Index

A historical performance, 35–36 B absolute priority rule, 101–102 interpretation issues, 36 backfill bias, of hedge funds, 69 absolute-return vehicles, 63 investment characteristics, 37–40 back office, 200 accounting risk, 209–210 market for, 28–35 backtesting, 229 accreting swaps, 143–145 in portfolios, 40–41 back-to-back transactions, 131 active managers, selecting, 10–11 real estate, 13–26 backwardation, 48–49, 161, 170 active risk, 212 benchmarks, 15–17 Bankers Trust, 144–145 actual extreme events, scenario analysis due diligence, 26 Bank for International Settlements, 449n.4 with, 232 historical performance, 17–18 Bank Herstatt, 207 age effects, hedge fund, 75 interpretation issues, 18 bankruptcy process, 100–103 Aktiengesellschaft (AG), 33 market for, 13–15 absolute priority rule, 101–102 alpha, 13, 63, 288 in portfolios, 20–26 Chapter 7 and Chapter 11, 102 alpha core, 13 solutions to problems, 119–127 netting in, 247 alpha strategies, 288 traditional vs., 7–13 prepackaged filings, 102 alternative investments, 6–127 Alternative Investments Management in United States vs. other countries, commodities, 43–55 Association, 76–77 100–101 benchmarks, 45–46 Altman-NYU Salomon Center Bankruptcy Reform Act (1978), 100 historical performance, 46–49 Defaulted Public Bond and Bank Basel Committee on Banking interpretation issues, 49 Loan Index, 95 Supervision, 240–241 investment characteristics, 50–53 American options, 238, 366 Basel I (Capital Accord of 1988), market for, 44–45 American Stock Exchange (AMEX) 240–241 in portfolios, 53–55 and NAREIT Index, 17 Basel II (New Basel Capital Accord), common features, 7 NASDAQ 100 Trust Shares, 367n.3 240–241 defined, 7 American style , 479, 484, basis distressed securities, 93–103 485 defined, 274–275 bankruptcy process, 100–103 AMEX. see American Stock and expected hedged return, 279 benchmarks, 95 Exchange and futures exchange rates, 277–279 example, 102–103 amortizing swaps, 143–145 and hedged return, 272 historical performance, 95–96 analytical method, 215–220 basis point value (BPV), 314 interpretation issues, 96 angel investors, 30 basis risk investment characteristics, 97 Apple Computers, 37 in currency risk management, 277–279 market for, 94 and hedging with commodity forwards in portfolios, 97–100 defined, 308 and futures, 185–186 evaluation of, 10–11 distressed , 98 BB Holdings, 324–325 hedge funds, 56–84 forwards pricing by, 163–167 bear spreads, 386–389 benchmarks, 61–63 apparent arbitrage and resolution, behavioral considerations, of risk due diligence, 75–78 164–165 management, 252 fund effects, 74–75 with positive lease rate, 165–167 Belgium, 14 historical performance, 63–66 asset allocation beliefs, about currencies, 291 interpretation issues, 66–70 adjusting, 335–341 benchmarks investment characteristics, 71 and equity market risk, 473–476 for commodities, 45–46 market for, 56–60 and futures, 335–344 for distressed securities, 95 performance evaluations, 78–84COPYRIGHTEDadjusting asset allocation, MATERIAL 335–341 for hedge funds, 61–63 in portfolios, 71–74 pre-investing in asset classes, alpha determination and absolute- investors’ goals for, 6 342–344 return investing, 63 low-return environments, 8–9 strategic, 92–93 comparison of manager-based hedge managed futures, 84–93 asset class(es) fund indices, 62–63 benchmarks, 86 and asset/currency returns, 291 for managed futures, 86 historical performance, 86–88 currency as, 294 for private equity, 35 interpretation issues, 88 pre-investing in, 342–344 for real estate, 15–17 investment characteristics, 88–89 asset swaps, 136 beta market for, 85–86 asset under management (AUM) changing, 334–335 performance persistence, 91 fees, 59 defined, 212 in portfolios, 89–91 Australia measuring and managing, 322–323 strategic asset allocation, 92–93 benchmark hedge ratio for investors, biases practice problems, 106–118 293 backfill, 69 private equity, 26–43 currency risk management, 270, 286, for hedge funds, 66–69 about, 26–28 288 in index creation, 66–68 benchmarks, 35 real estate market, 16, 20, 24 stale price, 69 due diligence, 41–43 REITs, 14 survivorship, 68–69 I-1

index.indd 1 03/05/12 3:19 PM I-2 Index

bid–ask spread, credit risk and, 204 Cambridge Associates, 35 CISDM Trend-following strategy, 87, 88 binomial model Canada Citigroup, 133 and box spreads, 400, 401 bankruptcy, 100 claw-back provision, 34 in, 433 currency risk management, 292 closed-end funds, 14 Black–Scholes–Merton pricing pension funds, 9 closeout netting, 247 and box spreads, 400, 401 public sector pension plans, 40 CLS. see continuously linked formula for, 394–395, 425–426 real estate benchmarks, 16 settlements and model risk, 206 REITs, 14, 24 CME. see Chicago Mercantile Exchange prices from, 367n.4, 381 caps, floating-rate loan, 413–417 CMT rate. see constant maturity volatility in, 212–213, 433 Capellas, Michael D., 99 treasury rate bonds Capital Accord of 1988 (Basel I), collars adjusting allocation between, 337–339 240–241 defined, 383 cheapest to deliver, 315 capital adequacy ratio, 241n.49 in equity portfolios, 394–398 dual currency, 466–469 capital allocation, risk management in, with floating-rate loans, 420–423 bond futures, risk of, 315–317 250–252 collateral, managing credit risk with, bond portfolios, risk of, 313–315 caplets, 413–415 246–247 bond portfolio risk, 313–321 caplet payoff, 416, 422 collateral return, 48 balancing types of risks, 315–317 carried interest, 33 commingled real estate funds (CREFs), of government bond portfolios, carry, 170 14–15 317–320 carry markets, 170–173 commitment, for private equity risk of bond futures, 315 convenience yield, 171–173 investments, 33, 37, 41, 42 risk of bond portfolio, 313–315 storage costs, 170–171 commitment period, 41 variations and problems, 320–321 cash Committee of Sponsoring Organizations bond price, yield and, 313–314 equitizing cash, 330–331 of the Treadway Commission, 200n.3 borrowing from equity, 331–335 commodities, 43–55 calls with, 403–408 invested in private equity, 42 benchmarks, 45–46 swaptions in anticipation of, 479–483 synthetic index funds, 327–330 defined, 7, 43 box spreads, 400–403 cash-and-carry arbitrage historical performance, 46–49 BPV. see basis point value cash flow, 169 commodity index return breakeven point described, 166–167 components, 48–49 , 388 and , 172 recent performance, 47 , 402 cash flow(s) interpretation issues, 49 , 385 cash-and-carry arbitrage, 169 investment characteristics, 50–53 spread, 392 from VC and buy-out funds, 38 commodities as inflation hedges, call options, 370, 376 cash flow at risk (CFAR), 229 52–53 collars, 395–396 cash receipts, foreign, 346, 464–466 risk characteristics, 50–52 covered calls, 377 CBOT. see Chicago Board of Trade market for, 44–45 protected puts, 381 CCAA. see Companies’ Creditors size of market, 44–45 put options, 373, 374, 376 Arrangement Act types of commodity investments, 44 , 399 Center for International Securities and in portfolios, 53–55 Brightman, Christopher J., 10 Derivatives Markets (CISDM), 22, types of, 44 Brin, Sergey, 31 60–62, 95 commodity forwards and futures, budgeting, risk, 243–245 CFAR. see cash flow at risk 159–192 bull spreads, 383–386 Chapter 7 bankruptcy, 93, 100, 102 about, 159–161 business risk, 202n.5 Chapter 11 bankruptcy, 93, 100–102 carry markets, 170–173 butterfly spreads, 389–394 cheapest to deliver bond, 315 convenience yield, 171–173 buyout funds, VC funds vs., 38 Chicago Board of Trade (CBOT) storage costs, 170–171 corn futures, 177, 179 and commodity lease rate, 167–170 C futures pricing, 160 forward prices, 168–170 callable debt, removing calls from, futures, 320n.16 lease market for commodities, 487–489 U.S. Treasury bond futures, 315 167–168 call features Chicago Mercantile Exchange (CME), commodity spreads, 184 adding calls to noncallable debt, 286n.6 corn , 176–179 489–492 hedging the principal, 270 electricity, 162–163 removing calls from callable debt, SPAN system, 231 equilibrium pricing of forwards, 487–489 weather derivatives, 187 161–162 call options (calls) China, 14 forwards pricing by arbitrage, 163–167 adding, to noncallable debt, 489–492 CISDM. see Center for International apparent arbitrage and resolution, with borrowing, 403–408 Securities and Derivatives Markets 164–165 in equity portfolios CISDM CTA trading strategy with positive lease rate, 165–167 combinations of puts and, 394–403 benchmarks, 86–88 gold futures, 173–176 covered, 376–380 CISDM Currency strategy, 87, 88 evaluation of gold production, long/short positions for, 369–372 CISDM Discretionary strategy, 87, 88 175–176 managing currency exposure with, 286 CISDM Diversified strategy, 87, 88 gold investments, 174–175 premiums, 219 CISDM dollar-weighted CTA index hedging strategies, 185–188 removing, from callable debt, 487–489 (CTA$), 86–88, 90 basis risk, 185–186 call payoffs, 403, 404, 406–407 CISDM equal-weighted CTA index for jet fuel with crude oil, 186–187 Calmar ratio, 82n.120 (CTAEQ), 86, 87 for weather derivatives, 187–188 CalPERS, 290 CISDM Financial strategy, 87, 88 natural gas, 179–182

