES OF RISKS
Risk Exposures
                   INVOLVED

                                    Credit           Leverage

...
The ‘Da Vinci’ Code


Sunday, July 11, 2010
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL




Sunday, July 11, 2010
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL


                              cu...
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL




                      (Bt*Cyt)...
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL




                        (Bt*Cy...
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL
                                  ...
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL




Sunday, July 11, 2010
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL



                               ...
The ‘Da Vinci’ Code
                      POSITIVE CARRY
                         MODEL



                               ...
The ‘Da Vinci’ Code
                      CALCULATING
                        RETURNS




Sunday, July 11, 2010
The ‘Da Vinci’ Code
                      CALCULATING
                        RETURNS

                         Marked-to-...
The ‘Da Vinci’ Code
                      CALCULATING
                        RETURNS

                           Marked-t...
The ‘Da Vinci’ Code
                      OPTIMIZING




Sunday, July 11, 2010
The ‘Da Vinci’ Code
                      OPTIMIZING


                                            (deltat*Bt*OBRt – s – d...
The ‘Da Vinci’ Code
                       OPTIMIZING




                      (Capt*OBRt + (Bt – Capt)*Lt)

            ...
The ‘Da Vinci’ Code
                      OPTIMIZING




                                              ((0.9*deltat*Bt*OBR...
The ‘Da Vinci’ Code
                       REAL LIFE
                      APPLICATION




Sunday, July 11, 2010
The ‘Da Vinci’ Code
                       REAL LIFE
                      APPLICATION

                                  ...
The ‘Da Vinci’ Code
                       REAL LIFE
                      APPLICATION
                       (RESULTS)

 ...
The ‘Da Vinci’ Code
                       REAL LIFE
                      APPLICATION
                       (RESULTS)

 ...
Q&A




Sunday, July 11, 2010
A presentation by   TY ‘Da Vinci’ Thong Fund...


                                             Q&A




Sunday, July 11, 20...
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Fi (convertible arbitrage)

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Fi (convertible arbitrage)

