Event-Driven Hedge Funds

Question 1

1. List the three primary categories of single-strategy event-driven hedge funds.

Answer 1

• Activist Hedge Funds
• Merger Arbitrage Funds
• Distressed Securities Funds

Question 2

2. Why are event-driven hedge funds often characterized as selling insurance?

Answer 2

• Event-driven hedge funds are often characterized as selling insurance because they purchase shares during the period near an event (such as a proposed merger announcement) and the eventual resolution of uncertainty regarding the event. This act may be viewed as providing event risk insurance to the equity market.

Question 3

3. Why would activist hedge fund managers need to understand corporate governance?

Answer 3

• Corporate governance is central to the activist hedge fund’s investment strategy as it is the means to assert change or threat of change into the management of the target corporation.

Question 4

4. List the five dimensions of shareholder activists.

Answer 4

• Financial versus social activists
• Activists versus pacifists
• Imitators versus followers
• Friendly versus hostile activists
• Active activists versus passive activists

Question 5

5. What is the economic term for a person or entity who allows others to pay initial costs and then benefits from those expenditures?

Answer 5

• A free rider

Question 6

6. Is Form 13F a U.S.-required form that is targeted towards activist hedge funds?

Answer 6

• No, Form 13F is a required quarterly filing of all long positions by all U.S. asset managers with over $100 million in assets under management, including hedge funds and mutual funds, among other investors.

Question 7

7. What is the difference between a spin-off and a split-off?

Answer 7

• A spin-off occurs when a publicly traded firm splits into two publicly traded firms, with shareholders in the original firm automatically becoming shareholders in the new firm.
• A split-off occurs when Company A splits off (divests) Company B and the investors in Company A have the choice to retain their ownership in Company A or exchange their shares in A for shares in the newly created firm (Company B).

Question 8

8. What are the positions utilized in a traditional merger arbitrage strategy?

Answer 8

• Traditional merger arbitrage generally uses leverage to buy the stock of the firm that is to be acquired and sell short the stock of the firm that is to be the acquirer in a stock-for-stock merger.

Question 9

9. What is financing risk in the context of an event-driven investment strategy?

Answer 9

• Financing risk is the economic dispersion caused by failure or potential failure of an entity, such as an acquiring firm, to secure the funding necessary to consummate a plan such as an acquisition.

Question 10

10. How is short selling of equity in a distressed firm similar to an option position?

Answer 10

• Shares in highly leveraged firms resemble call options, therefore short-selling distressed equities is analogous to writing naked call options on the firm’s assets and generates a negatively skewed return distribution. An investor has a naked option position when the investor is short an option position for which the investor does not also have a hedged position.