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kr
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Posted: 2004-04-21 20:29

So everybody here knows what no-arb is, but it has only limited overlap with what is known as a 'Wall Street Arb'.  If you read 'Den of Thieves', you'd be amused that Boesky called himself an arbitrageur... but at the end of the day, the game's amusing, no? 

Went to see a panel discussion last night with Guy Wyser-Pratte.  He made the comment that just picking stocks and hoping for things to go your way is kind of dull.  Anybody who finally understood that their complicated financial theories were nothing but one mondo convergence trade understands this.  So why not try to manipulate the situation and dump the passive-aggressive approach? 

Incidentally, this issue overlaps with my discussion elsewhere on Nuke in re: using pricing models to initiate events. 

Anybody here have similar interactions with these kinds of economic agents, and what's your opinion? 


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Nonius
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Posted: 2004-04-22 15:39

I thouht arb in the traditional sense was buying something in one market and selling it in another market for a higher price instantaneously.  then again, I know diddly squat about the flavors of what people call arb now.  My first interview on wall street was at Bear Stearns with an obnoxious young dude who had NOT ONE BUT TWO UNDERGRADUATE DEGREES FROM PRINCETON.  For, surely, the sheer act of GETTING into Princeton as an UNDERGRAD is much more valuable than, say, having a slimy Ph.D. from that lame school on the Left Coast....anyway, the little fuk told me that he did "Non-deterministic Arbitrage"....say what Honkie?  anyway, I was thinking, hmmm....ain't that an oxymoron?  Anyway, the young little sheah ended up quitting Wall Street and last I heard he is a Rabbi....

 


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kr
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Posted: 2004-04-22 16:16

ok, right, arb used to be about horses racing from New York to Philadelphia...

no, talking about risk arb and variants as it used to be practiced in the 80s and beyond (i.e. coinciding with 'traditional' in derivatives history)

 


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Nonius
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Posted: 2004-04-23 14:49

interesting.  Risk arb is merger arb or pairs trading, is it not?

 


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Patrik
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Posted: 2004-04-23 14:58

I've seen some people equating the term risk arb and merger arb, other people seem to let risk arb denote a much wider type of situations (for example stuff like Shell/Royal Dutch).

btw, I have never really liked the term risk arb, it just not nice and clean.


kr
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Posted: 2004-04-23 15:00

Risk Arb = Merger Arb = Pairs Trading based on fundamental data

See, I'm big on fundamentals modelling because there is room for direct risk management...

http://www.sec.gov/litigation/admin/34-44283.htm

 


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Nonius
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Posted: 2004-04-23 15:03

there's definitely no quant risk managemnt that I can see, but savvy market risk managers are all over those guys asses at our shop...

those guys, three of them in  NY, made more money then God during the last wave of mergers...it was very dry for a while, picking up though.


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kr
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Posted: 2004-04-23 15:21

I suppose when you start running around with >5% of the float, any risk manager is gonna start reaching for the pepto-bismol. 

Anyhow, spreads are tight in that business as well, not so easy to make money in this round given the risk.  GWP below said he spent a few days in a French jail based on some of his aggressive activities, so it's not really riskless either... Smiley 

(And btw that is why he's not doing similar things in Russia... it's not that the climate is not favorable, but there is a big difference between a French jail and a Russian jail.. He and the other speaker from Elliott Assocs (them with extensive experience in chancy latam nations like Peru) were actually quite negative on Russia, was very interesting news to me.)


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Nonius
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Posted: 2004-04-23 16:21
tell me more about Elliot...I tried to get a job there once.....a long time ago..they were looking for a quant in 1991....ain't I a loser?

Chiral is Tyler Durden

kr
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Posted: 2004-04-23 17:05

whaddaya wanna know?

