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Hedge Fund
DEFINITION of 'Hedge Fund'
Hedge funds are alternative investments using pooled funds that may use a number of
different strategies in order to earn active return, or alpha, for their investors. Hedge funds
may be aggressively managed or make use of derivatives and leverage in both domestic
and international markets with the goal of generating high returns (either in an absolute
sense or over a specified market benchmark). Because hedge funds may have
low correlations with a traditional portfolio of stocks and bonds, allocating an exposure to
hedge funds can be a good diversifier.
money in the fund for at least one year, a time known as the lock-up period. Withdrawals
may also only happen at certain intervals such as quarterly or bi-annually.
t is important to note that "hedging" is actually the practice of attempting to reduce risk, but
the goal of most hedge funds is to maximize return on investment. The name is mostly
historical, as the first hedge funds tried to hedge against the downside risk of a bear market
by shorting the market. (Mutual funds generally can't enter into short positions as one of
their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't
accurate to say that hedge funds just "hedge risk." In fact, because hedge fund managers
make speculative investments, these funds can carry more risk than the overall market.
Hedge fund managers are compensated in two ways: a fee for assets under
management (AUM) and an incentive fee, which is a percentage of any profits. A
typical fee structure may be 2 and 20, where the AUM fee is 2% and the incentive fee
is 20% of profits. Often times, fee limitations such as high-water marks are employed
to prevent portfolio managers from getting paid on the same returns twice. Fee caps
may also be in place to prevent managers from taking on excess risk.
Equity market neutral: These funds attempt to identify overvalued and undervalued
equity securities while neutralizing the portfolios exposure to market risk by
combining long and short positions. Portfolios are typically structured to be market,
industry, sector, and dollar neutral, with a portfolio beta around zero. This is
accomplished by holding long and short equity positions with roughly equal exposure
to the related market or sector factors. Because many investors face constraints
relative to shorting stocks, situations of overvaluation may be slower to correct than
those of undervaluation. Because this style seeks an absolute return, the benchmark
is typically the risk-free rate. (For more, see: Getting Positive Results With MarketNeutral Funds.)
Distressed securities: Portfolios of distressed securities are invested in both the debt
and equity of companies that are in or near bankruptcy. Most investors are
not prepared for the legal difficulties and negotiations with creditors and other
claimants that are common with distressed companies. Traditional investors prefer to
transfer those risks to others when a company is in danger of default. Furthermore,
many investors are prevented from holding securities that are in default or at risk of
default. Because of the relative illiquidity of distressed debt and equity, short sales
are difficult, so most funds are long. (For more, see: Activist Hedge Funds: Follow
The Trail To Profit and Why Hedge Funds Love Distressed Debt.)
Merger arbitrage: Merger arbitrage, also called deal arbitrage, seeks to capture the
price spread between current market prices of corporate securities and their value
upon successful completion of a takeover, merger, spin-off, or similar transaction
involving more than one company. In merger arbitrage, the opportunity typically
involves buying the stock of a target company after a merger announcement and
shorting an appropriate amount of the acquiring companys stock. (See also: Trade
Takeover Stocks With Merger Arbitrage.)
Emerging markets: These funds focus on the emerging and less mature markets.
Because short selling is not permitted in most emerging markets and because
futures and options may not available, these funds tend to be long.
Fund of funds: A fund of funds (FOF) is a fund that invests in a number of underlying
hedge funds. A typical FOF invests in 1030 hedge funds, and some FOFs are even
more diversified. Although FOF investors can achieve diversification among hedge
fund managers and strategies, they have to pay two layers of fees: one to the hedge
fund manager, and the other to the manager of the FOF. FOF are typically more
accessible to individual investors and are more liquid. (For more, see: Fund of Funds:
High Society for the Little Guy.)
a forward contract can be customized to any commodity, amount and delivery date. A
forward contract settlement can occur on a cash or delivery basis. Forward contracts do not
trade on a centralized exchange and are therefore regarded as over-the-counter (OTC)
instruments. While their OTC nature makes it easier to customize terms, the lack of a
centralized clearinghouse also gives rise to a higher degree of default risk. As a result,
forward contracts are not as easily available to the retail investor as futures contracts.
being very careful in their choice of counterparty, the possibility of large-scale default does
exist.
