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How do you decompose alpha to distinguish genuine manager skill from luck and factor exposure?
Alpha decomposition is the process of separating a manager's excess return into its component sources to determine how much (if any) represents genuine investment skill. The key insight is that not all alpha is created equal.
How do I apply Black-Scholes specifically for employee stock option valuation?
Black-Scholes for employee options uses the same equation with adjusted inputs: expected term instead of contractual, historical plus implied volatility, and dividend yield over the term.
How are short-term interest rate (STIR) futures priced and quoted?
STIR futures quote as 100 minus rate. A 95.50 price implies 4.50% rate. Tick is 0.5bp worth $12.50 on a $1M quarterly notional.
Why are executive stock options harder to value than traded options?
Executive options differ from traded options due to non-transferability, service requirements, long duration, and no dividend protection. Expected term adjustments reduce valuation meaningfully.
What is the convexity bias in Eurodollar (now SOFR) futures and how big is it?
Convexity bias arises because futures mark to market linearly while forwards are convex in rates. Adjustment is roughly half sigma squared times T1 times T2.
What is a break clause on a swap and how is the breakage cost calculated?
Break clauses permit optional early termination at predetermined dates. Kestrel Industries pays $1.52M breakage to exit a 4.05% pay-fixed swap when rates fall to 2.95%...
What are Performance Share Units (PSUs) and how are they valued?
PSUs are RSU-like awards where payout depends on performance or market targets, often 0 to 200 percent of target. Non-market conditions use probability estimates; market conditions use Monte Carlo.
How do you calculate the invoice price paid to the short at delivery?
Invoice price equals Futures Settle times CF times Face plus accrued interest. A worked example shows $98,819.90 for a 2040 bond.
What is novation of a swap position and what consent is required?
Novation transfers swap rights/obligations to a new party with three-way consent. Petrali Trading novates $2.3M negative MTM swap to Bank Raynfield, paying MTM plus $60K fee...
How are RSUs accounted for and how do they differ from stock options?
RSUs are promises to deliver shares upon vesting with grant-date fair value equal to spot price. No Black-Scholes needed. Treasury stock method dilutes EPS with limited proceeds.
What are the timing options the short has during the delivery month?
The short holds quality, timing, wild card, and end-of-month options that collectively reduce the fair futures price.
What is portfolio compression and why do dealers use it?
Compression terminates offsetting swaps across counterparties, cutting gross notional without changing risk. Aldermont, Cressidale, Wharnby reduce $3.9B gross to $100M net...
How do Employee Stock Ownership Plans (ESOPs) impact financial statements?
An ESOP is a qualified retirement plan investing primarily in sponsor stock. Leveraged ESOPs borrow to buy shares, creating a contra-equity account and compensation expense at fair value of released shares.
How is the conversion factor calculated and why does it matter for delivery?
The conversion factor is the clean price per dollar face of a deliverable bond priced to yield 6% at first delivery date.
Why is daily variation margin called 'settled-to-market' instead of 'collateralized-to-market'?
STM (settled-to-market) treats VM as actual cash settlement, resetting MTM to zero daily. Wensleydale Hedge Fund's 10-year swap balance sheet footprint shrank 37% post-re-characterization...
How are market conditions like TSR targets treated in stock option valuation?
Market conditions are tied to share price or relative stock performance. They are embedded in grant-date fair value via Monte Carlo and expense is never reversed if the condition fails.
Why does the cheapest-to-deliver bond switch and how should traders model this option?
The cheapest-to-deliver bond minimizes the short's delivery cost. Longer low-coupon bonds dominate above 6% notional; shorter high-coupon bonds below.
What margin do I post on a cleared swap vs. an uncleared one?
Cleared swaps require Initial Margin (2-3% of notional via SPAN) plus daily Variation Margin. Harwick Pension posts $180M SIMM-based IM under UMR Phase 6 uncleared rules...
How do performance-based vesting conditions affect stock compensation expense?
Performance conditions are non-market conditions tied to company metrics. They affect whether expense is recognized but not the grant-date fair value. Probability estimates update each period.
What is basis trading in T-note futures and how do traders profit from it?
Basis trading exploits the difference between the spot price of a deliverable Treasury note and its futures-implied price multiplied by the conversion factor.
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