It was Paul Singer speaking.  Relevant news was:
- Elliot is closed to new investments for the first time in a very long while
- I asked him about this and determined that they are having the same problems we're all having... basically the spreads are too tight to justify the risk
- They are opening a new office in HK which they are quite pleased with; basically it's been a long work in progress and others will have to face real barriers to entry
- bullish on China, and India, bearish on Rus
- they are into very big plays, big names and sovs, not midsize or smaller stuff
- $4bn in assets, very impressive Sharpe figures, even to somebody like me who basically doesn't believe in Sharpe

I think the big thing they're known for is whipping Peru govt lawyers in international courts, and getting out at par when others took 50+ point haircuts, other stuff is out there but you have to do your research


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TonyC
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Posted: 2004-05-20 17:14
kr wrote >impressive Sharpe figures, even to somebody like me who > basically doesn't believe in Sharpe . . . so what should i believe in?

flaneur/boulevardier/remittance man/energy trader

TonyC
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Posted: 2004-05-20 17:15
and why cant i get paragraphs to show up . . . i hit the carriage return, i'm using netscape 7.1

flaneur/boulevardier/remittance man/energy trader

opmtrader
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Posted: 2004-05-20 20:25

TonyC, thanks for showing up.  I also have similar problems when using the Opera browser.  Everything works great when using IE.  Maybe InspectorKojak, our administrator, can give us some tips.


chiral3
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Posted: 2004-05-20 20:36

"I thouht arb in the traditional sense was buying something in one market and selling it in another market for a higher price instantaneously.  then again, I know diddly squat about the flavors of what people call arb now.  My first interview on wall street was at Bear Stearns with an obnoxious young dude who had NOT ONE BUT TWO UNDERGRADUATE DEGREES FROM PRINCETON.  For, surely, the sheer act of GETTING into Princeton as an UNDERGRAD is much more valuable than, say, having a slimy Ph.D. from that lame school on the Left Coast....anyway, the little fuk told me that he did "Non-deterministic Arbitrage"....say what Honkie?  anyway, I was thinking, hmmm....ain't that an oxymoron?  Anyway, the young little sheah ended up quitting Wall Street and last I heard he is a Rabbi...."

 

That little fuk didn't happen to be an Asian guy who had been Americanized, was he?


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JabairuStork
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Posted: 2004-05-21 05:43

Arroway
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Posted: 2004-06-10 22:30

What about "share-class arb"?  Does anyone do that?  It was mentioned on the CFA material, but only in passing, no detail given.

It would seem that you'd need huge leverage to gain anything from what I would imagine would be tiny spreads (if they were even >0).  Or doing something that was not technically "arb".

For example, Travelers has two share classes, one with 1 voter per share (TAPA), one with 7 (TAPB).  I think this was set up because Citigroup wanted to retain control after the IPO but before they finished the spinoff (but that's not really important now). 

There are no conversion rights, or any hard rules to keep B more expensive than A.  So, if A was more expensive you could short it and buy B, but technically that would not be arb, because there was nothing to "force" the prices the other way, right?  It could persist for a while, I would imagine.  Without converfsion rights the 7 votes per share are kind of meaningless unless you were shooting for control anyway.

On the other hand, and I can't think of a good example, there are some share classes that do give you the right to convert.  So, a similar strategy in those shares would be "textbook" arb.  Of course the conversion rights would ensure that such a scenario wouldn't last very long, which is the whole point of traditional arb. 

So, it would seem that this is not a profitable area, but I don't know for sure.  Does anyone do this stuff?


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AndyM


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Posted: 2004-06-10 22:37
It can be a dirty business...ask the Wella pref holders...

Hell is other forums...

kr
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Posted: 2004-06-10 23:20

This reminds me of a question I wanted to raise with respect to CDS... what's the scoop on situations where the holder of the cash instrument has some kind of corporate-action-based option, but the CDS holder does not.  Is this just part of the inherited risk when you own synthetic product? 

specific example:  Company is tendering for bonds, because the company is getting bought.  If insufficient bonds get tendered, all bets are off and the buyer has to go home.  If the majority do submit their bonds, the purchase will go through, and the refinancing will most likely result in a leverage increase.  Holders of CDS basically get the worst situation because of the 'borrowed money' clause - i.e. they didn't have the option to stop early at par before the leverage ratcheted.  If it were me, I'd much rather own the cash instrument in this case. 

