A Tale Of 2 Hedge Funds Magnetar S Inv
Que) Explain the investment strategy of Magnetar
The strategy followed by Magnetar is that it structured a Finance Arbitrage Trade and attacked securities that it believed could become troubled but were paying big returns.
The strategy was based on the view that certain tranches of CDO’s were systematically mispriced because of turmoil in the markets which, therefore, created new investment opportunities.
Using this strategy, it could replicate the same basic trade many times across many securities. It could also invest large sums of money to work while having little effect on market prices, undertaking little risk, and locking in returns that were nearly certain, a dream trade for hedge funds.
Magnetar observed that the equity and mezzanine tranches of ABS CDO’s had very different yields and therefore capitalized by buying CDS protection on the mezzanine tranche and going long on the equity tranche.
The CDS’s acted as a form of protection- insurance- against losses on the CDO’s. It wasn’t clear which CDO’s it hedged against, but these swaps broadly soared in value when the CDO’s dived last year.
Magnetar only needed to realize that the aforementioned tranches were relatively priced. Trades could be structured to generate cash on an ongoing basis because the current yields flowing in from the equity long positions were so much higher than the current yields being paid on the mezzanine short positions.
In the event of high defaults, the principal balance on the mezzanine shorts would be higher than that of the equity longs, so the strategy would have a large payoff if prices of the overall underlying collateral took a turn for the worse.
The only way the strategy would lose money is if the equity got wiped out while the mezzanine tranche stayed intact. Magnetar considered the probability of this event occurring as being remote.
Magnetar made over $ 1 billion in profits, noting that equity tranche of CDO’s and CDO-derivative financial instruments are relatively
The strategy followed by Magnetar is that it structured a Finance Arbitrage Trade and attacked securities that it believed could become troubled but were paying big returns.
The strategy was based on the view that certain tranches of CDO’s were systematically mispriced because of turmoil in the markets which, therefore, created new investment opportunities.
Using this strategy, it could replicate the same basic trade many times across many securities. It could also invest large sums of money to work while having little effect on market prices, undertaking little risk, and locking in returns that were nearly certain, a dream trade for hedge funds.
Magnetar observed that the equity and mezzanine tranches of ABS CDO’s had very different yields and therefore capitalized by buying CDS protection on the mezzanine tranche and going long on the equity tranche.
The CDS’s acted as a form of protection- insurance- against losses on the CDO’s. It wasn’t clear which CDO’s it hedged against, but these swaps broadly soared in value when the CDO’s dived last year.
Magnetar only needed to realize that the aforementioned tranches were relatively priced. Trades could be structured to generate cash on an ongoing basis because the current yields flowing in from the equity long positions were so much higher than the current yields being paid on the mezzanine short positions.
In the event of high defaults, the principal balance on the mezzanine shorts would be higher than that of the equity longs, so the strategy would have a large payoff if prices of the overall underlying collateral took a turn for the worse.
The only way the strategy would lose money is if the equity got wiped out while the mezzanine tranche stayed intact. Magnetar considered the probability of this event occurring as being remote.
Magnetar made over $ 1 billion in profits, noting that equity tranche of CDO’s and CDO-derivative financial instruments are relatively