CFA Level II ExamAlternative InvestmentsMedium
An investor is evaluating a hedge fund that uses sophisticated quantitative models to identify temporary mispricings between highly correlated securities, such as convertible bonds and their underlying equities, or pairs of stocks. The fund typically takes offsetting long and short positions to minimize market risk. This approach best describes which hedge fund strategy?
- ARelative Value Arbitrage
- BGlobal Macro
- CLong/Short Equity
- DEvent-Driven
Show answer & explanationAnswer & explanation
Correct answer: A. Relative Value Arbitrage
The strategy described, which involves using quantitative models to identify temporary mispricings between highly correlated securities (e.g., convertible bonds and underlying equities, or pairs of stocks) and taking offsetting long and short positions to minimize market risk, is the hallmark of a Relative Value Arbitrage strategy.
Why the other options are wrong
- B. Global macro strategies make directional bets on macroeconomic trends, not relative mispricings.
- C. Long/short equity focuses on mispricings in individual equities but typically has a net market exposure, unlike the market-neutral aim of relative value arbitrage.
- D. Event-driven strategies focus on corporate events, not mispricings between correlated securities.
Relative Value Arbitrage
A hedge fund strategy that seeks to profit from temporary price discrepancies between related financial instruments, often by taking offsetting long and short positions to minimize market risk.
- Exploits mispricings between related securities.
- Aims for market neutrality.
- Common examples: convertible arbitrage, fixed income arbitrage, equity pairs trading.
Memory trick: Arbitrage finds hidden value in price gaps.