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Solutions Overview
Scenario
The client wanted to automate and improve their convertible trading operations. They actively
trade a book of over 1,200 positions representing the full variety of convertible securities.
Many tasks were time consuming and data intensive. They wanted to create a system that was
both flexible and powerful, and could handle large amounts of data. They chose Excel for
its user friendly interface and powerful analytical capabilities in conjunction with a central
Sybase database in which to store the data.
Company Profile
A leading worldwide investment banking and securities trading and brokerage firm.
Situation
The convertible desk had a number of requirements. First, they needed a way to price convertible
securities, which are often traded infrequently, or not exchange traded. Methods for pricing
these securities were needed to value the portfolio and monitor real-time P & L. Their
second requirement was a way for traders to package hedging strategies so that a group of
positions could be treated as a single strategy with a single hedge ratio. Lastly, the fund
wanted better risk management procedures including stress testing and VaR analysis.
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- Equity Parity (Gross Parity)
- Parity Less Accrued Interest (Net Parity)
- Best Bid of any/all contributed Reuters page prices
- Maximum of the Market Maker’s Best Bid and Parity
- Any of the above less the cost of carry
- A combination of the above
An automated system was developed to price over 1,200 positions and provide the trading
desk with a real-time P & L.
Hedge Ratios, Analysis and Adjustments
In the world of convertible arbitrage, being able to set up several securities as a package
comprising a particular hedge strategy is essential. These hedges would then be analyzed
as a group.For example, you could be long convertible preferreds combined with being long
and short equity calls & puts as “equity equivalents” along with being short common
stock and long ADRs.Methods were devised to enable a wide variety of different types of
hedge groups to be analyzed together in order to obtain a single hedge ratio for each particular
hedge group.
Likewise, we developed techniques for buying and selling equities as the prices of stocks
move up and down in order to capture market volatility, and thereby profit.This technique
is known as delta hedging. When the user is analyzing any particular hedge, what-if scenarios
can be performed to determine the stock orders that need to be placed in order to make adjustments
to the hedge ratio and to capture the stock volatility. The stream of orders can then be
monitored in real-time.
Stress Testing/Analysis and Value At Risk
We developed a number of standard stress scenarios including stock price, volatility and
interest rate stress tests and integrated the scenarios into a variety of convertible models.
These stress tests are used to manage and report on the risk associated with the convertible
arbitrage positions. Another major component of risk management involves the calculation
of Value at Risk or VaR. We implemented a 100-day history of prices, foreign exchange rates
and interest rates that combined data from various sources, including internal databases
and real-time data feeds. The data is used in combination with internally developed models
order to calculate and report on VaR.
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