index.indd 2 03/05/12 3:19 PM Index I-3

nonstorability of, 162–163 covariance management of currency risk profile oil, 182–184 of asset returns and local currency with, 293 practice problems, 189 value, 273 technical approach, 293–294 seasonality of, 176–179 and risk of equities, 322 currency overlay manager, 292 solutions to problems, 190–192 covered calls currency risk, reducing, 286–290. see Commodity Futures Trading and bull spreads, 384 also foreign currency risk Commission, 320n.16 in equity portfolios, 376–380 currency risk management, 269–303 commodity index returns, 48–49 CPOs. see commodity pool operators about, 269–270 commodity lease rate crack spread, 184 with futures or forward currency and commodity forwards and futures, cram down, 101 contracts, 270–281 167–170 credit default swaps, 248 basis in, 277–279 forward prices, 168–170 credit derivatives hedging the principal, 270–273 forwards pricing by arbitrage with defined, 203n.7 implementation, 279–280 positive lease rate, 165–167 managing credit risk with, 248 minimum-variance hedge ratio, and lease market for commodities, credit risk 273–277 167–168 identifying, 203–204 for multiple currencies, 280–281 and storage costs in carry markets, 171 managing, 245–248 hedging commodity market, 44–45 with collateral, 246–247 with futures or forward currency and commodity lease rate, 167–168 with credit derivatives, 248 contracts, 270–281 size of, 44–45 by limiting exposure to credit risk, with options, 284–286 types of commodity investments, 44 245–246 strategic hedge ratio, 290–292 commodity pool operators (CPOs), 85 by marking to market, 246 insuring, 281–284 commodity spreads, 184 with netting, 247 with options, 281–286 commodity swaps, 148–150 reducing, 245–248 hedging with options, 284–286 counterparty, 132–134 with standards and enhanced insuring with options, 281–284 example, 130–135 product companies, practice problems, 297–298 market value of , 134–135 247–248 reducing currency exposure, 286–290 physical vs. financial settlement, transferring, 248 solutions to problems, 298–303 130–131 measuring, 233–239 strategic and tactical, 290–294 pricing, 132, 148–149 calculating exposures, 238–239 currency asset class, 294 with variable quantity and price, of forward contracts, 236 currency overlay, 292–294 149–150 option-pricing theory, 234–236 strategic hedge ratio, 290–292 commodity trading advisors (CTAs), 43 of options, 237–239 currency risk profile, 293 and characteristics of managed futures, of swaps, 236–237 currency swaps, 145–148. see also 88–89 forwards, 248 forward currency contracts; interest historical performance of, 86–88 credit spread options, 248 rate swaps performance persistence, 91 credit standards, 247–248 about, 145–147 registration of, 85 Credit Suisse First Boston, 31 with floating interest rates, 147–148 communication, with client, 11 Credit Suisse/Tremont Index, 61, 62 formulas for, 147 Companies’ Creditors Arrangement Act credit VAR, 234 interest rate vs., 463 (CCAA), 100 CREFs. see commingled real estate notional principal in, 239 competition, in private equity funds time horizons of, 280 evaluation, 41 cross-default provisions, 233 current credit risk, 233 concentrated portfolios, diversifying, cross-hedges, 280–281, 294 customers, opinions of, 42 469–471 crude oil, hedging strategies for, consistency, of performance evaluations, 186–187 D 82–84 crush spread, 184 days in underlying, 403 constant maturity treasury (CMT) rate, crush spreads, 184 DB pension plans. see defined-benefit 144 CTAs. see commodity trading advisors pension plans , 49, 161, 170, 186 CTA$. see CISDM dollar-weighted CTA debt continuously linked settlements (CLS), 207 index callable, 487–489 contract risk, 208 CTAEQ. see CISDM equal-weighted distressed, 98 (see also distressed convenience yield CTA index securities) in carry markets, 171–173 CTA managed accounts. see managed noncallable, 489–492 of commodities, 50–51 futures Debt Management Associates, 319–320 convertible arbitrage hedge fund currency debtor-in-possession, 100 strategies, 57 for alpha funds, 294 decision risk, for alternative convexity (term), 212 as asset class, 294 investments, 11–12 cooling degree-day, 187 beliefs about, 291 default swaps, 153 core-satellite investing, 13 in strategies for managed futures, 85 deferred swaps, 142–143 corn forward market, 176–179 currency conversions defined-benefit (DB) pension plans, 203 corporate form (private equity funds), 33 and exchange rate risk, 460–466 delta corporate governance, 200 of foreign cash receipts, 464–466 defined, 212 corporate venturing, 31 of loans, 460–464 and dynamic hedging, 284–285 correlations, as performance appraisal currency futures and forwards. see gamma and risk of, 432–433 measures, 82 currency swaps; forward currency and option portfolio risk management, counterparty contracts 424–425 of commodity swaps, 132–134 currency overlay, 270, 292–294 and option price sensitivity, 426 of interest rate swaps, 137–138 fundamental approach, 294 and time, 427

