Hedge funds can employ many strategies and focus on virtually any kind of investing style or market. They also have the flexibility to change their strategy as they see fit. Morningstar and other services will group hedge funds into categories and provide benchmarks based on their average performances. As of 2016, there are over 12,000 hedge funds, and over half of those are required to report to the SEC. Continue reading...
Hedge funds can require initial investments that are quite large. This may be somewhere between $250,000 to $10,000,000. They will generally only accept Accredited Investors, meaning high net worth individuals that pass SEC standards which exempt the fund from some reporting and disclosure requirements. While the minimum investment varies, most Hedge Funds will accept only so-called accredited investors. Continue reading...
Hedge funds have historically been very secretive. They still mainly fall under Regulation D and private-placement laws, but their reporting requirements have been slightly expanded after the Dodd-Frank Act in 2010. Now, they are a little more transparent, but not fully. Up until the Dodd-Frank Act, it was basically impossible to know what hedge funds were investing in and who was involved. Hedge fund managers and their investment banks were under no obligation to report the holdings, and they generally avoided leaking any information about their market positions for fear of damaging their advantages. Continue reading...
Hedging against future price risk was the main reason Futures contracts came into being. If an investor or a business knows that they need to acquire an asset or security at a future date, they might go ahead and agree to a price and have it in writing on a Futures contract. A futures contract means that an item has been sold at a stated price, and only awaits settlement at a future date. This will protect them from the risk that the price will move unfavorably in the future, and it will allow them to balance books and plan a budget with more certainty. Futures contracts are standardized and traded on exchanges. Continue reading...
Hedge funds are private investment groups that attract high net worth individuals (and in some cases institutions), and use investment strategies that may be riskier than would be suitable for the average investor. While the name "hedge" implies that the fund serves a defensive purpose, today’s hedge funds use wide array strategies, and more often than not the goal is total return. The strategies used are often speculative, contrarian, or alternative compared to most investment options in say mutual funds or traditional long-only asset managers. Continue reading...
Hedge funds are sometimes the highest-earning investment vehicles, and sometimes they do that much worse than everything else. They have a high buy-in, low transparency, and limited liquidity. There are also other advantages and disadvantages worth mentioning. A good hedge fund can provide you with an excellent diversification of your investable assets and give you exposure to the best and brightest money managers in the world. Continue reading...
Delta hedging is the process of reducing exposure to potential loss resulting from price fluctuations in the security underlying his or her options positions by bringing the delta – or price relationship between options and their underlying securities – of a portfolio to zero, or closer to it (a position called ‘delta neutral’ or ‘delta hedged’). This is accomplished by purchasing financial instruments which counterbalance each other's exposure to price fluctuations, often adding short or long positions in other options or the underlying securities themselves. Continue reading...
Investment banking activity is different than traditional banking. Investment banks often serve as intermediaries that underwrite a new issue of stock and help to distribute it. They also trade in their own accounts, run hedge funds, and generally invest and speculate in ways that most institutions can’t. Investment banks can assist with new issues of stocks and bonds, purchasing large blocks of them to distribute at a premium. Continue reading...
Not all hedge funds are obligated to disclose their holdings, trades, or performance. About half of them are, however, and their performance can be found online through Morningstar and other sources. This information may not be as detailed as you would like, and you may try other means. Since the Dodd-Frank Act in 2010, more information about hedge funds is available to the public. This does not mean that all the information you seek will be readily available, however, and there are many hedge funds that do not make their information public. Continue reading...
Systematic risk is the broad risk of fluctuations and downturns in the market as a whole, which it is said cannot be eliminated through diversification. Systematic risk is also known as market risk, which is the exposure of all investors to the broad movements and downturns of the market as a whole. Theoretically it cannot be controlled for through simple diversification, since that would only bring a portfolio closer to the broad market performance, with a Beta closer to 1. Continue reading...
