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Market Neutral Arbitrage (Relative Value) Market Neutral Arbitrage (Relative Value)

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January 25, 2009
January 25, 2009
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Explanation of the Relative Value strategies

Relative value managers benefit from exploiting temporary anomalies in market prices of related instruments, for example, shares and convertible bonds of the same company. Usually, market neutral strategies are considered as less risky, because they are not affected by equity market movements and changes in fixed interest rates. The most distinct subcategories of relative value strategies are as follows.

Market Neutral: Long/Short Equity.
Managers using that strategy simultaneously take a long position on the undervalued security and a short position on the one they believe is overvalued. Similarly to the Global strategies, the long/short funds may exploit two distinct techniques to pick equities: quantitative (systematic) and fundamental. While quantitative managers rely on stochastic models of market pricing to find over - and undervalued securities, fundamental managers base their decisions on classic companies’ valuation methodology.
Unlike market neutral equity  funds, this strategy does not necessarily have zero market risk. Most funds using that strategy exhibit a long bias.

Market Neutral: Convertible Arbitrage
In brief, this strategy mean establishing arbitrage positions by buying the convertible bond and taking a short position on the shares of the same issuer to offset the share price included to the convertible bond. Managers seek to identify convertible bonds of companies whose debts they view as undervalued.

Market Neutral: Equity
This strategy implies a zero market risk, because means taking long and short positions of the matched equity simultaneously. Typically, those positions are highly leveraged to multiply returns.

Market Neutral: Fixed Income
Managers, exploiting Fixed Income strategies, identify pricing anomalies in various fixed income markets and trade instruments ranging from government bonds to mortgage-backed securities. This strategy is most commonly used by institutional asset managers, because it requires a substantial capital to benefit from relatively small price movements.

Article is in the following categories:
Quant KB » Due Diligence» Hedge Fund Strategies

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