Prasad Jagtap

Table of Contents Task 1 ................................................................................................................................................3 Solution .............................................................................................................................................3 Task 2 ................................................................................................................................................3 Solution .............................................................................................................................................3 Task 3 ................................................................................................................................................4 Solution .............................................................................................................................................4 Task 4 ................................................................................................................................................6 Solution .............................................................................................................................................6 Task 5 ................................................................................................................................................7 Solution .............................................................................................................................................7 Task 6 ................................................................................................................................................8 Solution .............................................................................................................................................8 Task 7: ...............................................................................................................................................8 Solution .............................................................................................................................................9 Task 8 .............................................................................................................................................. 11 Solution ........................................................................................................................................... 11 Task 9 .............................................................................................................................................. 12 Solution ........................................................................................................................................... 12 References ....................................................................................................................................... 14 2 Task 1 What is the notional value of 1.000 contracts of each of the futures contracts using the most recent price of the current active contract, i.e. the-? Solution The current active contract in e-S&P mini is ESM0 as it expires in June’20. The current active contract in crude oil is CLK0 as it expires in June’20. Task 2 Future contracts on equity index needs to be rolled either monthly or quarterly depending on t he contract, and primarily experience contango. Given that you have a portfolio of 1.000 contracts of S&P 500 mini. How much do you lose/gain in dollars, when rolling the contracts on the day before the expiration day? Solution ESU9 Index that runs from July’19 to September’19. It expires on 20th September having the cost of 1 contract as $3013.61. It will be rolled over to the next quarter and will become ESZ9 that will expire in the month of December’19 before the date of expiration. As per question, if we roll over on 19th September (the day before expiration), the value of 1 contract of ESU9 is 3006 and it will be rolled over to ESZ9 having the value of 1 contract of 3008. So basically the trader will lose money (loss of $2) if he roll over. If we calculate the loss of 1000 contracts, then that would be $2 x 1000 = $2000. Speaking of ESZ9 that runs from October’19 to December’19, expires on 20 December having the market value of $3231.02. If we roll it over to ESH0, the day before the expiration then the market value of 1 contract for ESZ9 and ESH0 on 10th December is $3207 and $3211.75 respectively. In this deal the trader will again lose money, 3211.75 – 3207 = -4.75 per contract, i.e. $4750 for 1000 contract. In the case of ESH0 that runs from January’20 to march’20, expires on 20 march’20 having the market value of $2437.98. If we roll it over to ESM0 just the day before it expires then the market value of 1 ESH0 contract is $ 2403.25 and the market value of 1 ESM0 contract is $ 2389. The trader will make the profit of $ 14.25 per contract, that means $ 14250 for 1000 contract. In terms of ESM0. This contract runs from April’20 to June’20. It should be roll over to ESU0, however, there is no data given regarding that so it is not possible to calcul ate the profit/loss for this contract. 3 Task 3 Analyze the curve of the contracts with different maturity on the- for both S&P 500 mini and crude oil. What is the explanation for this behavior? Solution Units Behavior of the contract of S&P 500 as of 1/4/- Price Volume ESU9 ESZ9 ESH0 ESM0 2875.5 2879.5 2885.75 2890.75 3652 246 5 0 S&P- - ESU9 ESZ9 ESH0 ESM0 The prices of e-mini S&P 500 is in contango for every contract as of 1st April. As the contract approaches to it maturity, they are heavily traded. As for ESU9, it is going to expire in September 2019. From the excel sheet it can be seen that it is heavily traded on April 4 as the volume is 3652 and the volume also stays the average to around 1500 until it expires on Friday 20 September’19. The volume on 2 April is 815 and on 3rd April its again 3679. Also, the prices went down from 1st to 2nd of April from 2875 to 2872 and then and went up again to 2884.75 on 3rd April. It implies there is high variance i.e. higher volatility and more liquidity. If seen carefully the change in volume from 1 st to 2nd and then again spiking up high mean that there must be certain events, such as the company's earnings report or a major news release, can cause volume to spike. 