index.indd 3 03/05/12 3:19 PM I-4 Index

delta hedge, 285, 424–432 Dow Jones equity hedge fund strategies, 57, 59 delta-normal method, 219–220 hedge fund indices, 60 equity market-neutral hedge fund demand REIT indices of, 16, 17 strategies, 57 business-cycle related, 50 Dow Jones-AIG Commodity Index equity market risk for venture capital, 29 (DJ-AIGCI), 45–47, 50 forward and futures strategies for derivatives. see also specific types, e.g.: Dow Jones Euro STOXX 50, 473 managing, 321–335 options Dow Jones Hedge Fund Strategy cash from equity, 331–335 credit, 203n.7, 248 benchmarks, 61–62 equity from cash, 326–331 defined, 305 Dow Jones Industrial Average, 221 risk of equities, 322–324 OTC, 204, 207, 246–247 downside deviation, 250 risk of equity portfolios, 324–326 weather, 187–188 downside volatility, 79–80 swap strategies for managing, 469–478 derivative contracts, accounting risk dual currency bonds, 466–469 and allocation of stocks and bonds, with, 209 due diligence 473–476 Derivatives Policy Group, 231 for alternative investments, 9, 11–12 diversifying concentrated portfolios, derivative product companies, 247–248 defined, 7 469–471 Deutsche Bank, 9 for hedge funds, 75–78 insider exposure, 476–478 diff swaps, 148 for private equity, 41–43 international diversification, 471–473 dilution, of interest, 42 for real estate, 26 equity portfolios direct commodity investment, 44 duration options strategies for managing, direct venture capital investment, of bonds, 212, 313 367–403 32–33 ex post, 318, 319 combinations of calls and puts, discretionary trading strategies, 85 of fixed-income portfolios, 453–455 394–403 Disney World, 345 Macaulay, 314n.7 money spreads, 383–394 distressed debt arbitrage, 98 modified, 314, 454 standard long and short positions, distressed securities, 93–103 of swaps, 451–455 369–376 bankruptcy process, 100–103 target dollar, 316–317 and the underlying, 376–383 absolute priority rule, 101–102 dynamic hedging, 284–285 risk of, 324–326 Chapter 7 and Chapter 11, 102 equity REITs, 14 prepackaged filings, 102 E equity swaps, 474–478 in United States vs. other countries, EACM 100 Index, 61, 72 ERM. see enterprise risk management 100–101 EACM Advisors, 61, 62, 95 ESG risk, 210 benchmarks, 95 early-stage financing, 29 Euribor. see Euro Interbank Offered defined, 7 earnings at risk (EAR), 229 Rate example, 102–103 economic risk euros historical performance, 95–96 exposure, 345 converting interpretation issues, 96 in minimum-variance hedge ratio, 275 to British pounds, 460–462 investment characteristics, 97 EDPCs. see enhanced derivative product to Canadian dollars, 465–466 market for, 94–95 companies currency hedges with, 280, 281, 294 in portfolios, 97–100 effective interest dual-currency bonds in, 466–468 distressed debt arbitrage, 98 with call, 405–407 forward contracts on, 348–349 long-only value investing, 98 with cap, 417 and insuring with options, 282–284 private equity, 98–100 with , 422 , interest rate swaps with, turnaround equity, 99 with floor, 419 139–142 private equity of, 98–100 with put, 409, 411–413 futures types of, 94 effective loan rate controlling risk with, 312–313 distressed securities hedge fund with call, 405–407 hedging floating-rate loans with, 353 strategies, 57–58 with cap, 417 EuroHedge, 61 distressed securities market, 94–95 with put, 409, 411–413 Euro Interbank Offered Rate (Euribor), size of, 95 effectiveness, of risk governance, 199 480, 481 types of distressed securities, 94 efficiency, of risk governance, 199 Europe diversification electricity, 162–163 private equity activity, 35 of concentrated portfolios, 469–471 emerging markets hedge fund real estate allocations in, 20 with hedge funds, 72 strategies, 58 European options, 238, 366–367 international, 471–473 employment contracts, 42 European Private Equity, 35 for managed futures, 85 enhanced derivative product companies European style swaptions, 479 with private equity, 40, 41 (EDPCs), 247–248 European Union, 33 with real estate, 21–24 Enron, 133–134 Eurozone with swap strategies, 469–473 enterprise risk management (ERM), benchmark hedge ratio for investors, diversification effect, for VAR, 222 199–201, 242 293 dividends equilibrium pricing of forwards, 161–162 currency loss on assets, 291–292 and stock index futures trade, 324 equities. see also specific types event driven hedge fund strategies, 59 in synthetic index funds, 329–330 adjusting allocation between, 339–340 event risk, of distressed securities, 99 dividend recapitalization, 32 orphan, 94, 98 exchange rate risk DJ-AIGCI. see Dow Jones-AIG risk of, 322–324 and currency conversions, 460–466 Commodity Index equity and foreign cash receipts, 464–466 dollar (U.S.) cash from, 331–335 and loans, 460–464 converting yen into, 464–466 equitizing cash, 330–331 risk of dual currency bonds, 466–469 currency hedges with, 280, 281 synthetic index funds, 327–330 swap strategies for managing, dual-currency bonds in, 466–469 Equity Analysts, Inc., 326 460–469

