You have started a hedge fund that will follow Bernie Madoffs split-strike strat

Question

You have started a hedge fund that will follow Bernie Madoffs split-strike strategy. Your strategy is (i) take a long position of 1000 shares in SPY (the S&P 500), (ii) sell 2000 one-month call options with strike price 10% above the current price and (iii) buy 1000 one-month put options with strike price 5% below the current price (assume that 2 x call price = put price so you do not need to calculate the cost). Each month you will take your gains or losses and then start again for the next month. (a)Using the last 60 months of returns for SPY, calculate the initial value of your portfolio in time -61 and each subsequent return for your hedge fund (after considering the effect of the options). (b)Calculate the buy-and-hold return for your fund over the last 60 months. Compare this with the buy-and-hold return for SPY. Note: to calculate this find (1+r1)(1+r2)(1+rn). The easy way is to find 1+r for each month and then use the =PRODUCT( ) function in excel. (c)Compare the standard deviation of your returns to the standard deviation of SPY (d)Calculate the correlation between your portfolio and SPY (use the =corr( ) function) (e)Compare how many months had a negative return on your portfolio compared to SPY

Explanation / Answer

you basically have it right, but he was a Hedge Fund Manager (also called a Portfolio Manager)...he was not an investment banker. In the investment finance world those are two totally different positions...otherwise on a high level, yes, he cooked the books and made up investments and profits, and used money from new investors to pay fake profits to earlier investors...the early investors would in turn be so happy with the profits they would bring all their friends and family members in to ride the wave...helping him to raise more and more money.

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