4 Speaking of ESZ9, it has the expiry on December’19, therefore, it is not traded as much as ESU9 as it is not near to its expiry. Since 1st April, the prices are increasing continuously, that means the pools of companies associated with this index are performing good and traders have got confidence that they will keep it up with their performance. The liquidity is same for this index as compared to ESZ9, however, due to the lower volume trade it is more as popular to trade as much as its counterpart ESU9. Units ESH0 and ESM0 both has the expiry in March’20 and June’20 therefore they are not generally traded on 1st April as the volume is nearly 0 for both indices. - CLM9 CLN9 CLQ9 CLU9 CLV9 CLX9 CLZ9 CLF0 CLG0 CLH0 CLJ0 CLK0 Volume- 51621 65213 30664 26035 83435 8913 3152 11299 2660 1496 Price 61.83 61.78 61.65 61.48 61.27 61.03 60.76 60.47 60.19 59.19 61.71 61.8 Crude Oil 63 62 61 - CLM9 CLN9 CLQ9 CLU9 CLV9 CLX9 CLZ9 CLF0 CLG0 CLH0 CLJ0 CLK0 From the crude oil, we can see that the curve for every contract on 1st April is going in backwardation which basically means that the supply for the crude oil at present is higher, then in future. The prices of future contracts are lower than the spot price. The same logic applies here too as the contract approaches to maturity, it is heavily traded. That’s why the volume of June contract is greater than the contracts of subsequent months. 5 Task 4 Is there a time where it is more beneficial to roll the contracts than others and why? Try computing the monthly and quarterly seasonality of the volumes of the two futures contracts. Solution Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract in a further-out month. They are rolled over to a different month to avoid the costs and obligations associated with settlement of the contracts. Rolling futures contracts refers to extending the expiration or maturity of a position forward by closing the initial contract and opening a new contract for the same underlying asset at the then-current market price. A roll enables a trader to maintain the same risk position beyond the initial expiration of the contract, since futures contracts have finite expiration dates. It is usually carried out shortly before expiration of the initial contract and requires that the gain or loss on the original contract be settled. Price Below line graph is depicted in the sense to analyze the breakeven and accordingly conclude the beneficial time period to roll the contracts for crude oil- For Crude oil, after analysis, it can be seen that if we roll-over 35-40 days before the maturity, we can make profit. So, the seasonality will be 7-8 weeks before the date of maturity. Price Accordingly, below line chart is illustrated to compute certain time interval at which the contract could be rolled over in order to gain minimalistic gains with respect to capital- For e-mini 500, the seasonality will be roughly around 15 weeks before the date of maturity. 6 Task 5 Does the crude oil futures experience contango or backwardation? If yes, why may that be and why would we care? Price Solution- CLM9 Linear (CLM9) 0 5 10 15 20 25 30 35 40 80 Price 60 CLN9 40 Linear (CLN9) 20 0 0 10 20 30 40 50 60 70 60 Price 50 40 CLJ0 30 Linear (CLJ0) 20 10 0 Price 0 50 100 150 200 250 300 - CLK0 Linear (CLK0) 0 50 100 150 200 7 250 300 All of the above graphs are based on the data and shows us brief descriptive view towards the behavior of certain contract with the respective time period in terms of its price. All of the graphs constitutes to the solution justifying its significance and classifing the certain patche s in some parts. For an instance, the behavior of CLM9 can be classified in 3 parts, first which is always in contango. It signifies that people want to buy the oil as the demand in the market is pretty high. Second part is the important part of the graphs that indicates prices of the oil is going into backwardation and this is where traders roll over even though the deal is in the loss. The last part usually constitutes going into contango as it is the time when the buyers, capable of storing the oil purchase, store as the oil as commodity use. ( CME group, 2020) However, the last two graphs are from the April’20 and May’20 month contracts where it is visible that the last part of the graph is in backwardation, it clearly implies that even the oil buyers does not want to buy the oil as the commodity use which is not a good thing to happen for the market. Also, after carefully analyzing every month contract from June’19 to may’20, it can be conlcuded that most of the contract are in backwardation as the future prices are less than the spot price of when the futures are bought. The futures of the crude oil are in backwardation. Usually, it is useful in making profit for crude oil as we can sell the contracts at higher prices and buy later in futures at lower price. Task 6 Describe a trading strategy which profits from futures contracts in backwardation and show how it would make money. Solution Backwardation is a market condition in which a futures contract far from its delivery date can be traded at a lower price than a contract closer to its delivery date. Oil market is very