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A Tale Of Two Hedge Funds Magnetar And Peloton Case Solution
| Solution Id | Length | Case Author | Case Publisher |
|---|---|---|---|
| 1248 | 741 Words (3 Pages) | David P. Stowell, Stephen Carlson | Kellogg School of Management : KEL402 |
A Word File
Peloton’s winning strategy was effective in 2006 and allowed Peloton Partners to become one of the top hedge funds in the country. Ron Beller, the head of the company bet against the United States housing market. Before the subprime crisis hit the country, and people started to default on their mortgage, Beller was able to earn a healthy return by taking a short position on the housing market. The objective was to invest in the mortgage as the banks were issuing mortgages to a large number of people irrespective of their credit history. The investment in mortgage paid around 80% return in 2007.
Following questions are answered in this case study solution
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Describe in your own words, Peleton's winning strategy in 2006.
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Describe in your own words how Peleton went bankrupt. What role did liquidity play in Peleton's failure? What role did UBS play? How was Ron Beller trying to save the fund? Why didn't it work? How might gaining access to additional liquidity have helped? What arguments do you think Ron Beller was making to its financing banks in order to convince them to help?
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Explain in your own words Magnetar's investment strategy which allowed it to earn high returns in 2007. Be sure your answer is able to explain the following quote: "Mortgage analysts note that Magnetar's trading strategy wasn't all luck--it would have benefited whether the subprime market held up or collapsed." (Hint: You need to understand exactly what tranches of CDOs Magnetar was short and long. You also need to understand how they were short, and how they were funding their short position).
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How could Magnetar have lost money? Using information from the rest of the case, describe how you think they came to the conclusion that the risk of losing money was remote. (Hint: Though this is a tough question, the answer has to do with how assets in the CDO are correlated).
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In your opinion, what is the most critical difference between Peleton's investment strategy and Magnetar's? (Hint: Think here of the difference between hedging and hedge funds. Do all hedge funds use a "hedged" investment strategy?)
Case Analysis for A Tale Of Two Hedge Funds Magnetar And Peloton
2. Describe in your own words how Peleton went bankrupt. What role did liquidity play in Peleton's failure? What role did UBS play? How was Ron Beller trying to save the fund? Why didn't it work? How might gaining access to additional liquidity have helped? What arguments do you think Ron Beller was making to its financing banks in order to convince them to help?
Ron Beller misunderstood the prices of highly rated mortgage securities and believed that the prices were unfairly punished after the crisis. So, he decided to lever up the investment by nine times. The investment took a severe hit when Alt-A-backed AAA securities fall by 10 to 15 percent. This happened when UBS announced that the bank owed $21.2 Billion worth of high-rated securities. Thus, UBS gave the market the signal that it is going to sell these securities. To save funds, Ron Beller asked the investor for more funding, liquidate all the positions that could generate cash and asked banks to delay margin calls. This did not work because banks were dealing with their mortgage losses. The additional funding could help the firm to avoid illiquidity and hence bankruptcy.
3. Explain in your own words Magnetar's investment strategy which allowed it to earn high returns in 2007. Be sure your answer is able to explain the following quote: "Mortgage analysts note that Magnetar's trading strategy wasn't all luck--it would have benefited whether the subprime market held up or collapsed." (Hint: You need to understand exactly what tranches of CDOs Magnetar was short and long. You also need to understand how they were short, and how they were funding their short position).
Magnetar rapidly moved downwards to the securities which they believe were mispriced. They took a long position on the collateralized debt obligations which have the highest risk but have the potential of healthy returns in good times. It was hedged against the less risky layer of the CDO’s or the same securities. Although, the risky securities incur losses, hedging against the less risky securities paid more when the market collapsed.
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