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.
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
- Conclusion
Objectives and Key Themes
This essay aims to explain the nature and functioning of hedge funds. It examines their origins, key characteristics, and typical strategies, culminating in an analysis of both the potential benefits and drawbacks they present to the financial landscape. * The definition and historical development of hedge funds. * Key characteristics of hedge funds, including their investment flexibility, leverage usage, and regulatory environment. * Common hedge fund strategies, such as relative value, event-driven, and directional approaches. * The positive and negative impacts of hedge funds on market dynamics, including their potential for portfolio diversification, market efficiency, and the risks they pose to stability and volatility.Chapter Summaries
The introduction highlights the recent debate surrounding hedge funds, sparked by the near-collapse of two Bear Stearns funds invested in subprime mortgage-related securities. This event underscores the potential for hedge funds to destabilize the financial system due to their interconnectedness with other financial institutions. Chapter 2 delves into the definition, history, characteristics, and strategies of hedge funds. Hedge funds are defined as private pooled investment partnerships operating outside traditional regulatory frameworks, allowing them to employ a variety of investment techniques, including leverage, short selling, and derivatives. The history of hedge funds traces back to the 1940s, with a focus on the evolution of long-short equity funds and global macro strategies. Key characteristics of hedge funds, including their absolute return target, flexibility in investment, use of leverage, and limited transparency, are explored. This chapter concludes with an overview of common hedge fund strategies, such as relative value, event-driven, directional, and multi-strategy approaches.Keywords
Hedge funds, alternative investments, absolute return, leverage, short selling, derivatives, market efficiency, financial stability, risk management, regulatory environment, portfolio diversification, subprime mortgages, CDOs, global macro strategies, relative value, event-driven, directional, multi-strategy.- Quote paper
- Daniel Detzer (Author), 2007, Characteristics, Strategies and Aspects of Hedge Funds, Munich, GRIN Verlag, https://www.grin.com/document/118396