liquid and usually, if a futures contract trades below the spot price, it will increase because the price must eventually converge with the spot price upon contract expiration. The future contract that is bought at cheaper price might increase due to this convergence, earning potential gains for the investors from the market. (Chen, 2019) However, Backwardation can be beneficial to speculators and short-term traders wishing to gain from arbitrage. It can be beneficial to short-term investors who try to profit from price imbalances by buying and selling assets on different markets, and for those who engage in speculation. Investors who trade futures contracts in commodities considered to be in backwardation are most likely going to hold a long position. (Radcliffe, 2020) Task 7: Explain the difference between a mutual fund and a hedge fund business structure in a European context. If you were to start a mutual fund or a hedge fund management company in Luxemburg and operate across Europe, what steps do you need to go through? What are the initial and running costs of each setup? What are the minimum technologies, licenses, and legislations you need to be aware of? 8 Solution Mutual funds are investment strategies that allow you to pool your money together with other investors to purchase a collection of stocks, bonds, or other securities that might be difficult to recreate on your own. Hedge funds are financial partnerships that use pooled funds and employ different strategies to earn active returns for their investors. These funds are managed aggressively or make use of derivatives and leverage to generate higher returns. The strategies include long-short equity, market neutral, volatility arbitrage, and merger arbitrage. They are generally only accessible to accredited investors. (Gad, 2020) Difference: Mutual funds are regulated investment products offered to the public and available for daily trading. Hedge funds are private investments that are only available to accredited investors and are known for using higher risk investing strategies with the goal of achieving higher returns for their investors. (Investopedia, 2019) There are many instruments on which the investments can be done in Luxembourg. The investment options are for the classified into two categories: 1. SIF : These are the Specialized Investment Funds for the qualified investors with large portfolios. Over the last few years device majority of hedge fund in Luxembourg has been set up as specialized investment fund (SIF). There are no restrictions on type of assets involved and is approved by CSSF. The minimum capital investment for the investor is €125,000. (Taxation of SIF in Luxembourg, 2020) 2. UCI: It stands for undertaking collective investments and is further divided into FCP, SICAV and SICAF. (Create Luxembourg, 2020).    FCP is followed by the management company, does not have any legal entity and requires the minimum assets to be €1,250,000. SICAVE is the open-ended investments having variable income and UCI-SICAV is primarily known as mutual funds and often called as UCITS (undertaking collective investments of transferable securities) in Luxembourg. Here, variable invested capital is equal to minimum net assets. SICAV is the open-ended mutual fund investment company having variable capitals. Here the fixed capital is used which is not necessarily equal to the net assets. Our preference is to start a mutual fund called UCITS. (UCITS in Luxembourg, 2020) Steps to open: 1. The applicant must submit an application for approval with the CSSF and if the fund will set up with sub-compartments then each compartment must also apply for consent. 2. CSSF send the questionnaires to know more about the types of activities handled by the fund. 3. Applicant must submit and get approved the list of documents with his signature in 3 years which are as follows: - Article of association 9 - Fund prospectus or Key Investor Information document (KIID) - Contract with several providers - Articles of incorporation. 4. Applicant will be asked about information regarding Finance regulator, information about the depository bank, auditor, and the proof of funds regarding the financial stability of the applicant. His experience and reputation are also taken into the account. Taxation and exemption: - - - There is a subscription tax of 0.05%, accounted annually is calculated on the net assets in last quarter of the year. It can be exempted if the capital is invested into the pension fund which is already exempted from subscription tax. NO income tax or the capital gains tax. Must pay the capital duty, which is imposed at a fixed fee of EUR 1,250. They are subjected to withholding taxes on the received income; however, investors can use the terms of the double taxation treaties in which Luxemburg signed agreement for the dodging the double taxation with the investor’s tax resident country. Exempted form VAT. (VAT Luxembourg, 2020) Legislations and license These are supervised by CSSF and governed under the Part I of the 2010 law 17 issued in December 2010. There is no restriction on the nationality of the director or his place of residence. Each UCITS is authorized under Luxemburg Financial Regulator. It is a corporate firm which can be assigned under public limited company, private limited liability company and partnership limited by shares. An alternative investment fund manager (AIFM) who is approved by CSSF manages this type of fund. Also, an independent auditor needs to be appointed. with minimum net assets value to €300,000 at the time of investment and should be increased to €1,250,000 in subsequent six months. Associated cost: - - - - Legal structure cost: €15,000 to €25,000- (registration fee, lawyer fee, etc., etc.) including