Deutsche Bank Finding Relative-Value Trade Harvard Case Solution & Analysis

Deutsche Bank Finding Relative-Value Trade Case Study Solution

Shortcomings or disadvantages of short and long position approach

A short selling is one of the efficient trading or investment strategies that speculate on the reduction in the price of stock or other securities. This is the advanced trading strategy that need to be undertaken by the experienced investors and traders. It occurs when the security or stock is borrowed by the trader or investor, and sold out to the open market for the further plans of purchasing the same stock back, for less money. On the short sale, there is an unlimited amount of risks or rewards due to the fact that it can offer a huge profit returns, but the price of stock or any asset might rise to infinity.

The seller on the short position might be costly due to the reason that in case the seller guesses something inaccurate about the movement of the stock prices, then a trader bought stock or asset might lose 100 percent of their outlay in case the stock or asset moves to 0. The risk along with the short position trading strategy could have probable chances to occur because of the absence of the ceiling or a boundary put for the price of stock, which might rise to infinity or beyond.

In addition to this, if it comes to close the short position; the trader or seller on short position could face difficulties in finding sufficient stocks to purchase – if the asset or stock is traded thinly, or if other traders or investors are shorting the assets or stocks(AMADEO, 2018).

Apart from the discussed shortcomings of the short position trading technique; there are some additional costs that the investors or traders should carefully consider:

1. At the time of short selling, the margin account needs to be opened by the investor, which allows to borrow the funds from the brokerage corporation by using investor’s investment as collateral. If the investor or trader slips below the minimum maintenance requirement; the investor or trader would be subjected to margin call, and could be forced to liquidate position and put in more cash.
2. Although, the firm is overvalued, it would take a while for its prices of stock to decline. Meantime, the investors or traders would be vulnerable to the margin calls, interest and being called away.
3. Another risk that is faced by the investors on short position is the regulatory risk,at which the regulators sometime impose bans on the short sales in the broad market or even in a specific sector for the purpose of neglecting the unwanted selling pressure and panic.
4. Another disadvantage associated with the short selling are the stock loan fees, margin interest and above all of them, the cost of opportunity being tied up because of the margin requirements.(CHEN, 2019).

Apart from the shortcomings of the investors and traders’ short position; the long position stipulates that the huge capital amount is tied up, which in turn could result in the other market opportunities to be missed out. The shortcomings of the long position of investors or traders are as follows:

1. The long position investor or trader might suffer due to the abrupt or considerable short term moves and price changes.
2. There is a likelihood that the long position might expire before even realizing the advantage.

Conclusion

The Bank has formed an internal research and development (R&D) deportment for the fixed income instruments. Deutsche Fixed Income Research Group consists of approximately 50 strategists and analysts. The mandate of the Fixed Income Research Group is to look for the opportunities to tap the untapped value among the interest rate derivatives and bond markets. . The fixed income research group is divided into the two considerable activities,which are, to present the strategic advice on the macroeconomic trends as well as putting a major focus on the relative value activities. The role of the fixed income research group is to get the external clients informed about the macroeconomic forecast and trends. Another role of the fixed income research group is the customized work for the particular clients who need assistance in consulting and analyzing of their client’s asset liabilities, mismatches and balance sheet mismatches.

The short position technique is a strategy which is used when the potential investor anticipates the stock price would fall down in the short term. On the other hand, the long position technique is a bullish view, in which the asset is purchased and owned by investor, with the expectations that the price of the stocks would rise. The long and short positions are determined after extracting the difference between the model prediction prices and the US Treasury bond prices.The result shows that the short trading strategy is more recommended due to the fact that the predicted prices are lower than the price zero coupon implied. The difference between the model prediction yield and the US treasury yield is used to find the long as well as short recommended techniques. The difference shows that despite of bond with 8 and 9 years maturity, all the bonds are short due to the fact that the model prediction yield is lower as compared to the implied zero coupon market yield.

The shortcomings of the short position includes unlimited risk, no ceiling for the price of stock, difficulty in finding sufficient stocks to be purchased, stock loan fees, margin interest and the cost of opportunity.

Exhibit A – Short or long on the basis of yield differences

Exhibit B – Short or long on the basis of price differences

Exhibit C – Shortcomings of short and long position

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