index.indd 4 03/05/12 3:19 PM Index I-5

executives, equity swaps involving, 478 foreign-market asset portfolio, risk of, funds of funds (FOFs), 58 rate, of swaptions, 479 348–352 fund effects for, 74–75 exits formative-stage companies, venture roles of, 71, 72 from private equity investments, capital for, 29 futures 29–30 forwards asset allocation with, 335–344 from swaps, 134–135 commodity (see commodity forwards adjusting asset allocation, 335–341 expansion-stage companies, venture and futures) pre-investing in asset classes, capital for, 29 futures vs., 270, 352–354 342–344 expected hedged return, basis and, 279 risk management applications of (see and basis, 277–279 ex post duration, 318, 319 risk management applications of basis risk, 277–279 exposure. see risk exposure forward and futures strategies) expected hedged return and basis, extensions of VAR, 230–231 forward contracts 279 measuring credit risk of, 236 commodity (see commodity forwards F repricing, 246 and futures) Fabozzi, Frank J., 313n.3 and swaps, 448 currency risk management with, factor push models, 232 forward currency contracts. see also 270–281 fallen angels, 97 currency swaps on foreign assets, 287 Federal Reserve, 323 basis in, 277–279 forwards vs., 270, 352–354 Financial Accounting Standards Board basis risk, 277–279 hedging the principal with, 270–273 (FASB), 209 expected hedged return and basis, 279 managed (see managed futures) financial ownership, 14 currency risk management with, minimum-variance hedge ratio, financial review, of private equity, 42–43 270–281 273–277 financial risk, 202 hedging the principal, 270–273 economic risk, 275 financial settlement, of commodity implementation, 279–280 hedging total currency risk, 276 swaps, 130–131 minimum-variance hedge ratio, implementation of, 276, 277 financial statements, 42 273–277 translation risk, 275 financial strategies for managed futures, economic risk, 275 risk management applications of (see 85 hedging total currency risk, 276 risk management applications of Financial Times Stock Exchange (FTSE) implementation of, 276, 277 forward and futures strategies) 100 Index, 327–330 translation risk, 275 strategy implementation, 279–280 first-stage financing, 29, 30 for multiple currencies, 280–281 futures pricing, interest rate differentials fixed-income arbitrage hedge fund forward curve, 160 in, 278–279 strategies, 57 forwards pricing fixed-income markets, in strategy matrix by arbitrage, 163–167 G of alternative investments, 289 and commodity lease rate, 168–170 gain-to-loss ratio, hedge fund, 81–82 fixed-income portfolios, duration of, equilibrium pricing of forwards, gamma 453–455 161–162 defined, 212, 432 fixed-income swaps, equity vs., 474–478 and storage costs in carry markets, and risk of delta, 432–433 fixed-rate loans, converting floating- 170–171 GARP. see Global Association of Risk and, 449–453 forward rate agreements (FRAs) Professionals floating interest rates, currency swaps hedging with, 308–309 Germany, 33 with, 147–148 in interest rate swaps, 135 GICS. see Global Industrial floating-rate loans loans with, 309–313 Classification System with caps, 413–417 floating-rate loans, 312–313 global asset allocators hedge fund with collars, 420–423 single-payment loans, 309–312 strategies, 59 converting fixed- and, 449–453 forward strip, 160 Global Association of Risk Professionals with floors, 417–420 forward swaps, swaptions and, 492–493 (GARP), 242 with FRAs, 312–313 franc (French), 291 global custodian, 201 inverse, 457–459 franc (Swiss), 468–469 Global Industrial Classification System leveraged floating-rate notes, 456–457 France (GICS), 14 floors, 417–420 corporate form of publicly-traded global macro hedge fund strategies, 58, floorlets, 417–418 companies, 33 74 floorlet payoff, 419, 422 real estate market, 16, 24 gold futures, 173–176 FOFs. see funds of funds REITs in, 14 gold investments, 174–175 Ford Credit, 257–258, 265 FRAs. see forward rate agreements Goldman Sachs Commodity Index Ford Motor Company, 256, 257, 264 front office, 200 (GSCI), 17, 45 foreign cash receipts, 346, 464–466 FTSE 100 Index. see Financial Times and commodities as inflation hedge, foreign currency deposits, 273 Stock Exchange 100 Index 52–53 foreign currency payments, 346–348 FTSE EPRA/NAREIT Global Real Estate contracts based on, 50 foreign currency risk Index, 16, 17 historical performance, 46–47, 49 forward and futures strategies for FTSE Industry Classification and risk diversification with managing, 344–352 Benchmark, 14 commodities, 54–55 risk of foreign currency payments, full currency-option hedges, 284 Goldman Sachs Group, Inc., 222–226 346–348 fundamental approach to currency gold production, evaluation of, 175–176 risk of foreign currency receipts, 346 overlay, 294 Google, Inc., 31, 37 risk of foreign-market asset portfolio, fund effects, hedge fund, 74–75 governance, risk, 199–201 348–352 funding risk, 204n.10 government bond futures contracts, 320 foreign exchange risk budgeting, 243 fund management companies, risk government bond portfolios, 317–320 foreign markets, investing in, 287 budgeting by, 244 grade, commodity, 185

index.indd 5 03/05/12 3:19 PM I-6 Index

GSCI. see Goldman Sachs Commodity with swaps, 452 calls with borrowing, 403–408 Index of total currency risk, 276 caps with floating-rate loans, GSCI Energy subindex, 49 hedging the principal, 270–273 413–417 GSCI Industrial Metals subindex, 49 Heine, Max L., 94 collars with floating-rate loan, Herstatt risk, 206–207 420–423 H HFCI. see Hedge Fund Composite Index floor with floating-rate loan, 417–420 heating degree-day, 187 HFR. see Hedge Fund Research puts with lending, 408–413 hedged equity strategies, 58 HFR Distressed Securities Index, 95–96 interest rate parity, 278 hedge funds, 56–84 HFR Fixed-Income High-Yield Index, 95 interest rate risk benchmarks, 61–63 high-water mark (HWM), 59 forward and futures strategies for alpha determination and absolute- high-yield investing, 98 managing, 309–321 return investing, 63 historical method, 220–226 swap strategies for managing, 449–459 comparison of manager-based hedge historical simulation method, 221 converting floating- and fixed-rate fund indices, 62–63 Hong Kong, 14, 280 loans, 449–453 defined, 7 HSBC AsiaHedge, 61 duration of fixed-income portfolios, due diligence, 75–78 hurdle rate, 34 453–455 fund effects, 74–75 HWM. see high-water mark risk of structured notes, 455–459 interpretation issues, 66–70 hypothetical events, scenario analysis interest rate swaps, 135–145 backfill bias, 69 with, 232 amortizing and accreting swaps, biases in index creation, 66–68 143–145 relevance of past data on I currency vs., 463 performance, 68 IAS 39. see International Accounting deferred swaps, 142–143 stale price bias, 69 Standard 39 example, 135–136 survivorship bias, 68–69 IASB. see International Accounting implicit loan balance of swap, 141–142 investment characteristics, 71 Standards Board pricing and counterparty, 137–138 market for, 56–60 IBM, 221 reason for using, 143 size of market, 60 ICREIM/IPD Canadian Property Index, swap curve, 139–141 types of hedge fund investments, 16 swap rate, 138–139 57–60 idiosyncratic risk, 323n.19 interest rate swaptions, 479–486 performance evaluations, 78–84 illiquidity, of private equity investments, in anticipation of future borrowing, consistency, 82–84 37 479–483 correlations, 82 implicit loan balance, , terminating swaps with, 483–486 performance appraisal measures, 141–142 internal capital requirements, in capital 80–82 implied yield, bond, 315 allocation, 251–252 skewness and kurtosis, 82 inclusion bias, 69 internal rate of return (IRR), of private volatility and downside volatility, incremental VAR, 229 equity, 37 79–80 indenture agreement, 101 International Accounting Standard 39 in portfolios, 71–74 index funds, synthetic, 327–330 (IAS 39), 209 hedge funds as diversifiers, 72 indirect investment International Accounting Standards historical performance, 72–74 in commodities, 44 Board (IASB), 209 skewness and hedge funds, 73–74 of venture capital, 32–33 international diversification, 471–473 types of investments, 57–60 inflation hedges International Monetary Fund, 210 Hedge Fund Composite Index (HFCI), commodities as, 52–53 inverse floaters, 457–459 21n.31, 22 real estate as, 19 investability, of manager-based hedge historical performance, 63–67, 72 information ratio (IR), portfolio fund indices, 63 managed futures correlation, 87 managers’, 244 investments, traditional vs. alternative, Hedge Fund Intelligence Ltd., 61 infrastructure funds, 14, 15 7–13 hedge fund market, 56–60 initial public offerings (IPOs) Investment Property Databank size of, 60 Google, Inc., 31 (IPD), 16 types of hedge fund investments, private equity for, 28 investment strategies, currency impact 57–60 insider exposure, 476–478 on, 288–290 HedgeFund.net, 61 Institute of Canadian Real Estate investors Hedge Fund Research (HFR), 60–62 Investment Managers (ICREIM)/ goals of, 6 hedge fund structure, distressed IPD Canadian Property Index, 16 identity of, 42 securities with, 94 Institutional Alternative Investment IPD. see Investment Property Databank hedging Survey, 9 IPOs. see initial public offerings with commodity forwards and futures, insurance IR. see information ratio, portfolio 185–188 options as, 281–284 managers’ basis risk, 185–186 protective puts as, 382 IRR. see internal rate of return for jet fuel with crude oil, 186–187 Intel Corporation, 37 for weather derivatives, 187–188 intellectual property, 42 J in currency risk management, 270–290 interest rates, floating, 147–148 Japan costs of, 291 interest rate calls, loans with, 405–407 benchmark hedge ratio, 291, 293 with futures or forward currency interest rate differentials commodity market, 44 contracts, 270–281 and futures prices, 278–279 corporate form of publicly-traded with options, 284–286 in hedging costs, 291 companies, 33 strategic hedge ratio, 290–292 interest rate options currency risk management, 270 data hedging over time, 425–432 and options on futures, 434–435 foreign cash receipts, 464–465 defined, 308 risk management applications, 403–423 foreign currency payments, 347