setting up your limited partnership and any other additional entities required. legal counsel will assist with the creation of your operating memorandum/disclosure documents/private placement memorandum. Fund administrative cost: €10,000- €15,000- often utilize large software packages designed to connect and receive data from various third parties making the management of daily/monthly numbers more efficient, cost effective, and accurate. Tax and Audit Costs: €10,000- €20,000- An auditor that is familiar with the work of the attorney as well as the fund administrator can help keep costs low as well as expedite the entire audit process. Also, we will require a specialist familiar with the taxation issues relating to a fund. Using a CPA without these qualifications can cost us more money and, more importantly, open to potential legal issues. Technology Costs: €5,000- €8,000- core technology items include having solid internet connectivity, professionally hosted and archived email, a secure location for storing documentation with backups, and that the office (whether home based or in a dedicated location) has the proper cyber security protocols in place. 10 - Marketing Costs: €4,000- €10,000 - Having a professional image, a clear message on the fund’s strategy, and a process for getting in front of potential investors is critical to the success. Task 8 What is an ETF? In what way is it different from a mutual fund? In what ways can the managers of an ETF make it cheaper and more efficient (more liquid) than a mutual fund? Solution An exchange-traded fund (ETF) is a type of security that involves a collection of securities such as stocks that often tracks an underlying index, although they can invest in any number of industry sectors or use various strategies. ETF's can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types. An ETF is a marketable security, meaning it has an associated price that allows it to be easily bought and sold. Mutual funds and exchange-traded funds (ETFs) have a lot in common. Both types of funds consist of a mix of many different assets and represent a common way for investors to diversify. However, Mutual Funds are listed on exchanges and ETF shares trade throughout the day just like ordinary stock . There are key differences, though, in the way they are managed. “ETFs can be traded like stocks, while mutual funds only can be purchased at the end of each trading day based on a calculated price. Mutual funds also are actively managed, meaning a fund manager makes decisions about how to allocate assets in the fund. ETFs, on the other hand, usually are passively managed and based more simply on a particular market index.” [https://www.investopedia.com/terms/e/etf.asp]. Key takeaways in terms of comparing Mutual Funds & ETFs can be described in few words as below; ETFs Pros    Lower tax bill with qualified dividends. Lower investment minimums. Intraday pricing, meaning prices fluctuate throughout the day. Cons   Mutual Funds Pros  One price each day after the close of the market.  Automatic investments and withdrawals. Cons   Charge for commission, making frequent buying and selling expensive. Can’t make automatic investments or withdrawals. Not as tax-efficient as ETFs. Usually have a flat dollar amount for minimum investments. Mutual funds charge their shareholders for transaction fees, distribution charges, and transfer-agent costs. In addition, they pass along their capital gains tax bill on an annual basis. These costs decrease the shareholder's return on their investment. On the other hand, ETFs offer more trading flexibility, generally provide more transparency, and are more tax efficient than mutual funds. Fund managers or 11 teams have a strategic authority to make certain decisions to buy or sell stocks/securities within the funds to leverage the investors with the profit. Those funds are not cheaper as they consume efforts such as workforce &effective resources. Shredding such costs might help ETF to be cheaper than mutual fund and since, the ETF could be managed passively. ETFs tend to be cheaper than mutual funds. However, there are exceptions and investors are supposed to examine the relative costs of ETFs and mutual funds that track the same indexes. The structural differences between the 2 products do give ETFs a cost advantage over mutual funds. Task 9 Nordnet has introduced a concept called Smart Portfolios, using Swap contracts with JP Morgan. This is an alternative approach to buying ETFs directly. In what way is this approach different? Use the example of buying SPY compared to entering into a Swap agreement that gives the same return. How is this done in practice? What permissions are needed to do so? What are the start costs and the running costs? What technologies do you need to run a hedge fund based on a swap contract, say wi th JP Morgan? Solution Nordnet Smart Portfolios are traded as mutual funds and they not only rely on equity growth, but respond automatically according to market movements. If the shares rise and the bonds fall or vice versa, these Smart Portfolios are automatically adjusted to maintain the desired risk i.e. volatility. Nordnet Smart Portfolios invests in equities, bonds and alternative investments such as commodities, properties and factor investments in equities. With exposure to thousands of underlying securities, the risk is distributed in assets worldwide. Nordnet Smart Portfolios uses leverage to increase exposure to asset classes that normally have low risk and low returns. The purpose is to scale up asset classes that diversify well, so that even a portfolio with higher expected risk and return is effectively diversified. (Nordnet, 2020) An equity swap is a convenient way of packaging a series of forward