Characteristics, Strategies and Aspects of Hedge Funds

Seminar Paper , 2007 , 15 Pages , Grade: 1,1

Business economics - Banking, Stock Exchanges, Insurance, Accounting

With the recent announcement of the investment bank Bear Stearns that two of their hedge funds High-Grade Structured Credit Enhanced Leverage Fund and High-Grade Structured Credit Fund had become nearly worthless, the discussion about hedge funds was newly rekindled. The funds were mainly invested in the market for mortgages loans to debtors with a medium or low degree of credit worthiness, the so called sub prime lending. They traded with collateralized debt obligations (CDO), which bunch the risk of those loans. Due to the decline in prices of properties and the increase in interest rate debtors got into trouble. Therefore the CDOs lost worth and the funds became bankrupt. Even if that is very problematic for the investors and the investment bank some economists think, that there could occur bigger problems. Meanwhile there are rumours that other funds got into trouble and economists worry that they could destabilize the whole financial system, due to their close relations to other financial institutions. Banks, in particular, which financed the funds, are in danger of being affected.
Whether this small crisis will spread or not can actually not be answered. In the next days and months that remains to be seen.
But for sure the discussion about hedge funds will be renewed. Therefore this essay will deal with that complicated topic. It is tried to explain what hedge funds are and how they work. For this purpose, first of all a proper definition for hedge funds is given. Secondly, the origin of hedge funds will be described and then the typical characteristics will be elaborated. Next, there is a short overview of the common strategies and about the development of hedge funds given. In the last part, the positive and the negative aspects will be described. Finally a short summary and a future outlook will end this paper.

Inhaltsverzeichnis (Table of Contents)

• Introduction
• Hedge Funds
  • Definition
  • History
  • Characteristics of hedge funds
    • Absolute return target
    • Flexibility in investment
    • Use of Leverage
    • Illiquidity of the invested capital
    • Little transparency
    • High minimum investment
    • Performance linked compensation
    • Less regulated environment
  • Strategies of hedge funds
    • Relative Value
    • Event Driven
    • Directional or opportunistic Strategies
    • Multi-Strategy
  • Positive Aspects
    • Option for portfolio diversification
    • Increase market efficiency
    • Negative feedback trading
    • Supply markets with liquidity
    • Overtake risk for other market participants
  • Negative Aspects
    • Increase of market volatility
    • Transmission of instability
    • Market risk
    • Complicate political desired corrections

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This essay aims to explain what hedge funds are and how they work, focusing on their origins, characteristics, strategies, and both positive and negative aspects. The paper explores the recent controversy surrounding hedge funds and their potential impact on the financial system. Key themes include:

• The definition and history of hedge funds
• The unique characteristics of hedge funds, such as their absolute return target, flexibility in investment, and use of leverage
• The various strategies employed by hedge funds, including relative value, event driven, directional, and multi-strategy approaches
• The potential benefits and drawbacks of hedge funds for the financial system, including their role in market efficiency, risk management, and potential for instability

Zusammenfassung der Kapitel (Chapter Summaries)

The introduction highlights the recent crisis involving hedge funds and their investment in sub-prime mortgages, emphasizing the potential for broader financial instability. The essay aims to provide a comprehensive understanding of hedge funds, beginning with a definition and historical overview. The chapter on hedge funds examines their characteristics, including their pursuit of absolute returns, flexibility in investment, and reliance on leverage. It delves into the various strategies employed by hedge funds, including relative value, event-driven, directional, and multi-strategy approaches. The essay then explores the positive aspects of hedge funds, such as their contribution to portfolio diversification, market efficiency, and liquidity provision. It also addresses the potential negative consequences of hedge funds, including increased market volatility, the transmission of instability, and market risk.

Schlüsselwörter (Keywords)

The paper explores the complex world of hedge funds, examining their definition, history, characteristics, strategies, and impact on the financial system. Key terms and concepts include: hedge funds, absolute return, leverage, illiquidity, transparency, strategies, relative value, event driven, directional, multi-strategy, market efficiency, volatility, risk management, and financial instability.

• College: Berlin School of Economics
• Course: National and International Financial Relations
• Grade: 1,1
• Author: Daniel Detzer (Author)
• Publication Year: 2007
• Pages: 15
• Catalog Number: V118396
• ISBN (eBook): 9783640216024
• ISBN (Book): 9783640216086
• Language: English
• Tags: Hedge, Funds, National, International, Financial, Relations