It was an issue for real consideration to me because the bonds are currently rated Caa3.  I had a different option - tender, or wait for the bonds to be called two days later.  These jerks are tendering under par, but they make up for it with a consent fee.  The differential economics between the two options is minimal, but I became concerned that if the bonds didn't get tendered, either (1) the buyer would try to immediately file Ch. 11 and force me into a much bigger haircut, or (2) the impact of the buyer having to walk might cause a reversal of the financial statements' windowdressing process in the following quarter (i.e. surely the numbers have been made to look optimistic for the sales process), which could result in busted covenants and the beginning of a death spiral.  This company took haircuts on its debt in the past, btw.

I'd really like to know, because I have an interest in doing the following:

1) buying senior unsecured bonds of bankrupt companies at the recovery rate

2) selling a new security with a BB rating.  This security would have a notional close to the recovery rate, it would live inside an SPV with its own dedicated interest reserve, and there would be the provision that when the underlying company exits Ch. 11 and refinances its debt, so that the old security is exchanged for a new one, the SPV security would pay off at par.  In order to allow a fudge factor, things would be structured on the conservative side, and I'd keep the equity.  I would have the option of either paying off the SPV par amount, or delivering the exchanged security.  Also, there would be a final maturity of 3y from the initial date, so again the physical asset could be delivered at that time, in case the BK goes on too long.
The interest reserve is there to make the thing trade around par, for convenience.

The trouble with this is that the holder of the paper has a lot of legal power over corporate actions and other voting issues.  Because I would own all the options, it might seem as if you'd want to always vote for max value, but it's not always this straightforward.  In fact, my objective would be to concentrate the legal power in the hands of the SPV equityholders, maybe even trading them at a much lower price than the value of whole debt claim classes.  I don't know if an investor would snub such a security because they didn't like the arrangement here - but has the issue come up for CDS?


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rowdyroddypiper
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Posted: 2004-06-11 00:25

Okay, the changes in the forum make me feel uncertain (i.e. I think I figured out how to get Wi|mott past the filters but the message that I did it in seems to be different than I remember it, also all the text is smaller and fuzzier).

kr...here is how I am viewing your trade.  Let me know if I am wrong and I'll take another run at it.

You plan on issuing securities from an SPV.  The proceeds of the securities sale will be used to purchase securities from a bankrupt company.  These securities, in addtion to some cash/loc/cash like instrument will be contributed to the SPV to create par (wrt the price you've purchased the securities) coupon bearing securities.  The other reading that I have is that the securities will not collateralize the SPV, rather the SPV will enter into a funded TROR (or something like it, does it make sense to have a funded TROR) with you, the holder of the securities.

In either case, the par of the SPV issued securities will be close to the recovery rate on the defaulted securities (this is what leads you to believe you can get them bumped to BB?) .  Your concern seems to be that the buyers of the SPV certificates may be sceptical that they have no seat at the table in the workout process because they hold the debt of the SPV and not the Debt of the Company.  And as crazy as it sounds, I have seen plenty of workout situations where the course of action that provides maximum value to a certain class of debt holder varies widly from participant to participant. 

Your idea of concentrating the equity in the hands of the holders of the SPV certificates is interesting but presents a couple of hurdles.  The biggest one is that depending on how many investors you have sold to you could have a hard time determining who is the clear decision maker is.  If notes aren't restricted and the ownership becomes diluted you could really run into some hurdles.  Also if someone isn't investing by buying the notes themselves, do you really want them putting in their .02 while you're trying to work this fucker out?  Another issue that may arise is can the investor hold the equity that provides controlling interest.  Part of the appeal to this security I would think would be allowing investors that are typically restricted from buying defaulted securities to get in on restructuring.  I don't know that providing them with equity in the SPV would casue them a problem, but I've heard of stranger shit.