index.indd 6 03/05/12 3:19 PM Index I-7

interest rate swaptions, 483–486 with FRAs, 309–313 markets real estate allocations in, 20 floating-rate loans, 312–313 commodity, 44–45, 167–168 REITs, 14 single-payment loans, 309–312 distressed securities, 94–95 risk governance, 199 protected with interest rate calls, in evaluation of private equity weather derivatives, 187 405–407 investments, 41 jet fuel, hedging strategies for, 186–187 lock-up period, 60, 74 hedge fund, 56–60 J factor risk, 99 Loews Cineplex Entertainment managed futures, 85–86 JPMorgan Chase, 133–134, 213 Corporation, 98 private equity, 28–35 London Interbank Offered Rate (LIBOR) demand for venture capital, 29 K credit risk exposures, 238 exit from investment, 29–30 kabushiki kaisha (K.K.), 33 credit risk of swaps, 236 size of market, 34–35 kurtosis, 12n.10, 82 for currency funds, 294 supply of venture capital, 30–32 currency swaps, 460–461 types of private equity investments, L equity swaps, 474 32–34 later-stage financing, 29 interest rate compounding, 351 market liquidity risk, distressed lease market, commodity, 167–168 interest rate swaps, 135–136, 139, 140, securities’, 99 lease rate, commodity. see commodity 450–451, 453, 456–458 market risk. see also equity market risk lease rate loan interest rate of distressed securities, 99 legal review, of private equity, 42–43 calls, 404–405, 407 identifying, 203 legal risk, 208 caps, 414–417 managing, 242–245 Lehman Aggregate Bond Index, 17 collars, 421–423 measuring, 212–213 Lehman Brothers Corporate High Yield floors, 418–420 market value Bond Index, 65–66 forward and futures strategies, of commodity swaps, 134–135 Lehman Brothers Global Bond Index 309–312, 353 of investment and hedging strategies, commodities correlations, 46, 47 options, 403 280 distressed securities correlations, 96 puts, 408–412 marking to market, 246 hedge fund correlations, 64, 65, 67 as underlying rate, 353, 403 mass affluent, 9n.3 managed futures correlations, 87 swaptions, 479, 482, 483, 486, 487, matched book transactions, 131 Lehman Brothers Government Bond 489–491 maturity, forwards and futures contracts, Index (LGB), 477 total return swaps, 152 279–280 Lehman Brothers Government/ London International Financial Futures maximum drawdown, 80, 250 Index Exchange (LIFFE) maximum loss commodities correlations, 46, 47, 53, hedging the principal, 270 bear spread, 387, 388 54 managing currency exposure with, 287 box spread, 402 distressed securities correlations, 96 long-only value investing, 98 bull spread, 384, 385 hedge fund correlations, 64–67 long positions butterfly spread, 392 managed futures correlations, 87 for call options, 369–372 call options, 370, 371 Lehman Long Treasury Bond (LLTB) for put options, 372–376 in capital allocation, 251 index, 474 Long-Term Capital Management collars, 395–396 Leibowitz-Bova approach, 13 (LTCM), 240 covered calls, 377 lending, puts with, 408–413 loss. see also maximum loss optimization models, 232 leverage, VC vs. buy-out fund, 38 and sale, 271 protective puts, 381 leveraged floating-rate notes (leveraged gain-to-loss ratio, 81–82 put options, 373, 374 floaters), 456–457 low-return environments, 8–9 straddles, 398, 399 leverage limits, fund management LTCM. see Long-Term Capital maximum profit company, 245 Management bear spread, 387, 388 LGB. see Lehman Brothers Government box spread, 402 Bond Index M bull spread, 384, 385 LIBOR. see London Interbank Offered Macaulay duration, 314n.7 butterfly spread, 391, 392 Rate Mahonia, 133, 134 call options, 370, 371 LIFFE. see London International managed futures, 84–93 collars, 395–396 Financial Futures Exchange benchmarks, 86 covered calls, 377 limited liability company form (private defined, 7, 84 protective puts, 381 equity funds), 33 historical performance, 86–88 put options, 373, 374 limit setting, 252 interpretation issues, 88 straddles, 398, 399 Lipper, 60 investment characteristics, 88–89 MCI, 99, 100 liquidity, of private equity, 40 market for, 85–86 mean-variance analysis of currency liquidity limits, fund management performance persistence, 91 overlay, 294 company, 245 in portfolios, 89–91 mean-variance optimization (MVO), 72 liquidity risk and skewness of hedge funds, 74 measurement errors, for returns of VC, identifying, 204–205 strategic asset allocation, 92–93 38 measuring, 239–240 types of investments, 85–86 mega-cap buy-out funds, 31 LLTB index. see Lehman Long Treasury managed futures market, 85–86 merger arbitrage hedge fund strategies, Bond management 58 loans commitment of, 42 Merrill Lynch Corporate Bond (MLCB) and currency conversions, 460–464 experience of, 41 index, 474 and exchange rate risk, 460–464 manager-based hedge fund indices, Metallgesellschaft A.G. (MG), 186 fixed-rate, 449–453 62–63 mezzanine financing, 30 floating-rate see( floating-rate loans) MAR. see minimum acceptable return Microsoft, 37