Another risk that arises from the non-standard nature of forward contracts is that they are
only settled on the settlement date, and are not marked-to-market like futures. What if the
forward rate specified in the contract diverges widely from the spot rate at the time of
settlement? In this case, the financial institution that originated the forward contract is
exposed to a greater degree of risk in the event of default or non-settlement by the client
than if the contract were marked-to-market regularly.
DEFINITION of 'Futures'
A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset),
such as a physical commodity or a financial instrument, at a predetermined future date and
price. Futures contracts detail the quality and quantity of the underlying asset; they are
standardized to facilitate trading on a futures exchange. Some futures contracts may call for
physical delivery of the asset, while others are settled in cash. The futures markets are
characterized by the ability to use very high leverage relative to stock markets.
Futures can be used either to hedge or to speculate on the price movement of the
underlying asset. For example, a producer of corn could use futures to lock in a certain price
and reduce risk (hedge). On the other hand, anybody could speculate on the price
movement of corn by going long or short using futures.
DEFINITION of 'Option'
A financial derivative that represents a contract sold by one party (option writer) to another
party (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 (the strike price)
during a certain period of time or on a specific date (exercise date).
Call options give the option to buy at certain price, so the buyer would want the stock to go
up.
Put options give the option to sell at a certain price, so the buyer would want the stock to go
down.
In finance, an option is a contract which gives the buyer (the owner or holder) the right, but not the
obligation, to buy or sell anunderlying asset or instrument at a specified strike price on or before a
specified date. The seller has the corresponding obligation to fulfill the transaction that is to sell or
buy if the buyer (owner) "exercises" the option. An option that conveys to the owner the right
to buy something at a specific price is referred to as a call; an option that conveys the right of the
owner to sell something at a specific price is referred to as a put. Both are commonly traded, but for
clarity, the call option is more frequently discussed.
The seller may grant an option to a buyer as part of another transaction, such as a share issue or as
part of an employee incentive scheme, otherwise a buyer would pay a premium to the seller for the
option. An call option would normally be exercised only when the strike price is below the market
value of the underlaying asset at that time, while a put option would normally be exercised only when
the strike price is above the market value. When an option is exercised, the cost to the buyer of the
asset acquired is the strike price plus the premium, if any. When the option expiration date passes
without the option being exercised, then the option expires and the buyer would forfeit the premium
to the seller. In any case, the premium is income to the seller.
Long call
A trader who believes that a stock's price will increase might buy the right to purchase the stock
(a call option) at a fixed price, rather than just purchase the stock itself. He would have no obligation
to buy the stock, only the right to do so until the expiration date. If the stock price(spot Price,S) at
expiration is above the exercise price(X) by more than the premium (price) paid P, he will profit i.e. if
S-X>P, the deal is profitable. If the stock price at expiration is lower than the exercise price, he will let
the call contract expire worthless, and only lose the amount of the premium. A trader might buy the
option instead of shares, because for the same amount of money, he can control (leverage) a much
larger number of shares. For example, if exercise price is 100, premium paid is 10, then a spot price
of 100 to 110 is not profitable. He would earn profit if the spot price is above 110.
Long put[edit]
A trader who believes that a stock's price will decrease can buy the right to sell the stock at a fixed
price (a put option). He will be under no obligation to sell the stock, but has the right to do so until the
expiration date. If the stock price at expiration is below the exercise price by more than the premium
paid, he will profit. If the stock price at expiration is above the exercise price, he will let the put
contract expire worthless and only lose the premium paid. In the whole story, the premium also plays
a major role as it enhances the break-even point. For example, if exercise price is 100, premium
paid is 10, then a spot price of 100 to 90 is not profitable. He would earn profit if the spot price is
below 90.
Short call[edit]
A trader who believes that a stock price will decrease can sell the stock short or instead sell, or
"write", a call. The trader selling a call has an obligation to sell the stock to the call buyer, at the
buyer's option. If the stock price decreases, the short call position will make a profit in the amount of
the premium. If the stock price increases over the exercise price by more than the amount of the
premium, the short will lose money, with the potential loss unlimited.