This is a situation where the investor has to be confident in your workout abilites.  Does it make sense to have the control rights shift gradually back to the SPV (ie.  33% of the bonds are delivered end of year 1, end of year 2 and end of year 3) just so that if you suck at what you do the investors can take the reins before it gets too far out of hand??  I think that may make it less profitable for you, and present an incentive to resolve early, while you have all of the bonds and can get more of the upside.  I'll think about it more.

 

 


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kr
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Posted: 2004-06-11 23:38

1) It would be just a single security in the SPV - point is to do a repack and not a portfolio deal. 

2) The SPV equityholder would make all investment decisions connected to the underlying, and the SPV debtholder would basically be at the mercy of those decisions.

3) Yes, actually one should be able to target any particular rating by adjusting the par amount low enough, but the rating should be close to what you expect the emerging debt rating will be.

4) Yes, there are always many perspectives on optimal outcome.  I wouldn't recommend this in every situation - especially where the variance of outcomes is too high.  Otherwise one would not be able to establish a true high-spec-grade rating.  There are also plenty of restructures where the outcome is not all that complicated - they will blow away the equity and a big piece of the junior notes, find a new equity sponsor and emerge.

5) I wouldn't intend to trade the equity widely... the objective is to produce a fairly low-yielding instrument (i.e. 10-15%) which would take up the slack for the bonds' risk, but still maintain control.  Basically my premise here is that a workout shop need not be a highly capitalized operation... doesn't make much sense.  What sucks for these guys is that they are holding securities of completely different risks.  Mostly I think it doesn't make sense for them to be bondholders.

Really I'm thinking of situations where the control issue isn't that different from the one I described - i.e. they don't have much control, and material issues don't come up very often.  If the financial picture isn't a complete mess, it could make sense.  This would be a kind of 'flow distressed' security, represented by the larger middlemarket players whose operations are simple, and the capital structure is just lightly syndicated bank debt + Sr. sub notes, maybe the sr. unsec haven't even been put in above the subs yet. 


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rowdyroddypiper
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Posted: 2004-06-12 00:28

Right, Right, I think I said securities out of habit.  You have one risky asset and one risk free asset (interest reserve) collateralizing the SPV.  The SPV issues one class of debt security.  There is equity as well which directs the course of the workout. 

The Workout Shop (kr LLC) holds the equity and appoints itself to workout the asset held by the SPV.  kr LLC presumably buys the equity and the proceeds of the equity sale are used to fund the interest reserve account.

The goal here is to create off balance sheet financing for kr LLC. Another way of putting it: the goal is to fund acquisitions of kr LLC by issuing asset backed securities that are freely transferrable and tied to a specific deal.  You worry that investors will feel they don't have control over the workout process. 

Do you have a good feel for how kr LLC would be financed the old fashioned way.  I don't imagine that it would be all cash equity raises to acquire debt.  Is it some sort of entity wide credit line, bond offering, etc.   The reason I ask is that the kind of structure you propose may be appealing in that it allows a potential lender to be selective on what restructres it hops into the sack with you on.  If they are providing something like a warehouse line they seem to be in a worse of position than an investor in an issue backed by a single deal.  Of course being your wareheous lender they may be able to influence you more.  He with the big hammer, must rarely speak.

I don't think the control issue should be too much of a hinderance,namely because as you point out, many of these situations can be fairly cut and dry, and the ones that aren't, well that's where you use your charisma to sell it.  If an investor doesn't trust your expertise then you need to find a new investor.   An issue I can think of is time to raise.  I don't have a handle on how quickly the market for defaulted debt moves, but it could be a nusiance to have to go out and sell each deal before you buy the debt.  It would appear you need a warehouse line, or a shit pile of cash anyway. 

All in all :"Your ideas are intriguing to me and I wish to subscribe to your newsletter"

 


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Posted: 2004-06-13 20:27

My first interview on wall street was at Bear Stearns

 

Do you happend to remember the name,  by any chance? Sounds interesting - when was that?   


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