1008060-Cor-3_v3 - Equity Derivatives and Related Products...

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Unformatted text preview: Equity Derivatives and Related Products Class 3: Futures/Equity Swaps/Equity Finance Mark Zurack September 14, 2010 1002011-MBA-5 2 Class Objectives Complete discussion on Futures Explain what Equity Index Swaps are and describe how they are priced Explore index strategies like Cash Equitization and Portable Alpha Describe the Equity Finance business which primarily consists of lending money to equity investors and facilitating short sales Describe how Single Stock Swaps are used in Equity Finance transactions Introduce Equity Options 1008060-Cor-3 1002011-MBA-5 3 Price Fluctuation Band B u y f u t u r e s , s e ll s t o c k s . Time Concept of a Price Fluctuation Band Around Cost of Carry Price S e ll f u t u r e s , b u y s t o c k s . Futures markets react to information well before stocks do, causing futures to trade above or below fair value Arbitrageurs limit how large mispricings can be 1008051-Cor-2 1002011-MBA-5 4 Comparing the Use of ETFs and Futures The XYZ pension fund (U.S. based) wishes to invest $100 million in an S&P 500 index fund. The fund has approval to trade futures and exchange traded funds. Its investment horizon is 132 days. Below is the relevant information needed to make an informed investment decision: S&P 500 = 1,121.6 132-day LIBOR = .38% (annual rate) S&P 500 Div Yield = 2.21%/yr 132-day S&P 500 Futures = 1,114.8 S&P 500 Exchange Traded Fund (ETF) Fee 10 bps per year ETFs Nearby Management Fee Commissions Liquidity Shortfall Futures Mispricing Difference between Reinvestment Rate and LIBOR 2.7 3.0 0.9 3.0 Questions: 1. Which strategy would you recommend if the fund reinvests its cash at LIBOR plus 25 bps per annum 2. What if their reinvestment rate was LIBOR plus 25 but the futures were trading at 1,116.8 Estimated Transaction Costs (one-way commission and liquidity shortfall in bps) of: 1008051-Cor-2 1002011-MBA-5 5 Comparing the Use of ETFs and Futures Futures at 1,114.8 ETFs Futures Management Fee Commissions Liquidity Shortfall Futures Mispricing Reinvestment Rate minus LIBOR 3.6 2.7 3.0 0.9 3.0 5.6-9.0 Total 9.3 0.5 Futures at 1,116.8 ETFs Futures Management Fee Commissions Liquidity Shortfall Futures Mispricing Reinvestment Rate minus LIBOR 3.6 2.7 3.0 0.9 3.0 23.4-9.0 Total 9.3 18.3 Fair Value = 1,121.6 + 1,121.6 (0.0038-0.0221) X = 1,114.2 132 365 1008051-Cor-2 1002011-MBA-5 6 What is a Calendar Spread?...
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1008060-Cor-3_v3 - Equity Derivatives and Related Products...

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