Question

Recall the example of repo contract we talked in Lecture 1. Let’s now assume the hedge fund borrows $10M cash and uses 2-year T-notes as collaterals. The repo rate is 0.1% per month. Assume the hedge fund then uses the borrowed cash, $10M, to invest in stock market and purchases $10M worth S&P 500 ETF. After one month, S&P 500 realizes a total return of +10%. At the meantime, the T-note enjoys an interest rate of 0.25% per month, so that the cash lender has to return both $10M Treasuries and the interests back to the hedge fund when the contract expires. At the end of one month, the hedge fund closes all the positions. Please calculate the return on investment of this hedge fund over this month.

Answer 1

For computing the return on investment of this above hedge fund

Repo rate/month:- 0.1%

Therefore, Interest on borrowed fund is as calculated - $10M*0.1%=$10K

Interest receivable on T-notes as per 0.25%/month is $10M*0.25%=$25K

Market return i-e S&P500 ETF is given above as 10%, so that amount becomes $10M*10%=$1M.

Therefore return on investment is,

ROI= (Interest receivable - Interest payable) + Return from S&P500ETF ​​​​​​​​​​​​​​

Total Investment

ROI= ($25K - $10K) + $1M = 10.15%/month

$10M