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Hedge Funds

Hedge Funds Assignment / Homework Help
Hedge funds are vehicles of collective investment. It can be defined as “an aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns” (www.investopedia.com).

Hedge funding is primarily aimed at reducing the risk of the investors. Though they are like mutual funds, there are some important differences between the two. Mutual funds are open to the general public investing whereas hedge funds are open typically only to institutional investors and wealthy individuals. Hedge funds have fewer regulations whereas mutual funds are highly regulated. Hedge fund managers have the advantage of engaging in leverage, short sales and heavy use of derivatives across various markets which cannot be engaged by the managers of mutual funds.

Hedge funds cannot have more than hundred investors per fund and hence they set a high minimum investment amount which opens the way only for the wealthy public. Usually the hedge funds collect a management fee plus some percentage of profit. Generally hedge funds purchase securities that appear to be underpriced relatively and sell those securities that appear to be overpriced relatively. As an example, if the yield on corporate bonds appears to be relatively higher when compared to the yield on Treasury bonds which appear to be lower, the hedge fund would short sell the treasury bonds and purchase the corporate bonds. By this way, the fund maintains a ‘hedged’ position with respect to exposure of interest rate. Irrespective of happenings to the interest rate levels, the hedge funds aim at generating profits when the yield spread returns to the normal levels and thus striving to be neutral to the market.

Hedging in Foreign exchange risk:

Foreign exchange risk can be hedged by a change in the asset and liability position in the foreign currency. This can be achieved by entering a money-market hedge, by purchasing forward or futures exchange contracts, by foreign currency options, by repositioning cash, maintaining a balance between payables and receivables etc.

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