index.indd 7 03/05/12 3:19 PM I-8 Index

middle-market buy-out funds, 31–32 Netherlands, 14, 24 gamma and risk of delta, 432–433 minimum acceptable return (MAR), 250 net present value (NPV), commodities’, interest rate options and options on minimum credit standards, 247–248 167, 168 futures, 434–435 minimum-variance hedge ratio, 273–277 netting, 247 vega and volatility risk, 423–424 economic risk, 275 netting risk (settlement netting risk), 211 option-pricing theory, 234–236 hedging total currency risk, 276 New Basel Capital Accord (Basel II), Organization of Petroleum Exporting implementation, 276, 277 240–241 Countries (OPEC), 184 portfolio with, 276–277 new value exception, 101–102 orphan equities, 94, 98 translation risk, 275 New York Federal Reserve, 240 overnight Fed funds rate, 316n.9 minority interests, nonmarketable, 38 New York Mercantile Exchange (NYMEX) over-the-counter (OTC) derivatives MLCB. see Merrill Lynch Corporate crack spread options, 184 collateral in, 246–247 Bond futures pricing, 160 credit risk with, 204 model risk, 206 gold futures, 173, 174 marking to market in, 246 modified duration, 314, 454 natural gas futures, 180, 181 regulatory risk, 207 monetary position limits, 251 oil futures, 182–183, 185 settlement risk, 207 monetizing a call, 487n.33 New York Stock Exchange (NYSE) ownership, 12 money spreads and NAREIT Index, 16–17 bear spreads, 386–389 operational risk management by, 206 P bull spreads, 383–386 New York Times, 31 Page, Larry, 31 butterfly spreads, 389–394 nominal position limits, 251 payer swaptions, 150–151 in equity portfolios, 383–394 noncallable debt, adding calls to, 489–492 payments, foreign currency, 346–348 Monte Carlo simulation method, nonfinancial risks payment netting, 247 226–228 Basel II requirements, 240–241 PCA index. see Property Council of Moody’s Investors Service, 247 defined, 202 Australia index Morgan Stanley, 31, 60 measuring, 240–241 pension funds, 9 Morgan Stanley Capital International operational risk, 240–241 adjusting asset allocation of, 335–337, (MSCI), 61, 62 nonparametric (term), 221 339–340 Morgan Stanley REITs Index, 16, 17 nonstorability, of commodity forwards application of VAR to, 228 Morningstar, 60 and futures, 162–163 creating synthetic cash for, 332–334 mortgage REITs, 14 nonsystematic risk, 323 pension plans, defined-benefit (DB), 203 Mount Lucas Management Index, 86 North America, 20 performance appraisal measures, hedge MSCI. see Morgan Stanley Capital notional amount, swap, 131 fund, 80–82 International notional position limits, 251 performance evaluation MSCI Europe/Australia/Far East (EAFE) notional principal, 239, 454, 463 for hedge funds, 78–84 Index, 497 Novatel Wireless, Inc., 27 consistency, 82–84 MSCI Hedge Invest Index, 62 NPV, commodities’, see net present performance appraisal measures, MSCI World Index value, commodities’ 80–82 commodities on, 46, 47 NVCA. see National Venture Capital returns, 78–79 distressed securities correlations, 96 Association skewness and kurtosis, 82 hedge fund correlations, 64, 65, 67 NYMEX. see New York Mercantile volatility and downside volatility, managed futures correlations, 86, 87 Exchange 79–80 municipal bond futures contracts, 320 NYSE. see New York Stock Exchange and risk management, 248–250 MVO. see mean-variance optimization performance fees, hedge fund, 74 O performance netting risk, 211 N off-market swaps, 448n.1 performance persistence, 91 NAREIT. see National Association of oil, 182–184, 186–187 performance stopouts, 245 Real Estate Investment Trusts OPEC. see Organization of Petroleum P&G. see Procter & Gamble NAREIT Index, 16–18, 22 Exporting Countries Philadelphia Stock Exchange, 281 NASDAQ operational review, private equity, 42 physical settlement, of commodity options strategies with, 367 operational risk swaps, 130–131 private equity correlations, 36 identifying, 205–206 PIPE. see private investment in public NASDAQ 100 Trust Shares, 367n.3 measuring, 240–241 entity NASDAQ Composite Index, 216, 220, opinions, customer, 42 PLC. see public limited company 221n.39, 227, 228 optimal hedge ratio, 274, 277 political risk, 210 National Association of Real Estate options. see also specific types, e.g.: call portfolios Investment Trusts (NAREIT), 15 options (calls) bond, 313–317 National Council of Real Estate currency risk management with, commodities’ roles in, 53–55 Investment Fiduciaries (NCREIF) 281–286 distressed securities’ roles in, 97–100 Property Index, 15–18, 22, 23 on foreign assets, 287 distressed debt arbitrage, 98 National Futures Association, 85 on futures, 434–435 long-only value investing, 98 National Venture Capital Association hedging with, 284–286 private equity, 98–100 (NVCA), 34, 35 insuring with, 281–284 turnaround equity, 99 National Westminster Bank, 256 measuring credit risk of, 237–239 equity, 324–326 natural gas, 179–182 risk management with (see risk foreign-market asset, 348–352 NatWest Markets, 256–257 management applications of option government bond, 317–320 NCREIF Property Index. see National strategies) hedge funds’ roles in, 71–74 Council of Real Estate Investment option portfolio risk management hedge funds as diversifiers, 72 Fiduciaries Property Index strategies, 423–434 historical performance, 72–74 net dollar profit, 282 data hedging over time, 425–432 skewness and hedge funds, 73–74

index.indd 8 03/05/12 3:19 PM Index I-9

managed futures’ roles in, 89–91 types of private equity investments, receipts, foreign cash, 346, 464–466 private equity’s roles in, 40–41 32–34 receiver swaptions, 151, 487–492 rate of return and value of, 271–272 private investment in public entity regression hedge ratio, 274 real estate’s roles in, 20–26 (PIPE), 27 regret aversion, 291–292 diversification within real estate, private placement memorandum, 29 regret risk, 292 22–24 probability levels, VAR, 218–219 regulatory capital requirements, 252 real estate as diversifier, 21–22 Procter & Gamble (P&G), 144–145 regulatory risk, 207–208 worldwide investment in real estate, Professional Risk Managers’ International REITs. see real estate investment trusts 24–26 Association (PRIMA), 242 relative value hedge fund strategies, 58 portfolio managers, allocation of funds profit. see also maximum profit reorganization plans, bankruptcy, 101 to, 244 bear spread, 387, 388 responsiveness, bond, 315 position concentration limits, fund box spread, 402 returns management company, 245 bull spread, 383–385 collateral, 48 pounds (British) butterfly spread, 390–392 commodity index, 48–49 converting loans in, 460–462 call options, 369–370 expected hedged, 279 currency hedges with, 281 collars, 395–396 low-return environments, 8–9 dynamic hedging, 284–285 covered calls, 376–378 minimum acceptable, 250 and insuring with options, 281–282 protective puts, 380, 381 and performance evaluations of hedge investor’s beliefs about, 291 put options, 372–374 funds, 78–79 preferred return, 34 straddles, 398, 399 preferred, 34 pre-investing in asset classes, 342–344 Property Council of Australia index price, 48 premiums (PCA), 16 risk-adjusted return on capital, 249 of call options, 219 protective puts, 380–383 roll, 48 for caps vs. floors, 418n.24 psychological considerations, of risk rolling, 79 and currency hedges, 282 management, 252 return over maximum drawdown of put options, 219 public limited company (PLC), 33 (RoMAD), 250 prepackaged bankruptcy, 98, 102 put–call parity, 235 Reuters Jefferies/Commodity Research prepaid swaps, 130 put options (puts) Bureau (RJ/CRB) Index, 45, 50 present value of a basis point (PVBP), in equity portfolios reverse cash-and-carry arbitrage, 314–315 combinations of calls and, 394–403 164–166, 169 price discovery, in forward market, 163 long/short positions, 372–376 risk. see also specific types, e.g.: market price return, 48 protective, 380–383 equity risk price value of a basis point (PVBP), 314 with lending, 408–413 of bond futures, 315–317 PricewaterhouseCoopers, 34, 35 premiums, 219 of bond portfolios, 313–317 pricing put payoffs, 403, 408 of delta, 432–433 of commodity swaps, 132, 148–149 PVBP. see present value of a basis of dual currency bonds, 466–469 forwards (see forwards pricing) point of equities, 322–324 of interest rate swaps, 137–138 PVBP. see price value of a basis point of equity portfolios, 324–326 PRIMA. see Professional Risk Managers’ of foreign currency payments, 346–348 International Association R of foreign currency receipts, 346 prime brokerage, 56 range forwards. see collars of foreign-market asset portfolio, private equity, 26–43 range , 297 348–352 about, 26–28 RAROC. see risk-adjusted return on identifying, 201–211 benchmarks, 35 capital accounting risk, 209–210 defined, 7 rate of return, portfolio value and, analysis of risk exposures, 202–203 of distressed securities, 98–100 271–272 credit risk, 203–204 due diligence, 41–43 ratio spreads, delta hedges of, 430n.32 ESG, performance netting, and historical performance, 35–36 real estate, 13–26 settlement netting risk, 210–211 interpretation issues, 36 benchmarks, 15–17 legal/contract risk, 208 investment characteristics, 37–40 defined, 7 liquidity risk, 204–205 market for, 28–35 due diligence, 26 market risk, 203 demand for venture capital, 29 historical performance, 17–18 model risk, 206 exit from investment, 29–30 interpretation issues, 18 operational risk, 205–206 size of market, 34–35 investment characteristics, 19–20 regulatory risk, 207–208 supply of venture capital, 30–32 market for, 13–15 settlement risk, 206–207 types of private equity investments, in portfolios, 20–26 sovereign and political risks, 210 32–34 diversification within real estate, 22–24 tax risk, 208–209 in portfolios, 40–41 real estate as diversifier, 21–22 measuring, 211–241 types of investments, 32–34 worldwide investment in real estate, credit risk, 233–239 private equity funds, 26 24–26 liquidity risk, 239–240 private equity fund structure, distressed types of investments, 14–15 market risk, 212–213 securities with, 94 real estate investment trusts (REITs), 14 nonfinancial risks, 240–241 private equity market, 28–35 real estate market, 13–15 stress testing, 231–232 demand for venture capital, 29 size of, 15 value at risk, 213–231 early-stage financing, 29 types of real estate investments, 14–15 of private equity investments, 37 later-stage financing, 29 realized gain, on futures contract sale, 271 of structured notes, 455–459 exit from investment, 29–30 real options, 51 inverse floaters, 457–459 size of, 34–35 rebalancing scheme, for manager-based leveraged floating-rate notes, supply of venture capital, 30–32 hedge fund indices, 63 456–457