  1. 1. This projector is working... Sunday, July 11, 2010
  2. 2. Sunday, July 11, 2010
  3. 3. Susanny’s Final Presentation in SMU... Sunday, July 11, 2010
  4. 4. A presentation by TY ‘Da Vinci’ Thong Fund... FNCE204: Analysis of Fixed Income Prepared for Prof Thong Tiong Yang Chris Tan Kok Yong | Kumara Velan S/O Suppiah | Kwok Kin Fei | Leonardi Susanny Sunday, July 11, 2010
  5. 5. WHAT’S THE AGENDA? Sunday, July 11, 2010
  6. 6. WHAT’S THE AGENDA? The ‘Da Vinci’ Code Risks Exposure Convertible Debt Arbitrage Techniques Introduction to Convertible Bonds Sunday, July 11, 2010
  7. 7. Convertible Bonds INTRODUCTION TO CONVERTIBLE BONDS Sunday, July 11, 2010
  8. 8. Convertible Bonds INTRODUCTION TO CONVERTIBLE BONDS A type of bond that allows holder to convert into shares at conversion price Sunday, July 11, 2010
  9. 9. Convertible Bonds INTRODUCTION TO CONVERTIBLE BONDS In the money At the money 3 outcomes of a convertible bond Out of the money Sunday, July 11, 2010
  10. 10. Convertible Bonds WHY ISSUE CONVERTIBLE BONDS? Sunday, July 11, 2010
  11. 11. Convertible Bonds WHY ISSUE CONVERTIBLE BONDS? 1 2 Minimize negative Lower fixed-rate investor interpretation borrowing costs 3 4 Less equity dilution Increase total level compared to rights issue of debt-gearing Sunday, July 11, 2010
  12. 12. Convertible Bonds INTRO TO CONVERTIBLE DEBT ARBITRAGE Sunday, July 11, 2010
  13. 13. Convertible Bonds 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% Sunday, July 11, 2010
  14. 14. Convertible Bonds 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 Sunday, July 11, 2010
  15. 15. Convertible Bonds NUMERICAL EXAMPLE Sunday, July 11, 2010
  16. 16. Convertible Bonds NUMERICAL EXAMPLE 5% Coupon Rate, Annually 1 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% Sunday, July 11, 2010
  17. 17. DELTA NEUTRAL HEDGE Convertible Debt Arbitrage Techniques GAMME CAPTURE HEDGE Sunday, July 11, 2010
  18. 18. Arbitrage Techniques DELTA NEUTRAL HEDGE Sunday, July 11, 2010
  19. 19. Arbitrage Techniques DELTA NEUTRAL HEDGE Long Convertible Bond Short Underlying Stock at current Delta CV Delta ( ) = S Sunday, July 11, 2010
  20. 20. Arbitrage Techniques DELTA NEUTRAL HEDGE Long Convertible Bond Short Underlying Stock at current Delta CV Delta ( ) = S Yield no profit or loss from stock price movement Capture cash flows from coupon and interest Sunday, July 11, 2010
  21. 21. Delta Neutral Hedge BEGINNING POSITION Sunday, July 11, 2010
  22. 22. Delta Neutral Hedge BEGINNING POSITION Position Quantity Price Value Profit / Loss Convertible Long 1000 1000 $1,000,000 Position Short Stock 16000 40 -$640,000 Position Stock Price Moves 1% Convertible Long 1000 1006.4 $1,006,400 $6,400 Position Short Stock 16000 40.4 -$646,400 -$6,400 Position Delta = 0.64 Net Profit / Loss $- Sunday, July 11, 2010
  23. 23. Delta Neutral Hedge CHANGE IN DELTA AS STOCK PRICE CHANGES Sunday, July 11, 2010
  24. 24. Delta Neutral Hedge CHANGE IN DELTA AS STOCK PRICE CHANGES Position Quantity Price Value Profit / Loss Convertible Long 1000 1006.4 $1,006,400 Position Short Stock 16000 40.4 -$646,400 Position Stock Price Moves another 1% Convertible Long 1000 1012.89 $1,012,890 $6,490 Position Short Stock 16000 40.8 -$652,800 -$6,400 Position Delta = 0.651 Net Profit / Loss $90 Sunday, July 11, 2010
  25. 25. Delta Neutral Hedge RE-BALANCING REQUIRED Sunday, July 11, 2010
  26. 26. Delta Neutral Hedge RE-BALANCING REQUIRED Position Quantity Price Value Profit / Loss Convertible Long 1000 1006.4 $1,006,400 Position Short Stock 16225 40.4 -$655,490 Position Stock Price Moves 1% Convertible Long 1000 1012.89 $1,012,890 $6,490 Position Short Stock 16225 40.8 -$661,980 -$6,490 Position Delta = 0.651 Net Profit / Loss $- Sunday, July 11, 2010
  27. 27. Arbitrage Techniques GAMMA-CAPTURE HEDGE Sunday, July 11, 2010
  28. 28. Arbitrage Techniques GAMMA-CAPTURE HEDGE Long Convertible Bond Same as Delta Hedge Short Underlying Stock at current Delta Sunday, July 11, 2010
  29. 29. Arbitrage Techniques GAMMA-CAPTURE HEDGE Long Convertible Bond Same as Delta Hedge Short Underlying Stock at current Delta However Hedging ratio is different in order to Sacrifice some cash flow for capture Gamma greater capital gain 2 CV Gamma ( ) = 2 S Sunday, July 11, 2010
  30. 30. Gamma Capture Hedge BULLISH-GAMMA CAPTURE 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 Price Stock Price $35.50 $53.00 $79.05 Convertible Price $830.00 $950.00 $1,192.50 Delta 0.3 0.54 0.75 P/L Convertible -$12,000.00 $- $24,250.00 P/L Stock $12,250.00 $- -$18,235.00 Coupons $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 $12,345.00 12 month ROI 6.20% 6.23% 12.99% Sunday, July 11, 2010
  31. 31. Risk Exposures Sunday, July 11, 2010