Fund managers are allowed to accept up to 35 non-accredited investors, but for the most part you will either need to satisfy the “accredited investor” requirement of the SEC to invest directly in a hedge fund. Otherwise, there are now hedge fund indexes and ETFs that track and mimic hedge fund strategies that are accessible to everyone. You should know now that the minimum initial investment requirement to participate in a hedge fund can be quite large, such as upwards of $1 million. Continue reading...
Like a currency or interest rate swap, a commodity swap is a contractual agreement to trade one cash flow for another. Commodity swaps are facilitated by Swap Dealers (SDs) who pair up various companies, mostly in the oil industry, who are looking to trade a floating (market price) cash flow outlay for a fixed one, or vice-versa. Futures Commission Merchants (FCMs) are the agents licensed by the National Futures Association to solicit and broker commodity swaps through Swap Dealers (SDs). (Requirements — found here) Continue reading...
Futures contracts constitute a binding agreement to trade a commodity, share, or instrument at a future date at an agreed-upon price. They are auctioned on regulated futures exchanges. Futures contracts are used primarily to deal with agricultural assets and natural resources but have come into use for anything that can be commoditized, including financial instruments and technological resources. Continue reading...
Forex is the common name for the Foreign Exchange market, an international network of currency trading that is active 24/7. Forex is by far the most active and highest-volume market in the world, because it involves large trades between international institutions in an effort to diversify or consolidate their exposure to various currencies. Individual traders can also participate, usually by trading nano-lots, which are 100-unit increments of currency. Continue reading...
A Credit Default Swap is a contract that provides a hedge against credit default risk. To guarantee against the non-payment of a loan, a Credit Default Swap can be purchased for a premium. The seller of the swap bears the risk of payment if a bond issuer defaults, or if there is a similarly threatening “credit event” which is agreed upon in the terms of the swap contract. Generally, the buyer of a credit default swap will pay quarterly premiums for the protection, and the annualized premium is called the "spread," which may be a set percentage of the notional amount. Continue reading...
A derivative is a security which monetizes the risk or volatility associated with a reference asset. Derivatives derive their value from speculation surrounding an underlying or reference asset. The reference asset could be another security, an interest rate, or an index, for example, but there are also derivatives based on future weather patterns. Derivatives come in many forms; examples include options, swaps, and futures. Some derivatives trade on exchanges and some are Over-the-Counter (OTC). Derivatives might be used for speculation or hedging. Continue reading...
A swap is an over-the-counter agreement between institutions to "swap" one thing for another, usually the cash flow related to interest-bearing instruments. Given the negotiable and over-the-counter nature of swaps, there are many permutations and manifestations of this concept. The most common is the interest rate swap, in which the counter-parties agree to pay the interest due on principal amounts which are not exchanged. Continue reading...
A put option gives the owner of the option/contract the right to sell a stock at the strike price named in the contract. One kind of option is a put. A Put is a right to sell a particular asset (usually a stock) at a certain price (called the “strike price”) within a specified time-frame. The owner of the put contract doesn’t need to own the underlying stock. If the price of the stock drops below the strike price in the put, the owner of the put contract can buy the stock at the lower market price and immediately sell it at the higher strike price in the put contract. That is a speculative way to use a Put contract. Continue reading...
A Foreign Exchange (FX) Swap is a short-term arrangement where a company or institution swaps domestic currency for another, then swaps it back after a short time - this may involve the use of a Forward contract. If a company sells something internationally, and they now hold a significant amount of foreign currency, they may want to exchange it for their domestic currency. If, however, they already have a payment obligation in the foreign currency within the next few months, they may use an FX Swap arrangement. Continue reading...
The notion of who bears risk for various sorts of failures, circumstances, or losses is a prevalent one in the financial world, and many institutions make all of their money accepting risks. To accept a risk is to bear the burden of loss or replacement if an event occurs that causes an asset to lose value or disappear. There is a bright side to this, however. There is a real and theoretical “risk premium” due to those who accept a risk. Continue reading...