Short put[edit]
A trader who believes that a stock price will increase can sell the stock or instead sell, or "write", a
put. The trader selling a put has an obligation to buy the stock from the put buyer, at the buyer's
option. If the stock price at expiration is above the exercise price, the short put position will make a
profit in the amount of the premium. If the stock price at expiration is below the exercise price by
more than the amount of the premium, the trader will lose money, with the potential loss being up to
the full value of the stock. A benchmark index for the performance of a cash-secured short put option
position is the CBOE S&P 500 PutWrite Index (ticker PUT).
DEFINITION of 'Swap'
Traditionally, the exchange of one security for another to change the maturity (bonds),
quality of issues (stocks or bonds), or because investment objectives have changed.
Recently, swaps have grown to include currency swaps and interest rate swaps.
Primary market
From Wikipedia, the free encyclopedia
The primary market is the part of the capital market that deals with issuing of new securities.
Companies, governments or public sector institutions can obtain funds through the sale of a
new stock or bond issues through primary market. This is typically done through an investment
bank or finance syndicate of securities dealers.
The process of selling new issues to investors is called underwriting. In the case of a new stock
issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price
of the security offering, though it can be found in the prospectus. Primary markets create long term
instruments through which corporate entities borrow from capital market.
Once issued the securities typically trade on a secondary market such as a stock exchange, bond
market or derivatives exchange.
Secondary market
The secondary market, also called the aftermarket, is the financial market in which previously
issued financial instruments such asstock, bonds, options, and futures are bought and sold.
[1]
Another frequent usage of "secondary market" is to refer to loans which are sold by a mortgage
bank to investors such as Fannie Mae and Freddie Mac.
A market where investors purchase securities or assets from other investors, rather than
from issuing companies themselves. The national exchanges - such as the New York Stock
Exchange and the NASDAQ are secondary markets.
Secondary markets exist for other securities as well, such as when funds, investment banks,
or entities such as Fannie Mae purchase mortgages from issuing lenders. In any secondary
market trade, the cash proceeds go to an investor rather than to the underlying
company/entity directly.
Definition: Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of
customers, which commercial banks have to hold as reserves either in cash or as deposits with the
central bank. CRR is set according to the guidelines of the central bank of a country.
Description: The amount specified as the CRR is held in cash and cash equivalents, is stored in
bank vaults or parked with the Reserve Bank of India. The aim here is to ensure that banks do not
run out of cash to meet the payment demands of their depositors. CRR is a crucial monetary policy
tool and is used for controlling money supply in an economy.
CRR and SLR are the two ratios. CRR is a cash reserve ratio and SLR is statutory liquidity ratio.
Under CRR a certain percentage of the total bank deposits has to be kept in the current account
with RBI which means banks do not have access to that much amount for any economic activity
or commercial activity. Banks cant lend the money to corporates or individual borrowers, banks
cant use that money for investment purposes. So, that CRR remains in current account and
banks dont earn anything on that.
SLR, statutory liquidity ratio is the amount of money that is invested in certain specified
securities predominantly central government and state government securities. Once again this
percentage is of the percentage of the total bank deposits available as far as the particular bank
is concerned. The SLR, the money goes into investment predominantly in the central
government securities as I mentioned earlier which means the banks earn some amount of
interest on that investment as against CRR where it earns zero.
Definition of 'Fpo'
FPO is a process by which a company, which is already listed on an exchange, issues new shares to
the investors or the existing shareholders.
Definition: FPO (Follow on Public Offer) is a process by which a company, which is already listed on
an exchange, issues new shares to the investors or the existing shareholders, usually the promoters.
This type of security is also commonly used to redirect the interest and principal payments
from the pool of mortgages to shareholders. These payments can be further broken down
into different classes of securities, depending on the riskiness of different mortgages as they
are classified under the MBS.
