Chapter 7: 8 Flashcards
What do hedge funds hedge against?
Price risk
How do hedge funds profit?
They attempt to profit regardless of general movements of the market, by selecting a combination of asset classes.
What asset classes do hedge funds use?
- Derivatives (long and short)
What is a ‘naked’ short position?
Involves selling of shares which the fund doesn’t at that time own in hope of buying them back more cheaply if the market falls.
Why is hedge fund access restricted to wealthy investors and institutions?
They have high initial investment levels, meaning access is restricted to wealthy investors and institutions.
How else can people access hedge funds?
Through the funds of hedge funds.
What aspects are common of hedge funds?
- Structure
- High investment entry levels
- Investment flexibility
- Gearing
- Prime broker
- Liquidity
- Cost
What’s meant by structure?
Most hedge funds established as unauthorised and are unregulated CIS. Thus, cannot be generally marketed to private individuals as they’re considered too risky.
What’s the minimum initial investment for hedge funds?
Minimum £500k to £1m+.
What’s meant by investment flexibility?
Lack of regulation so can invest in whatever asset classes, e.g. long and short positions in bonds, equities, commodities, and currencies.
What investment style do hedge funds typically take?
Absolute returns.
What’s meant by absolute returns?
Positive returns regardless of the general direction of market directions.
What is gearing?
Hedge funds borrow funds and use derivatives to enhance their returns.
What is meant by prime broker?
Hedge funds buy and sell investments, borrow and entrust safekeeping of assets from one main wholesale broke - called their prime broker.
What is meant by liquidity?
To maximise investment freedom, hedge funds impose an initial ‘lock-in’ period before investors can sell on their investments.
What is the typical length of a ‘lock-in’ period?
1-3 months.
What is meant by cost?
Hedge funds levy performance related fees if certain performance levels are achieved, otherwise paying a fee comparable to that charged by other growth funds.
What is a typical performance fee?
20%+ of the ‘net new highs’/’high water mark’.
What is Private Equity?
Medium-Long-term finance, provided in return for an equity stake in a potentially high growth company.
What forms does finance take?
Providing venture capital or completing buy-outs.
What risk does private equity face?
Private equity is invested in a company and the investor’s returns are dependent on the growth and profitability of the business, thus faces risk of failure.
What is the reward for private equity?
Private equity firm is rewarded on the company’s success.
When does the private equity firm realise capital gains?
On exit.
How does a private equity firm realise capital gains?
- Selling shares back the management of the investee company.
- Selling shares to another investor, e.g. another PE company.
- A trade sale (the sale of a company’s shares to another firm).
- Company achieving a stock listing.
