Consider a hedge fund with a hypothetical initial equity of £ 1,000,000 to inves

Question

Consider a hedge fund with a hypothetical initial equity of £ 1,000,000 to invest. The investment companies strategy involves a long and a short position in equities Ax and Bz.Assume that the positions the hedge fund takes are £900,000 long in Ax and £800,000 short in Bz.

Assume that the Ax shares increase from £10 to £11 and pay an additional £1 dividend at the end of the month. Also assume that the shares of Bz have also increased from £10 to £10.25 and also paid a £0.25 dividend at the end of the month. If the interest paid on the short proceeds are 6% p.a. the unused capital can be invested at the same percentage. Finally if the interest fee on the short position is 1% p.a. then calculate the total P/L of the position.

Explanation / Answer

The company has a long position on Ax for 900000 pound and has taken a short position on Bz for 800000 pound.

Profit/ (Loss) of the above position are:-

.Dividend from Ax = 90000*1 = 90000

Dividend lost from Bz = 80000*0.25= (20000)

Increase in value of Investment = (90000 - 20000) = 70000

Interest Saved in Bz = 800000*6% =48000

Interest income from additional capital = 100000*6% = 6000

Interest fees on short postion of Bz = 800000*1% = (8000 )

So total Income = 186000 pound is shown in the P/L of the above postion

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