Wash sale
From Wikipedia, the free encyclopedia
A wash sale (not to be confused with a wash trade) is a sale of a security (stock, bonds, options) at
a loss and repurchase of the same or substantially identical security shortly before or after.[1] The
regulations around wash sales are to protect against an investor who holds an unrealized loss and
wishes to make it claimable as a tax deduction within the current tax year. The security is then
repurchased in the hope that it will recover its previous value, which would only become taxable in
some future tax year. A wash sale can take place at any time during the year. In the UK, a similar
practice which specifically takes place at the end of a calendar year, is known as Bed and
breakfasting. In a bed and breakfasting transaction, a position is sold on the last trading day of the
year (typically late in the trading session) to establish a tax loss. The same position is then
repurchased early on the first session of the new trading year, to restore the position (albeit at a
lower cost basis). The term, therefore, derives its name from the late sale and early morning
repurchase.[2]
In some tax codes, such as the USA and the UK, tax rules have been introduced to disallow the
practice, e.g., if the stock is repurchased within 30 days of its sale. The disallowed loss is added to
the basis of the newly acquired security.
For instance, this rule will be applicable if an investor sells a security X at a loss of $20 and
immediately purchases the same security or a substantially identical security within 30 days. In
this case the loss cannot be claimed and the same should be added to the cost basis of the
remaining pool of securities of X or substantially identical security (except in case of point 4
above)
Current Ratio =
Quick Ratio
Quick Ratio =
Quick Assets
---------------------Current Liabilities
Net Income
---------------------------------Average Total Assets
Net Income
-------------------------------------------Average Stockholders' Equity
Net Income
----------------Sales
Net Income
--------------------------------------------Number of Common Shares Outstanding
Sales
---------------------------Average Total Assets
Sales
----------------------------------Average Accounts Receivable
Total Liabilities
---------------------------------Total Stockholders' Equity
Cash Dividends
-------------------Net Income
Net Income
-------------- X
Sales
Sales
------------------Average Total Ass
Sale Price : It is the price you pay when you invest in a scheme and is also
called "Offer Price". It may include a sales load.
Repurchase Price : - It is the price at which a Mutual Funds repurchases its
units and it may include a back-end load. This is also called Bid Price.
Redemption Price : It is the price at which open-ended schemes repurchase
their units and close-ended schemes redeem their units on maturity. Such
prices are NAV related.
Sales Load / Front End Load : It is a charge collected by a scheme when it
sells the units. Also called, Front-end load. Schemes which do not charge a
load at the time of entry are called No Load schemes.
Repurchase / Back-end Load : It is a charge collected by a Mufual Funds
when it buys back / Repurchases the units from the unit holders.
WHAT ARE VARIOUS TYPES OF MUTUAL FUNDS :
Open ended funds are allowed to issue and redeem units any time during
the life of the scheme, but close ended funds can not issue new units except
in case of bonus or rights issue.
funds can fluctuate on daily basis (as new investors may purchase fresh
units), but that is not the case for close ended schemes. In other words we
can say that new investors can join the scheme by directly applying to the
mutual fund at applicable net asset value related prices in case of open
ended schemes but not in case of close ended schemes. In case of close
ended schemes, new investors can buy the units only from secondary
markets.
The mutual fund schemes come with various combinations of the above
categories. Therefore, we can have an Equity Fund which is open ended
and is dividend paying plan. Before you invest, you must find out what
kind of the scheme you are being asked to invest.
scheme as per your risk capacity and the regularity at which you wish to
have the dividends from such schemes
Interest rate derivatives: The underlying asset is a standard interest rate e.g. the London
Interbank offer rate, or the rate on US treasury bills. Examples of interest rate OTC derivatives
include Swaps, Swaptions, and FRAs.
Credit derivatives: The underlying is the credit quality, risk or credit event of a particular asset or
counterparty. One example is Credit Default Swaps (CDS) on fixed-income securities, which
make payments if the underlying bonds are downgraded by credit rating agencies or if the
company that issued the bonds defaults.
Commodity derivatives: The underlying are physical commodities like wheat or gold. Examples
are forwards.
Equity derivatives: The underlying are equities or an equity index. Examples: Equity swaps or
forwards
Fixed Income: The underlying are fixed income products - including mortgages