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Level 85

Investing in Hedge Funds


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hedge funds
broad group of invest. vehicles pursuing wide variety of inv. strategies
difference hedge funds vs mutual funds
hedge funds less regulated, less disclosure, fewer restrictions
arbitrage based
hedge fund strategies
arbitraged based strategy
profit from security mispricing
convertible bond arbitrage strategy
long convertible bond & short underlying equity
equity market neutral strategy
hedge market exposure (beta neutral)
event driven strategy
distressed debt funds
merger arbitrage
risk arbitrage strategy
fixed income arbitrage strategy
long lower credit bond, short higher quality
medium volatility strategy
long & short positions in securities
global macro strategy
bets based on expectations of specific markets and asset classes
long short equity strategy
flexibility to adjust beta
managed futures strategy
quant model to speculate in futures
multistrategy
employ a combination of strategies
directional
bets based on expectations of movements
dedicated short bias strategy
beta close to negative 1
emerging markets
short selling restrictions, limited avail. derivatives
equal weighting indices
performance of an average fund
size-weighted indices
performance of hedge fund industry
for which funds is survivorship bias lower?
funds of funds, asset weighted indices, investible indices
negative skewness, high kurtosis
how is the return distribution of hedge funds?
positive skewness, low kurtosis
what type of return distribution do investors prefer?
short volatility strategies
short options, merger arbitrage, fixed income arbitrage
long volatility strategies
long options, managed futures
types of replicating strategies
static: factor exposures estimated using regression analysis
funds of funds
intermediary funds that invest in a portfolio of hedge funds
advantages of funds of funds
due diligence, diversification, lower minimum inv
disadvantage of funds of funds
additional layer of fees (1% mgmt fee + 10% performance fee)
outperform bottom hedge fund
performance of funds of funds
Market neutral
Goal: offset risk with opposite positions in pairs of securities
High water mark
Manager only gets performance fees when fund value is higher than its previous highest value.
Returns earned high enough to provide reasonable return
Why do hedge fund investors willingly pay high fees?
Why do hedge fund investors willingly pay high fees?
Hedge fund net returns around same as overall stock market return
Low
expected volatility of market neutral
arbitrage
when an investor simultaneously buys something at some price in one market and seek to sell it for a higher price in another market
Distressed securities
Goal: buy securities that are being offered at deep discounts resulting from company-specific or sector-wide distress
Low to moderate
Expected volatility of distressed securities
Macro
Goal: Attempt to profit from changes in global economies brought about by govt. policies that affect interest rates, currencies, or commodity prices.
high
expected volatility of macro
short selling
goal: managers of a pure hf of this kind only short sell
Market timing
Goal: Managers of these HFs attempt to identify trends in particular sectors or overall global markets
Fund of funds
Additional and significant layer of fees on top of the already hefty fees to begin with.