  32. 32. NOT FOOL-PROOF! Risk Exposures Source: Dow Jones Hedge Fund Strategy Benchmarks : Convertible Arbitrage Fact Sheet Sunday, July 11, 2010
  33. 33. NOT FOOL-PROOF! Risk Exposures (%) Monthly Returns After Fees 7.5 0 -7.5 -15 -22.5 -30 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 Source: Dow Jones Hedge Fund Strategy Benchmarks : Convertible Arbitrage Fact Sheet Sunday, July 11, 2010
  34. 34. NOT FOOL-PROOF! Risk Exposures Sunday, July 11, 2010
  35. 35. NOT FOOL-PROOF! Risk Exposures 1 Default Risk Sunday, July 11, 2010
  36. 36. NOT FOOL-PROOF! Risk Exposures 1 Default Risk 2 Unwinding their positions prior to realizing bond’s fundamental values Sunday, July 11, 2010
  37. 37. TYPES OF RISKS Risk Exposures INVOLVED Risks Sunday, July 11, 2010
  38. 38. TYPES OF RISKS Risk Exposures INVOLVED Credit Risks Sunday, July 11, 2010
  39. 39. TYPES OF RISKS Risk Exposures INVOLVED Credit Risks Equity Market Sunday, July 11, 2010
  40. 40. TYPES OF RISKS Risk Exposures INVOLVED Credit Leverage Risks Equity Market Sunday, July 11, 2010
  41. 41. TYPES OF RISKS Risk Exposures INVOLVED Credit Leverage Risks Equity Market Interest Rate Sunday, July 11, 2010
  42. 42. TYPES OF RISKS Risk Exposures INVOLVED Credit Leverage Risks Liquidity Equity Market Interest Rate Sunday, July 11, 2010
  43. 43. TYPES OF RISKS Risk Exposures INVOLVED Credit Leverage Risks Liquidity Equity Market Currency Interest Rate Sunday, July 11, 2010
  44. 44. TYPES OF RISKS Risk Exposures INVOLVED Credit Leverage Execution Risks Liquidity Equity Market Currency Interest Rate Sunday, July 11, 2010
  45. 45. The ‘Da Vinci’ Code Sunday, July 11, 2010
  46. 46. The ‘Da Vinci’ Code POSITIVE CARRY MODEL Sunday, July 11, 2010
  47. 47. The ‘Da Vinci’ Code POSITIVE CARRY MODEL current income of delta neutral position financing cost of delta neutral position Carryt Sunday, July 11, 2010
  48. 48. The ‘Da Vinci’ Code POSITIVE CARRY MODEL (Bt*Cyt)+(deltat*Bt*OBRt- s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt) current income of delta neutral position financing cost of delta neutral position Sunday, July 11, 2010
  49. 49. The ‘Da Vinci’ Code POSITIVE CARRY MODEL (Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt) Sunday, July 11, 2010
  50. 50. The ‘Da Vinci’ Code POSITIVE CARRY MODEL Capital base required to Current yield of Short financing establish position bond at time t charge (Bt*Cyt)+(deltat*Bt*OBRt - s – dyt) – (Capt * OBRt + (Bt-Capt) * Lt) Price of convertible Overnight Dividend bond at time t bank rate compensation paid Leverage rate to stock lender as percentage of Bt Sunday, July 11, 2010
  51. 51. The ‘Da Vinci’ Code POSITIVE CARRY MODEL Sunday, July 11, 2010
  52. 52. The ‘Da Vinci’ Code POSITIVE CARRY MODEL ::Condition for starting the carry strategy:: Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0 Sunday, July 11, 2010
  53. 53. The ‘Da Vinci’ Code POSITIVE CARRY MODEL ::Condition for starting the carry strategy:: Cyt + deltat*OBRt - s – dyt) – ((OBRt – Lt)*(Capt/Bt) + Lt) > 0 Position is held until this condition is rendered void! Sunday, July 11, 2010
  54. 54. The ‘Da Vinci’ Code CALCULATING RETURNS Sunday, July 11, 2010
  55. 55. The ‘Da Vinci’ Code CALCULATING RETURNS Marked-to-market portfolio value for day t Vt = Bt - SSt deltat*Bt Sunday, July 11, 2010
  56. 56. The ‘Da Vinci’ Code CALCULATING RETURNS Marked-to-market portfolio value for day t Vt = Bt - SSt deltat*Bt ::Therefore:: ((Vt - Vt - 1) + (SSt-1*OBRt – s – dyt)-(Bt-1-Capt-1)*Lt-1) Rt = Capt-1 Daily return on the positive carry trade Sunday, July 11, 2010
  57. 57. The ‘Da Vinci’ Code OPTIMIZING Sunday, July 11, 2010
  58. 58. The ‘Da Vinci’ Code OPTIMIZING (deltat*Bt*OBRt – s – dyt) CFDs as proxies for shorting ((0.9*deltat*Bt*OBRt)-dyt) Sunday, July 11, 2010
  59. 59. The ‘Da Vinci’ Code OPTIMIZING (Capt*OBRt + (Bt – Capt)*Lt) Minimizing Lt Bt*OBRt Sunday, July 11, 2010
  60. 60. The ‘Da Vinci’ Code OPTIMIZING ((0.9*deltat*Bt*OBRt)-dyt) Maximizing OBRt (20(0.9*deltat*Bt*OBRt) – dyt) Sunday, July 11, 2010
  61. 61. The ‘Da Vinci’ Code REAL LIFE APPLICATION Sunday, July 11, 2010
  62. 62. The ‘Da Vinci’ Code REAL LIFE APPLICATION Olam 6% CB 15102016 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 Sunday, July 11, 2010
  63. 63. The ‘Da Vinci’ Code REAL LIFE APPLICATION (RESULTS) Carryt -$23,241.8 OCt $87,400 Return 58.26% Fund Management Fees (20/2) $148,172 Sunday, July 11, 2010
  64. 64. The ‘Da Vinci’ Code REAL LIFE APPLICATION (RESULTS) Carryt -$23,241.8 OCt $87,400 BOOMZ! Return 58.26% Fund Management Fees (20/2) $148,172 Sunday, July 11, 2010
  65. 65. Q&A Sunday, July 11, 2010
  66. 66. A presentation by TY ‘Da Vinci’ Thong Fund... Q&A Sunday, July 11, 2010

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