The Complete Arbitrage Deskbook
The Complete Arbitrage Deskbook (By Stephane Reverre)
Edition 2001 http://astore.amazon.com/zw-20/detail/0071359958
Executive Summary by Tobias M. Dijkstra
This book describes tools, cases, arbitrage in stocks, futures, indices and money markets. It is a manual for professionals and non-professionals on mathematics, fundamentals and risk management, Stephane Reverre practiced this as former head of index arbitrage and quantitive trading for Société Générale.
Part 1: Theory and Tools Introduction Stocks Futures and Related Instruments Money Markets Aggregate Indicators: Stock Indices
Part 2: Financial Valuation and Risk Analysis Valuations Risk Analysis
Part 3: Common Arbitrage Situations Index Arbitrage Risk Arbitrage Risk Arbitrage steps Business Politics: Failure of Mergers Pair Trading and Technical Trading
Part 1: Theory and Tools Introduction This book gives a step-by-step guide to arbitrage. Cases are discussed from day-to-day and hour by hour. The book learns the reader to follow this process. It has has real-life examples of arbitrage situations in the past. The book contains formulas for the whizzkids between the investors community. Though it is not only useful for them. From the practicle examples everybody reader can get wiser. The writer tells about his experience as employee in a French bank. He tells about Index Arbitrage and Risk Arbitrage, Pair Trading and Technical Trading as common arbitrage situations. Before taking part in a deal the financial valuation and risk analysis in this book reduces the chance of mistakes. In this deskbook you can also read how the money markets works, futures and relates instruments, aggregate indicators like stock indices. Stocks An arbitrageur have to look at the availability of listed share capital, below in an example I explain why. Issuance from bonds and convertible bonds has no consequence on the positions held during arbitrage. There is an exception at conversion of outstanding bonds. It can influence the outstanding capital therefore it must be tracked. At the dealingroom a lot of these issues are passed by. If the trader sees a lot of conversions he takes this in deliberation. A stock will be analyzed by its price, cash flow and number of outstanding share capital. Futures and Related Instruments Futures are contracts to enable buyers to have products for a certain price on a certain date. Financial futures are more traded then agriculatural and commodity futures. Futures are needed to give farmers and other interests an insurance for their business. Money Markets With money markets we mean transactions around borrowing or lending and the cashlows between them. To prevent mistakes it’s wise to research interest rates and overnight financing. This relates to day-to-day funding of an arbitrage activity which is crucial to know for profit optimalization by a treasurer. Aggregate Indicators: Stock Indices Stock indices are as old as stocks are in circulation. The meaning of the indices is to converge all the information around the return on investment of equities in one number. The index is a computation of the average individual prices. The index indicates the general profitability of a particular industry, not the specific events influencing the welfare of corporations. Index financiers follow the ups and downs of indices to select and enclose the best companies. For example, in 1999 Dow Jones included Nasdaq stocks in its index, more a picture of the market then. That said. Monitoring company news is also significant to a better reflection of what happens in the index. Another reason for the relevance of indices is that several futures and options are linked to them. These can be applied as an insurance during bear markets. There is a lot of liquidity in this instruments, to simply protect capital and due to the capital asset pricing model (CAPM), this model argues that you get burned by a lack of diversification. Markets with most of the cash in the world and a range of sectors is the best place to diversify assets. By the way investors appreciate the index for its liquidity, low price and easy to trade futures. This is a good option for investors for who it’s to difficult to find enough capitalization on particular investing opportunities.
Part 2: Financial Valuation and Risk Analysis Valuations Definition: Valuation is uniting what’s analyzed previously step-by-step, with the purpose to value everything. Two distinctive keywords: 1. Trust: trust is reached with downgrading the unsecurity by harsh handling the protocol. 2. Sense: choose the procedures that covers the investment situation and liquidation value as a whole and reflects the reality where its embedded. Risk Analysis It’s better to lose not money; one of the investing rules of Warren Buffett is: lose not money; though this can happen. Even if one did everything in his analysis to wipe out uncertainty. Overcome losing capital through measure the stake of capital at risk. Restrict loses is basically above return on assets. The market is to dynamic to always define what the loses are in positions. But there is no excuse to not knowing what the loses can be outermost. Risk management mechanics, for example a stop loss of 10% and using trailing stops to protect profits is appropriate at Zenway Group.
Part 3: Common Arbitrage Situations Index Arbitrage and Risk Arbitrage Risk Arbitrage has its ground in trading on news regarding companies and their course. Index Arbitrage is theorethical: it is based on daily trading deviation of the algabraic matrix. Risk Arbitrage is a miscellany of hypothetical and theorethical valuation. Therefore developing a proper personal judgment is necessary to cover the risk involved in the hypothetical part. With risk arbitrage instead of index arbitrage we are out of the secure situation of the theorethical pure algebraic index arbitrage. Thereabout application of man’s view is the key. Risk Arbitrage steps: · Must be a cash-deal · Does the managers not getting more than $200.000 per year. Is their salary appropiate by the current company succes and durability? · When does the event actually take place? · Is the takeover bid to high for the companies net-worth? · Is this a must-do-deal? · Follow shareholder actions of the attorneys ( for exameple who want a fair higher price for their shares) to gather more information (in the Supreme Court of the State of New York or elsewhere) · Look at what the companies are doing in the run to the final closing bell of the deal, to determine if the companies have better offers and opportunities for them from others. Better takeover bids or other unexpected entanglements are something to be aware of. · It is likelihood that the announced merger will actually be approved and go through? (go to the meeting in the pressroom or boardroom where the deal is approved) · Does the deal go through since there are financing problems or unexpected related issues, rejections by law and policy in the field of business competition or otherwise for example? Government institutions like SEC and FCC. · What is the track record of both investors, do they keep there word in deals? · Do the investors have enough cash? · Annualized 20% expected return · Estimated success probability of 80% · Moneymanagement: Advise is: 5-10% use of your portofolio · Write down 5 positive and 3 negative points about the Risk Arbitrage · Maximum margin of 25% portofolio net-worth Business Politics: Failure of Mergers Arbitrageurs don’t cope with the organizational convergence of corporations after a merger. Though as shareholders they have to see the economical advantages of a merger to gain more financial strenght. The deal can not got through if shareholders see the dangers for destroying their share’s value after a failed merger. Shareholders have to track their management’s decisions and if needful place new officials. It’s democratic if shareholders take action. They are the owners of the company. The management are only the executors and are working as a agency for them. We have here the agency problem: the management is not conducting in the best interests of shareholders. Carl Icahn is one of the best examples of shareholders activism. Cases like this often happen, as to that arbitrageurs have to determine the chance the deal will be persecute as proposed. Pair Trading and Technical Trading Pair trading is considering the supposition: information of particular industries influence the price of stocks, stocks in one industry are fluctuating the same. Though every pair of stocks who have the same characteristics can be put under the umbrella of pair trading. At technical trading, traders are looking for patterns in the markets without valuation procedures. This can be done. When we know the value of a corporation. For more information: http://astore.amazon.com/zw-20/detail/0071359958
By Dijkstra - Posted on 06 March 2009