Every concept, endless questions
Each concept is a small financial model. Read how it works, then draw a real interview question from it: forwards, backwards or what-if, with fresh numbers and a worked solution every time.
Forward runs a concept the usual way. Inverse runs it backwards, which is what separates understanding from memorizing.
Long / Short Equity
5 conceptsBeta-hedged pair trade attribution
A pair trade is a bet on one stock against another with the market taken out. The long earns its own return plus beta times the market; the short costs its own return plus beta times the market. Size the short so the two beta-dollar exposures cancel and whatever the market does washes out; what is left is the difference in the two stocks’ own returns — the alpha. A dollar-neutral hedge is the lazy version: it only cancels the market if the two betas happen to be equal. Attribution afterwards asks one question: how much of the P&L was the market you did not mean to own, and how much was the view you did?
Gross and net exposure
Two numbers describe a long/short book. Gross exposure — longs plus shorts over capital — says how much is at work and therefore how levered the fund is and how much it can lose if both sides go wrong at once. Net exposure — longs minus shorts — says which way the fund is leaning and roughly how much of the market it owns. Neither is complete without beta: a book that is net flat in dollars but long high-beta names against low-beta shorts is long the market. Beta-adjusted net is the number the risk desk actually watches.
Short rebate and the cost of carry
A short position is not free to hold. The cash raised from selling borrowed stock sits at the prime broker and earns interest — the rebate — but the broker charges a fee to borrow the stock, and if the company pays a dividend the short must pay it to the lender. Net those and you have the carry: positive when rates are high and the stock is easy to borrow, negative — sometimes brutally — when the name is hard to borrow or pays a fat dividend. Carry sets the bar: the stock must fall by at least the negative carry over the holding period for the short to break even, before any thought of being right.
Sizing to a contribution-to-risk target
Position size is not a measure of conviction; it is a risk budget. A pod is told how much volatility it may contribute to the fund, and each idea is sized so that its own share of that budget — its weight times its volatility times how much it moves with the rest of the book — fits inside the allowance. A second rule sits alongside: how far the stock can fall before the thesis is wrong, times the weight, must not exceed what the desk is willing to lose. Whichever rule gives the smaller position wins. Volatile, correlated, far-from-stop names get small; quiet, diversifying, close-to-stop names get big — regardless of how much the analyst loves them.
Crowding and factor overlap
Two things make a stock-picker’s position riskier than its volatility suggests. Crowding: if many funds hold the same name, the exit is through the same door at the same time, and the measure of that is how many days of normal volume it takes to get out. Factor overlap: if most of a stock’s movement is explained by a factor — the market, momentum, its sector — the position is a factor bet the fund did not mean to make, and the part that is genuinely the analyst’s view is smaller than the position size implies. Both are invisible in the P&L until the day everyone runs for the same exit.