index.indd 9 03/05/12 3:19 PM I-10 Index

risk-adjusted return on capital interest rate risk, 309–321 RoMAD. see return over maximum (RAROC), 249 and bond portfolio risk, 313–321 drawdown risk budgeting, 243–245 practice problems, 258–259 RR. see rolling return risk exposure solutions to problems, 360–363 Russell 3000 Index, 472, 497 analysis of, 202–203 risk management applications of option Russia, 210 credit risk, 238–239, 245–246 strategies currency risk, 286–290 about, 365–367 S defined, 197n.1 for equity portfolios, 367–403 sales prospects, in evaluation of private insider risk, 476–478 combinations of calls and puts, equity investments, 41 risk factor limits, fund management 394–403 Salomon Brothers, 297, 298 company, 245 money spreads, 383–394 sandwich spread, 392n.14 risk management, 195–268 standard long and short positions, scenario analysis about, 196 369–376 limits of fund management companies, currency risk (see currency risk and the underlying, 376–383 245 management) strategies, for stress testing, 231–232 identifying risk, 201–211 403–423 SE. see socíetas Europeae accounting risk, 209–210 calls with borrowing, 403–408 seasonality analysis of risk exposures, 202–203 caps with floating-rate loans, of corn futures, 176–179 credit risk, 203–204 413–417 of natural gas futures, 180–181 ESG, performance netting, and collars with floating-rate loan, SEC. see Securities and Exchange settlement netting risk, 210–211 420–423 Commission legal/contract risk, 208 floor with floating-rate loan, second-stage financing, 30 liquidity risk, 204–205 417–420 securities market risk, 203 puts with lending, 408–413 distressed (see distressed securities) model risk, 206 option portfolio risk management private equity investments, 28 operational risk, 205–206 strategies, 423–434 Securities and Exchange Commission regulatory risk, 207–208 data hedging over time, 425–432 (SEC) settlement risk, 206–207 gamma and risk of delta, 432–433 financial risk reporting required by, sovereign and political risks, 210 interest rate options and options on 229 tax risk, 208–209 futures, 434–435 registration of hedge funds with, managing risk, 241–252 vega and volatility risk, 423–424 56n.79 in capital allocation, 250–252 practice problems, 438–441 seed money, 29, 30 credit risk, 245–248 solutions to problems, 442–446 settlement netting risk, 211 market risk, 242–245 risk management applications of swap settlement (Herstatt) risk, 206–207 and performance evaluation, strategies, 447–510 SFAS 133. see Statement of Financial 248–250 about, 447–449 Accounting Standard 133 psychological and behavioral equity market risk, 469–478 Sharpe ratio considerations of, 252 and allocation of stocks and bonds, for hedge funds, 80–81 measuring risk, 211–241 473–476 and risk management, 249 credit risk, 233–239 diversifying concentrated portfolios, short positions liquidity risk, 239–240 469–471 for call options, 369–372 market risk, 212–213 insider exposure, 476–478 delta hedges of, 429–430 nonfinancial risks, 240–241 international diversification, 471–473 for put options, 372–376 stress testing, 231–232 exchange rate risk, 460–469 short selling hedge fund strategies, 59 value at risk, 213–231 and currency conversions, 460–466 Singapore, 14, 280 practice problems, 256–263 and foreign cash receipts, 464–466 single-payment loans, 309–312 as process, 196–199 and loans, 460–464 skewness, 12n.10 risk governance, 199–201 risk of dual currency bonds, 466–469 and performance evaluations, 82 solutions to problems, 264–268 interest rate risk, 449–459 and roles in portfolios, 73–74 risk management applications of converting floating- and fixed-rate sociedad anónima, 33 forward and futures strategies, loans, 449–453 socíetas Europeae (SE), 33 307–363 duration of fixed-income portfolios, société anonyme, 33 about, 307–309 453–455 Sortino ratio asset allocation with futures, 335–344 risk of structured notes, 455–459 for hedge funds, 81 adjusting asset allocation, 335–341 practice problems, 496–504 and risk management, 250 pre-investing in asset classes, solutions to problems, 505–510 South Korea, 14 342–344 swaptions, 478–493 Southwest Airlines, 186n.10 equity market risk, 321–335 and forward swaps, 492–493 sovereign risk, 210 cash from equity, 331–335 interest rate swaptions, 479–486 S&P 500 Index. see Standard & Poor’s equity from cash, 326–331 synthetically removing/adding call 500 Index risk of equities, 322–324 features, 487–492 Spain, 33 risk of equity portfolios, 324–326 RiskMetrics Group, 213n.27, 242 SPAN system, 231 foreign currency risk, 344–352 risk reversals. see collars S&PCI. see Standard & Poor’s risk of foreign currency payments, risk tolerance, in ERM, 242 Commodity Index 346–348 RJ/CRB Index. see Reuters Jefferies/ special purpose vehicles (SPVs), 248 risk of foreign currency receipts, 346 Commodity Research Bureau Index\ spot price, 48 risk of foreign-market asset portfolio, rogue traders, 205 spreads, 379n.8 348–352 rolling return (RR), 79 bear, 386–389 futures vs. forwards, 352–354 roll return, 48 bid–ask, 204

