Hedge Funds

Paper Summary:

This paper explains that hedge funds, large private investment pools that are not limited by the restrictions put on other types of investment vehicles, are allowed to take short positions in securities and to concentrate their investments in a particular firm, industry or sector. The author points out that, in the case of LTCM, the basic idea was hedging: over time, the value of long-dated bonds issued a short time apart would tend to become identical, and by a series of financial transactions (essentially amounting to buying the cheaper 'off-the-run' bond and short-selling the more expensive, but more liquid, 'on-the-run' bond), it would be possible to make a profit as the difference in the value of the bonds narrowed when a new bond came on the run. The paper concludes that there is no way to hedge away all the risk, especially when tough economic times materialize; therefore, a solid capital base must be a requirement in order to weather negative economic conditions, and hedge funds must be regulated.

Table of Contents
Introduction
Background of LTCM
The Collapse of LTCM
Results of the Collapse of LTCM
The Future of LTCM and Hedge Funds
Conclusion

From the Paper:

"With regard to leverage, the LTCM Fund's balance sheet on August 31, 1998, included over $125 billion in assets. But, even using the more generous January 1, 1998, equity capital figure of $4.8 billion, this level of assets still implied a balance-sheet leverage ratio of more than
25-to-1. The extent of this leverage implied a great deal of risk. The LTCM Fund's exposure to certain market risks was several times greater than that of the trading portfolios typically held by major dealer firms. The LTCM Fund's size and leverage, as well as the trading strategies that it used, made it extraordinary vulnerable to a down turn in financial market conditions."

More papers on Hedge Funds:

• Analytical Essay # 130240 : "Hedge Funds"
• Essay # 4058 : "Marketing Hedge Funds in Europe"
• Term Paper # 98571 : "Hedge Funds and Financial Markets"

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