Hedge Funds (GUEST LECTURE)

Question 1

What is a HEDGE FUND?

Answer 1

A method of investing using pooled funds and a number of different strategies and investment techniques to generate returns.

Most commonly set up as Limited Partnerships, open to a limited number of accredited investors.

Hedge fund managers will look for ways to reduce some risk while generating returns on investments.

Typical investors are institutional investors (around 2/3), pension funds and high net worth individuals.

Question 2

How are the company and managers paid?

Answer 2

The Management company generally receive an annual fee equal to 2% of the assets in the fund and the Portfolio Manager receives 20% of the year’s profits.

Question 3

Who do fund managers need to report to?

Answer 3

Do not have to report performance numbers to anyone other than investors or disclose their holdings- very secretive about performance and strategies.

Question 4

Why choose a hedge fund?

Answer 4

• Ability to reduce risk and add diversification
• Can generate attractive returns with fixed-income-like volatility
• Hedge funds can take “short” positions to take advantage of both strengthening markets “bull market” and also weakening markets “bear markets”

Question 5

Investment strategies: EQUITY HEDGE

Answer 5

Classic long/short model identifying over and under valued securities.

Question 6

Investment strategies: GLOBAL MACRO

Answer 6

Concentrate on market trends and trade in derivatives such as currencies, futures and options.

Question 7

Investment strategies: DISTRESSED

Answer 7

Also known as Activist funds, invest in distressed or undervalued securities by buying securities at a low price and then try to turn the company around.

Question 8

Investment strategies: RELATIVE VALUE ARBITRAGE

Answer 8

Purchase of a security that is expected to appreciate, while simultaneously selling short a related security that is expected to depreciate.

Question 9

Investment strategies: EMERGING MARKETS

Answer 9

Focus on emerging and less mature markets, where investment tends to be long.

Question 10

Investment strategies: FUND OF FUNDS

Answer 10

A fund that invests in a number of underlying hedge funds.

Question 11

Investment strategies: HYBRID

Answer 11

A fund that invests in private equity (pre IPO investments) alongside other investments.

Question 12

ACTIVIST STRATEGY

Answer 12

Hedge fund manager targets and undervalued company and aims to make structural changes to the company.

The fund purchases a large stake in the target company, apply pressure- private and public.

End result:

• Replace board members
• Changing company structure
• Spin-offs
• Returning value to shareholders

Question 13

Investment Products: EQUITIES

Answer 13

Buying stock in a corporation.

Question 14

Investment Products: BONDS

Answer 14

Buying a bond, essentially lending money to government agencies for promise of repayment and fixed annual return.

Question 15

Investment Products: FUTURES

Answer 15

Contract between two parties for the sale of an asset at a particular price.

There is an agreement to buy or sell a specified commodity in a designated future month at a price agreed upon by the buyer and seller.

Involves two parties: a long holder and a short holder.

No money exchanged on initial execution of futures contract.

Question 16

Investment Products: OPTIONS

Answer 16

A contract sold by one party (option writer) to another (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (strike price) during a certain period of time or on a specific date (exercise date).

Question 17

Investment Products: SWAPS

Answer 17

Contract between two parties agreeing to trade loan terms or equity performance.

Question 18

FIXED INCOME

Answer 18

A financial instrument that yields a regular (or fixed) return.
Borrowed money in the form of debt is fixed income because the borrower had to pay interest regularly.

Question 19

EQUITY SWAP

Answer 19

A “notional product” in a sense that no physical cash is moved for the value of “underlying” asset bought or sold.

The swap provides economic exposure to an underlying equity, equity-related security, equity basket, equity index or out-performance of one equity benchmark vs. another.

Under swap agreement, two parties agree to exchange total return (or price) performance of the underlying in exchange for a stream of payments based on an interest rate.

Question 20

What factors affect the value of options?

Answer 20

• The price of the underlying asset
• The option strike price
• Time to expiry
• Volatility of the underlying asset
• Interest rates
• Dividends