just a query about Q51…something about, which of the following type of hedge funds wouldn’t use short selling. A) Distressed Funds B) Emerging Markets what do ya reckon? I put Distressed Funds… my reasoning: if you’re investing in distressed funds, you’d most likely be planning to buy them at their complete low… why on earth would you SHORT a distressed stock??? their answer was emerging markets, since it would be harder to short, due to liquidity problems, etc… but i’d still say shorting would be more viable in an emerging market fund than a distrssed fund. your thoughts?
Bluey, I see your point, but at the end of the day. you just can’t short in emerging markets, that functionality doesn’t exist in those markets. (Unless you short EM ETFs or ADRs or something).
as a matter of fact many emerging markets dont allow short selling (for historical reasons ). regulators in those markerts are (still) wary of hedge fund/hot money destablising their systems
yeh thats true… i reckon its just hard to pick it, ya know? like,… is it a hard set rule that you CANT short-sell in emerging markets? maybe some markets you can? what about the sth-east asian stock markets…they are seen as emerging… what if some of them allow it? but with distressed funds… i’d say it would go against the whole ‘ethos’ or ‘mandate’ of the fund to short… the whole point of that sort of fund is you’re buying stock for dirt cheap since its distressed… ahhhh i dunno, i think im just tired and looking too deep into it thanks anyway smarshy…
yeh tahts true aye, dsylexic… ahhh well i guess its just a matter of choosing the MOST CORRECT answer
a) Reason to short sell - expectations of price decline b) Emerging markets - Price are generally increasing c) Distressed Funds - High likelihood of price collapse Therefore, Emerging markets is less likely to short sell.
hmmm i’d beg to differ… distressed funds investing, you’d be looking to pick them up for a bargain… i dont see why you’d want to short a distressed stock, just to pummel it some more?? thats sorta akin to having a fund where your mandate is only buying stocks after they’ve gone up 100%… doesnt make much sense to me
You have to think like the hedge fund players. The distressed strategy is more then just long/short stock. They make their money by buying bonds cheap and hedging the risk of further decline by shorting the stock. A bond could be trading at fifty cents on the dollar and the company could be tanking fast but the hedge fund figures even in default the bonds get priority to assets worth 60+ cents. Everyone runs for the hills and they make 10 - 20 cents on the dollar when the dust settles. At the same time they short the equity to hedge some risks and make money as the stock declines also.
ive realized they key to passing is choosing what CFAI thinks is the right answer, be damned if that’s not what happens in real life
Distressed funds at hedge funds don’t usually buy stock although as No1Sleeps points out, shorting stock might be a reasonable hedge if it exists. Most stuff held by distressed funds happens when significant trouble has happened to some company like bankruptcy, default, major debt restructuring, etc…When these things happen the stock is nearly or completely worthless, but things like bank debt, bonds, credit facilities, leases, contracts, bankruptcy court claims, (for K-mart) tax loss carryforwards, etc. can be worth lots of money but traditional investors don’t want them or want to wait around for uncertain timing of payoffs.
niraj_a Wrote: ------------------------------------------------------- > ive realized they key to passing is choosing what > CFAI thinks is the right answer, be damned if > that’s not what happens in real life Emerging markets is surely the right answer here. You just can’t easily short sell most emerging market stocks. In any event, shorting a stock is antithetic to the idea of “emerging”. You’re supposed to be in places where your capital is creating value not trying to short something in Sierra Leone.
what about the uptick rule? If it is distress stocks, the price should have been gone down. So you cannot short sell?
the uptick rule no longer applies in the real world… although it does on this exam?
thanks no1sleeps and joey… explained it really well
Bluey 1.8T Wrote: ------------------------------------------------------- > just a query about Q51…something about, which of > the following type of hedge funds wouldn’t use > short selling. > > A) Distressed Funds > B) Emerging Markets > > what do ya reckon? > > I put Distressed Funds… my reasoning: if you’re > investing in distressed funds, you’d most likely > be planning to buy them at their complete low… > why on earth would you SHORT a distressed > stock??? > > their answer was emerging markets, since it would > be harder to short, due to liquidity problems, > etc… but i’d still say shorting would be more > viable in an emerging market fund than a distrssed > fund. > > your thoughts? I selected the exact same answer of Distressed Securities, for the exact same reason stated by you but was slapped back by CFAI.
