Pine Street Capital

Introduction
Harold Yoon was a manager partner for $32 million equity hedge
fund. At 1 pm of July 27, 2000, he and the other partner of the hedge
fund met to discuss a potential change of hedging strategy.
The fund they managed tended to be a market- neutral fund,
meaning that the fund hedged out all market risk.
In the past they managed it by short-selling or shorting, shares of a
market index.
However, due to enprecendented volatility seen in the markets over
the past several months, they were considering hedging the risk by
purchasing put options on this market index rather than simply
shorting
Hedge Fund

Since 1988 to 1998, some of hedge fund around the globe icreased by
almost 425%, reaching estimated 5,830 funds with assets under
management which is grew from $42 billion to $311 billion.
Hedge funds are not publicly owned, they are less regulated than mutual
funds and enjoy additional privileges.
The lack of regulation gives hedge hedge funds flexibility in investment
strategies and risk management that mutual funds do not have.
This flexibility seems to translate into higher expected returns for hedge
funds as compared to mutual funds.
Two important ways hedge funds differ from mutual funds are their ability
to use leverage and their ability to hedge by shorting or using options.
Leverage

By using debt to finance a portion of the assets in a portfolio, a higher return on the portofolios
equity is possible compared with an all-equity financed portfolio.
The balance sheets of two portfolio, a aportfolio that is laveraged and all-equity portfolio, are
shown when assets appreciate 100%(100%ROA).
By keeping the initial equity amount $50 the same in the two portfolio, the impact of leverage can
be observed on ROE
Laverage impact
Employed and the assets lost value, then leverage works againts the
investor, amplifying the loss on equity relative to an all-equity
portfolio.
Increase the risk of an investment
Many hedge funds seek arbiterage opportunities in different markets,
searching of payoffs with litte to no risk most investors, higher
returns
Prime Brokers minimize the credit risk associated by monitoring, if the
value of fundss investment, or assets drops to a level such that little
quity remains, the broker can force the fund to put in more equity or
liquidate part or all of funds portfolio
Option & Derivatives (O&D)
Use O&D instrument to speculate on risky returns to limit the
overall risk of their investments.
 The value of the put options is negatively correllated with the value of
the stock in the portfolio.
From figure 2, put options are held insure the portfolio against market
fluctuation.
While the hedge position protects the portfolio from the downside of
risk, it also limits the potential gains.
Hedge Fund Strategies
Funds particular investment strategy is based on its fund managers
skills and where the fund manager feels he/she has competitive
adventage over other investors in assessing risk.
Manager might adopt market-neutral strategy, where market risk is
hedged away while firm specific risk is kept in the portfolio.
Pine Street Capital
PSC was a hedge fund taht specialized in the technology sector.
Holding undergraduate degrees in engineering / sciences as well as
MBAs and/or PhDs specializing in finance
PSCs portfolio reflected the partnerss strengths, particularly Yoons
PSC had been using a short-sale strategy to eliminate general market
risk from the fund.

Expected PSC portfolio Return = + *

(Market return)
Options-Based Hedging
Over the past 4 months, The Technology Sector had extremely volatile
From January of 1999 to March 2000, Nasdaq appreciate more than
115% of return. From early March 2000 to the end of June 2000,
Nasdaq declined nearly 40%.
To protect the high volatility in the market, one of the partners
suggested altering PSCs hedging program to use options on the
Nasdaq to be more sensitive to market movement immunize PSCs
portfolio to market movements
Conclusion

Option base hedging strategy allow the fund to keep utillizing the
leverage against large negative fluctuation in the market