Capital Structure ArbitrageHedge Funds
Among the most obvious places to find arbitrage opportunities is within a firm’s capital structure. Firms usually have many differing assets which use the firm’s value as the underlying investment. The value differences aren’t always held on a correct ratio to the firm’s value or other capital instruments. Differences in these values give traders potential arbitrage opportunities.
Capital structure arbitrage opportunities arise from differing investments issued by the underlying firm. The various components of capital structure include secured bonds, unsecured bonds, subordinated bonds, preferred banking debts, common or preferred shares, and many other potential examples. All of these instruments have the company’s value as the underlying asset. Price differences between assets are readily exploited for the profit of hedge funds. The underpriced assets are purchased, and the overpriced assets are short sold. Once the spread is narrowed, the purchased assets are sold and the short sales are closed. The profit is reinvested in other arbitrage capital opportunities.
Fund managers readily exploit these differences in hopes of gaining alpha. Alpha is generated by understanding the differing relationships capital instruments have with each other and the firm’s underlying value. Profit gained is determined by the manager’s knowledge of these relationships and ability to predict potential changes based on current and future events.
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International Economic Analysis:
- Major Currency Economic Summaries
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