yeh i understand now, based on what the guys said above… pretty much my difference was: ME: my reasoning: if you’re > investing in distressed funds, you’d most likely > be planning to buy them (stocks) at their complete low… PROPER: They make their money by buying bonds cheap and hedging the risk of further decline by shorting the stock. which is true… and which i totally looked over… they invest in the DEBT of distressed companies, rather than the equity
Bluey 1.8T Wrote: ------------------------------------------------------- > yeh i understand now, based on what the guys said > above… pretty much my difference was: > > ME: > my reasoning: if you’re > > investing in distressed funds, you’d most likely > > > be planning to buy them (stocks) at their > complete low… > > PROPER: > They make their money by buying bonds cheap and > hedging the risk of further decline by shorting > the stock. > Not really. A distressed company may not have any stock trading above 0. Distressed investing is all about picking up stuff from companies in trouble. In general though if you short stock and buy bonds and the company goes to heck you win big. > which is true… and which i totally looked > over… they invest in the DEBT of distressed > companies, rather than the equity
JoeyDVivre Wrote: ------------------------------------------------------- > Distressed funds at hedge funds don’t usually buy > stock although as No1Sleeps points out, shorting > stock might be a reasonable hedge if it exists. > Most stuff held by distressed funds happens when > significant trouble has happened to some company > like bankruptcy, default, major debt > restructuring, etc…When these things happen the > stock is nearly or completely worthless, but > things like bank debt, bonds, credit facilities, > leases, contracts, bankruptcy court claims, (for > K-mart) tax loss carryforwards, etc. can be worth > lots of money but traditional investors don’t want > them or want to wait around for uncertain timing > of payoffs. Thing is, if a stock or fund is currently practically worthless because it is distressed, who would want to short the position? the only potential from a distressed asset is upside? Say if a company was worth only $1 because it had $100 assets, -$100 liabilities $0 equity. You couldnt or wouldnt want to short sell. What you want to do is buy the distressed debt for say $1, sell the assets and cash in $99 of profit. If my understanding is correct, this is what the distressed asset business is all about. so, i would have still chosen A on that basis (and also because i dont know anything about emerging markets, but to me, its just risky stock so short selling is not exactly something that wouldnt be allowed).
Say what? What were you going to do with those liabilities? Virtually all liabilities are higher on the capital food chain than bondholders. There’s plenty of downside from distressed securities. If you buy a bond in default for 40 based on your chances of recovering more than that in bankruptcy you can: a) Lose all your 40 when it turns out that there is nothing of value for you to get b) Lose some of your 40 because you overestimated recovery c) Lose some of your 40 because other people jumped ahead of you that you didn’t think would get ahead d) Get all your 40 after it is tied up in court for 27 years e) Be given other securities that aren’t worth much because you thought they were or that’s what they were giving away. f) Take on serious liquidity problems that can wreck you though there is nothing inherently wrong with the bond g) Take a serious liquidity hit because there is something wrong with all such bonds. etc, etc. etc. Distressed investing is nothing like an easy game and you can’t just steal the assets and walk away. You go to jail for that kind of thing.
Joey, you are a superstar. I understand the question alittel better now. In terms of Distressed investing, it can be a very very profit game though. Using Japan as an example. Say you`re a superbank like SMBC, UFJ or Mitsui. Your year end is coming up and you need to get rid of all the bad debt on your BS otherwise the FSA will downgrade your credit rating. Lets say you have $1billion of bad loans all relating to one borrower/ company. To get it off the BS, you auction off the loans to anyone willing to pay for it. The loans are securitised against the collateral of the company ie real estate. Now say you are merril lynch and you are willing to pay $10M for these bad loans and win the bid. On ML books, you have a cost of $10M and a potential of up to $1B collections. What ML can do is 1) take the borrower to court to try and get as much of the collections as you can. the court proceedings can take years to resolve, plus there will be other creditors in line and different seniority of debt etc not a good option. 2) negotiate with the borrower to refinance the debt at a lower rate and forgive the differential. For the borrower to be able to refinance the debt, they need to get their ratios to an acceptable level and show that their core business is still profitable. Return on this option can take a few years as the company works on improving their numbers. 3)negotiate with the borrower to sell the noncore assets to pay off a portion of the loan and give debt forgiveness on the remaining loan. Say the borrower agrees and they sell the noncore assets for $300M and distribute to you $100M. They owed you $1B to start, after paying you back $100M, they now owe you nothing (debt forgiveness is $900M). You receive $100M cash from the borrower, it actually only cost you $10M (which is what you acquired it for at the auction), profit is $100M - $10M = $90M. 4) You do a corporate split. Split out the core business from the noncore business and sell off the noncore business. Option 3) is probably the quickest method to earn a profit. Its easy cash in the bank provided you have the right people willing to adivse the borrowers on what they can do to turn around their business. Its a win win siutation for both parties. The only loser is the superbank who lent out the initial outlay. The only thing is, its restricted game - like an oligopoly and only worth playing when the economy is in recession.