contracts on an index to meet the needs of the market. In an equity swap, one party promises to pay the return on an equity index on a notional principal, while the other promises to pay a fixed or floating return on a notional principal. Equity swaps enable fund managers to increase or reduce their exposure to an index without buying and selling stock. (Hull. J, 2012) The swap-based ETF is based on the concept of total return swap which fundamentally delivers the same performance as of the index. As the index has variation in its prices and the dividends or interest received upon certain time so do ETFs. SPDR S&P 500 (SPY) It holds almost all the funds into common stocks which has included in the SNP 500 index. It is well diversified that includes the assets of multiple sectors such as 22% of IT, 16% of healthcare, 14% of financial services, 10% of communication, 9% of industrial, 8.1% of consumer defense, 9.5% of customer cycles, 3.6% of utility and 3% of real estate. (Nickolas, 2020) 12 Procedures When we trade on the SPY it holds the investment in terms of cash rather stocks and when the swap agreement is placed the counterparty initiates to deliver the same amount of total return as of the index. If there is a variation end of the stocks in the index and there is a dividend to be paid then the SPY simply increase it its prices by that percentage. For instance, if there is an increase in 3% of stocks in the index with generating the dividend of 2%, then SPY will increase its price by 5%. ( BORTOLOTTI, 2017) Advantages 1. Swap based ETF is tax efficient. While holding a stock or a bond directly, we create the dividend which are taxable in nature. However, The ETFs gains defined against the capital gain are not taxable unless the holdings are sold, thereby, invading the tax on the generated income. Upon selling the holdings the capital gains tax is on the half the rate of the regular interest income and the dividends. 2. It is weary to track the index because they are obligated to deliver the return. However, swap based ETFs minors that benchmark with remarkable consistency. Therefore, SPY is suitable for an investor that wants to include the equities in their portfol io while taking only the moderate level of risk as the 5-year index return rate is 7.99 annually. Permissions In order to start an ETF investment companies first, it has to trade on the stock exchange across EEA countries before they can trade publicly. A national regulator, EEA competent authority makes the rules and procedures to allow said any ETFs to trade in European stock exchange. ETFs need to be first recognized as UTICS as open-end investment fund and the FCA authorization is necessary for the ETF based investment fund and further needs to be settled its account in Euro-Clear Bank. Associated cost To start a new Swap based ETF fund, it includes the cost of registration, hiring of the staff, fund administrator, compliance requirement and marketing to attract new customers. All this will account for the roundabout of half-a-million euros. An expense ratio is determined by dividing a fund's operating expenses by the average dollar value of its Assets under management and SPY holds the lowest expense ratio in the industry of 0.04% annually that means the investors are charged $4 per year for every $10,000 of investment. Technology Technology can make the analysis faster and more efficient as preferred in today’s market. Although, there are legacy CRM- suite available but one of the most used desktop platform is PerTrac 2000. Other soft wares like investor force and Microsoft Excel are also used to analyze the market. Nowadays, in the era of automation, Machine Learning Tools are useful as it can create the list of ETFs based on the analysis of the various factors which can make market analysis much efficient and accurate as compared to the provincial tools. 13 References Cmegroup. (2020), NYMEX WTI Crude Oil Futures & Options, from https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_contractSpecs_futures.html Chen, J. (2019). Backwardation Retrieved 13 May 2020, from https://www.investopedia.com/terms/b/backwardation.asp Radcliffe, Brent. (2020). What's the Best Way to Play Backwardation in the Futures Market ?, from https://www.investopedia.com/ask/answers/081414/what-best-way-play-backwardation-futuresmarket.asp VAT Luxembourg. (2020). VAT Registration in Luxembourg Retrieved 12 May 2020, from https://www.lawyers-luxembourg.com/vat-registration-in-luxembourg Taxation of SIF in Luxembourg. (2020). Start Luxembourg Fund Retrieved 12 May 2020, from https://www.startluxembourgfund.com/taxation-of-sif-in-luxembourg UCITS in Luxembourg. (2020). Start Luxembourg Fund Retrieved 12 May 2020, from https://www.startluxembourgfund.com/ucits-in-luxembourg Create Luxembourg. (2020). Open an UCI in Luxembourg Retrieved 12 May 2020, from https://www.lawyers-luxembourg.com/create-uci-luxembourg Gad, S. (2020). What Are Hedge Funds?. Retrieved 14 May 2020, from https://www.investopedia.com/articles/investing/102113/what-are-hedge-funds.asp Investopedia. (2019). Mutual Funds vs Hedge Funds: The difference ?, from https://www.investopedia.com/ask/answers/173.asp Nordnet. (2020). Smart Portfolios. Retrieved 12 May 2020, from https://www.nordnet.dk/dk/tjenester/smarte-portefoljer Hull, J. (2012). Options, futures & other derivatives (9th ed.,pp. 767-768). Upper Saddle River, NJ: Prentice-Hall Internat. BORTOLOTTI, DAN. (2017). What are pros and cons of swap-based ETFs? Retrieved 14 May 2020, from https://www.moneysense.ca/columns/ask-moneysense/swap-based-etfs/ Nickolas, Steven. (2020). SPY: SPDR S&P 500 Trust ETF Retrieved 14 May 2020, from https://www.investopedia.com/articles/investing/122215/spy-spdr-sp-500-trust-etf.asp 14