Question

A hedge fund has put on the following relative value trade: long shares of Apple, short shares of Facebook, dollar neutral. Which might be the fund manager’s view (separate from net carry considerations)? ******

1. Apple will decline in price, Facebook will rise
2. Apple will rise in price, Facebook will decline
3. Apple and Facebook will both decline to the same degree
4. Apple and Facebook will both rise to the same degree
5. Apple and Facebook may both decline but, if so, Apple will decline relatively less
6. Apple and Facebook may both decline but, if so, Apple will decline relatively more
7. Apple and Facebook may both rise but, if so, Facebook will rise relatively less
8. Apple and Facebook may both rise but, if so, Facebook will rise relatively more

B, E, G

The answers are provided can someone please give an explanation

Answer 1

Fund manager has Buy position on apple share and has sell position on Facebook share.

Let's assume both the share are priced at 100 dollars each.

Option B : If apple rises and Facebook declines, the fund manager will gain in both. Apple lets say goes to 110, fund manager gains 10. Facebook lets say goes to 90, fund manager gains here also because he will close his position at 90 and his sell price was 100, so a profit of 10.

Option E : Both decline, Apple decline relatively more. Assume apple share reached price of 80, fund manager loses 20. Facebook goes to 70, fund manager gains 30 in closing the position in facebook. (Refer reason in B above highlighted in bold) Net-net fund manager gains 10 (30-20)

Option G : Both rise, facebook rise relatively less. Suppose apple goes to 130, manager gains 30. Facebook goes to 120, manager loses 20 in closing the positions. (Same reasoning as bold in A). Net-net fund manager gains 30-20 = $10