Prepaid Variable Forwards

[analystDC]

The text describes a prepaid variable forward as a hedging instrument utilizing the dynamics of both a collar and a loan. Per my understanding, a dealer gives a % of the value of a specific set of shares in cash for the right to receive a variable number of shares in the future depending on the underlying stock movement. It is suggested that this is not a sale for tax purposes. I am confused how this is functioning like a collar? Could anyone provide some insight here? Thanks!

[acoxen]

Sure its a pretty easy concept.

Say you have a large position in stock you cant sell for some reason.

You purchase a collar one the stock to lock in the value in a tight range.

Then you take out a loan using the stock, which the value has been locked into a tight range, as collateral. The loan should be a high Loan to Value loan.

Then you can use the funds to invest in other assets.

If the stock moves outside of the collar you can repay a portion of the loan.

[pintoj4]

This has been answered by Magician in another thread. Please search it up. It has a wonderful example.

[S2000magician]

https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91357066

[MR-STRESS]

Anyone know why is PVF not considered a monetisations strategy for concentrated position please …

[Viraj_Swaroop]

It cannot be considered as a monetization strategy because you are not creating a risk less position as with the equity monetization strategies (Short sale against the box, Total return equity swap, forward conversion with options, forward sale contract). In all these equity monetization strategies, your market risk is essentially zero as you have totally hedged your position and hence you can earn high LTV and hence monetize. Also, in all these cases, your capital gains tax is delayed to a later point as you are not selling immediately.

For hedging strategies (Buying puts, PVF or Cash less Collars), although the capital gains tax is deferred, but market risk is not completely eliminated as you still have some risk with your position. So monetizing this does not make sense as you won’t be getting good LTV for your value of stocks. Though in PVFs, you essentially do monetize your position in the beginning by taking a margin loan from the dealer and making him payments at a future date according to a pre-set formula (This has been explained exceptionally well in the above S2000 magician thread). Hope it makes sense.

[MR-STRESS]

@Viraj_Swaroop

It cannot be considered as a monetization strategy because you are not creating a risk less position as with the equity monetization strategies (Short sale against the box, Total return equity swap, forward conversion with options, forward sale contract). In all these equity monetization strategies, your market risk is essentially zero as you have totally hedged your position and hence you can earn high LTV and hence monetize. Also, in all these cases, your capital gains tax is delayed to a later point as you are not selling immediately.

For hedging strategies (Buying puts, PVF or Cash less Collars), although the capital gains tax is deferred, but market risk is not completely eliminated as you still have some risk with your position. So monetizing this does not make sense as you won’t be getting good LTV for your value of stocks. Though in PVFs, you essentially do monetize your position in the beginning by taking a margin loan from the dealer and making him payments at a future date according to a pre-set formula (This has been explained exceptionally well in the above S2000 magician thread). Hope it makes sense.

thank you

[Viraj_Swaroop]

@MR-STRESS

@Viraj_Swaroop

It cannot be considered as a monetization strategy because you are not creating a risk less position as with the equity monetization strategies (Short sale against the box, Total return equity swap, forward conversion with options, forward sale contract). In all these equity monetization strategies, your market risk is essentially zero as you have totally hedged your position and hence you can earn high LTV and hence monetize. Also, in all these cases, your capital gains tax is delayed to a later point as you are not selling immediately.

For hedging strategies (Buying puts, PVF or Cash less Collars), although the capital gains tax is deferred, but market risk is not completely eliminated as you still have some risk with your position. So monetizing this does not make sense as you won’t be getting good LTV for your value of stocks. Though in PVFs, you essentially do monetize your position in the beginning by taking a margin loan from the dealer and making him payments at a future date according to a pre-set formula (This has been explained exceptionally well in the above S2000 magician thread). Hope it makes sense.

thank you

You’re welcome.