Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following assumptions: the price spread between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM betas of each twin-pair is also the same. The hedge fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average return on this arbitrage strategy is 8 % per year after all costs and fees. The standard deviation of the strategy return is 40 % per year. Which of the following statements are likely to be true? Choose all that apply. (Multiple answer question. Do not select all choices as some may have negative score). A. The strategy is risk-free. B. The strategy earns high returns because it is exposed to equity market risk. C. The strategy is more volatile compared to an investment in the stock market (say the S&P 500). D. The strategy does not have any systematic risk, it is only exposed to firm-specific (or idiosyncratic) risk.
Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following assumptions: the price spread between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM betas of each twin-pair is also the same. The hedge fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average return on this arbitrage strategy is 8 % per year after all costs and fees. The standard deviation of the strategy return is 40 % per year. Which of the following statements are likely to be true? Choose all that apply. (Multiple answer question. Do not select all choices as some may have negative score). A. The strategy is risk-free. B. The strategy earns high returns because it is exposed to equity market risk. C. The strategy is more volatile compared to an investment in the stock market (say the S&P 500). D. The strategy does not have any systematic risk, it is only exposed to firm-specific (or idiosyncratic) risk.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Consider a hedge fund specializing in arbitrage strategies involving dual-listed companies and multiple share classes of the same firm. For this exercise you can make the following
assumptions: the price spread between twin-stocks A and B fluctuates between -10 % and +10 % but the average value is zero (i.e., the twins have on average the same price). The CAPM
betas of each twin-pair is also the same. The hedge fund uses a dollar-neutral strategy to buy the relatively inexpensive twin and short the relatively expensive twin. The annualized average
return on this arbitrage strategy is 8 % per year after all costs and fees. The standard deviation of the strategy return is 40 % per year. Which of the following statements are likely to be
true? Choose all that apply. (Multiple answer question. Do not select all choices as some may have negative score).
O A. The strategy is risk-free.
O B. The strategy earns high returns because it is exposed to equity market risk.
OC. The strategy is more volatile compared to an investment in the stock market (say the S&P 500).
O D. The strategy does not have any systematic risk, it is only exposed to firm-specific (or idiosyncratic) risk.
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