index.indd 10 03/05/12 3:19 PM Index I-11

box, 400–403 style classification, manager-based hedge T bull, 383–386 fund index, 62 tactical currency risk management, butterfly, 389–394 stylized scenarios, analysis of, 231 290–294 commodity, 184 suitability, of alternative investments, 11 currency asset class, 294 crack, 184 supplements, VAR, 230–231 currency overlay, 292–294 crush, 184 supply and strategic hedge ratio, 290–292 defined, 383 business-cycle related, 50 tail value at risk (TVAR), 229 money, 383–394 of venture capital, 30–32 target dollar duration of portfolio, ratio, 430n.32 surplus, 228 316–317 sandwich, 392n.14 surplus at risk, 228 target semideviation, 250n.55 S&P REIT Composite Index, 16, 17 survivorship bias, hedge fund, 68–69 tax issues, with alternative SPSC. see Standard & Poor’s Small Cap swaps, 129–157 investments, 11 600 Index commodity swaps, 148–150 tax risk, 208–209 SPVs. see special purpose vehicles counterparty, 132–134 TBI for Institutional Commercial stack and roll, 186 example, 130–135 Property Performance. see stack hedge, 185 market value of swap, 134–135 Transaction-Based Index for stale price bias, of hedge funds, 69 physical vs. financial settlement, Institutional Commercial Property Standard & Poor’s, 247 130–131 Performance Standard & Poor’s 500 Index pricing, 132, 148–149 technical approach to currency overlay, commodities correlations, 46, 47, with variable quantity and price, 293–294 53–55 149–150 technology, validation of, 42 distressed securities correlations, 96 currency swaps, 145–148 theta, 213 in equity swaps, 470, 471, 474 about, 145–147 third-stage financing, 30 foreign investment in, 287 with floating interest rates, 147–148 Thomson Venture Economics, 34, 35 futures price of, 324 formulas for, 147 time, delta and, 427 hedge fund correlations, 64–67, 73 defined, 129 time horizons managed futures correlations, 86–88 interest rate swaps, 135–145 of currency swaps, 280 private equity correlations, 36 amortizing and accreting swaps, and strategic hedge ratio, 291 as proxy for true market portfolio, 322 143–145 for VAR, 218–219 VAR analysis, 216, 220, 221n.39, 227, deferred swaps, 142–143 timeline, venture capital, 30 228 example, 135–136 time to , 50–51 Standard & Poor’s Commodity Index implicit loan balance of swap, TOPIX index, 287 (S&PCI), 45–47 141–142 Toronto 300 Composite, 473 Standard & Poor’s Hedge Fund Indices, pricing and counterparty, 137–138 total portfolio risk, 290 60, 62 reason for using, 143 total return payer, 151 Standard & Poor’s Small Cap 600 Index swap curve, 139–141 total return swaps, 151–153, 248 (SPSC), 474 swap rate, 138–139 tracking risk, 212 start-up financing, 29, 30 measuring credit risk of, 236–237 trade settlement, 201 Statement of Financial Accounting practice problems, 155 Transaction-Based Index (TBI) for Standard 133 (SFAS 133), 209 risk management with (see risk Institutional Commercial Property Sterling ratio, 82n.120 management applications of swap Performance, 16 stocks, adjusting asset allocation strategies) transaction costs, 279, 285, 291 between bonds and, 335–337 solutions to problems, 156–157 transaction exposure, 345 stock index futures, 324, 326 swaptions, 150–151 translation exposure, 345 stock index options, 287 terminating, 483–486 translation risk, 275 storage costs total return swaps, 151–153 Trottman, Melanie, 186n.10 in carry markets, 170–171 swap curve, interest rate swaps, 139–141 turnaround equity, 99 for corn futures, 176–179 swap rate, 138–139, 203n.8 turnaround partners, 99 for natural gas futures, 180–181 swap spread, 140 TVAR. see tail value at risk straddles, 398–400 swap tenor, 136 twist, 231n.45 straight-through processing (STP) swap term, 136 2005-2006 Russell Survey on Alternative systems, 201 swaptions, 478–493 Investing, 20 strangles, 400 defined, 448 straps, 400 and forward swaps, 492–493 U strategic asset allocation, with managed interest rate swaptions, 479–486 the underlying futures, 92–93 removing/adding call features with, of covered calls, 376–380 strategic hedge ratio, 290–292 487–492 for equity portfolios, 376–383 asset types, 291 strategies for managing, 478–493 of protective puts, 380–383 beliefs on currencies, 291 types of, 150–151 United Energy Services, 317–319 costs of hedging, 291 Sweden, 24, 280 United Kingdom investment horizon, 291 Switzerland benchmark hedge ratio for investors, and regret aversion, 291–292 currency contracts for investments 293 total portfolio risk, 290 in, 280 corporate form of publicly-traded Strategic Money Management, 328–329 currency hedging by investors in, 281 companies, 33 strategic partners, 31 real estate as diversifier in, 24 equity in residential property in, 18 stress testing, 231–232 synthetic commodities, 161 inflation hedging by real estate, 19 strips, 400 synthetic index funds, 327–330 infrastructure funds in, 15 strip hedge, 185 systematic risk, 323 private equity in, 27 structured notes, 449, 455–459 systematic trading strategies, 85 real estate market, 16, 24

index.indd 11 03/05/12 3:19 PM I-12 Index

United States put options, 373–375 vintage effects, hedge fund, 75 bankruptcy process in other countries straddles, 398, 399 vintage year, 36 vs., 100–101 value at risk (VAR) volatility benchmark hedge ratio for investors, advantages and limitations, 229–230 in binomial model, 433 293 credit, 234 in Black–Scholes–Merton pricing corn production, 176 elements, 214–215 option, 212–213, 433 corporate form of publicly-traded extensions and supplements, 230–231 downside, 79–80 companies, 33 measuring, 213–231 of hedge fund performance, 79–80 currency hedging by investors in, 281 analytical method, 215–220 and market risk, 212–213 distressed securities in, 93–95 historical method, 220–226 volatility risk, 423–424 formative-stage companies, 29 Monte Carlo simulation method, volatility smile, 256 hedge fund market, 60 226–228 vulture capital, 98 interest rate spread of Japan and, 291 probability levels and time horizons, vulture funds, 98 municipal bond futures contracts 218–219 vulture investors, 98 in, 320 and risk budgeting, 243 pension funds in, 9 surplus at risk, 228 W private equity returns, 36 value investing, long-only, 98 weather derivatives, 187–188 real estate investment in, 12–19, 24 Vanguard mutual funds, 244 weighting scheme, for manager-based registration of CTAs and CPOs, 85 VAR. see value at risk hedge fund indices, 63 U.S. Commodity Futures Trading VAR-based position limits, 251 Wilshire, 16, 17 Commission, 85 variable price commodity swaps, 149–150 Wilshire 500 Index, 472 U.S. Treasury bills, 249 variable quantity commodity swaps, working capital allocations, 245 U.S. Treasury bond futures, 315 149–150 WorldCom, Inc., 99 U.S. Treasury strips, 313n.4 variance–covariance method, 215–220 World Trade Center bombing (1993), 206 University of Virginia Investment VC. see venture capital worst-case scenario analysis, 232 Management Company (UVIMCO), VC funds. see venture capital funds Wright, Christopher, 9n.2 10–11 VCTs. see venture capital trusts vega, 212, 423–424 Y V venture capital (VC). see also private yen (Japanese) value at expiration equity converting, into U.S. dollars, 464–466 bear spread, 386–388 defined, 26, 30 currency hedges with, 281 box spread, 401, 402 demand for, 29 overvaluing of, 291n.8 bull spread, 383, 385 for IPOs, 28 yield, bond, 313–315 butterfly spread, 389–390, 392 supply of, 30–32 yield beta, 316, 322n.17 call options, 369, 371, 375 venture capital firms, 28n.41 collars, 395 venture capital funds (VC funds), 30, 38 Z covered calls, 376, 377 venture capitalists, 30 zero-cost collars, 394 protective puts, 380, 381 venture capital trusts (VCTs), 30 zero risk investments, 249

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