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OT/ Hedge Funds...need a primer

Discussion in 'Uncategorized Threads' started by recurvyarcher, Oct 14, 2008.

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  1. recurvyarcher

    recurvyarcher Well-Known Member

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    I have a very limited knowlege of Hedge Funds and how investors use them. I guess that's because I don't understand much about short selling, either.

    Can ya tell that I'm not a trader...LOL!!!

    I'm wondering if somebody that "plays" can give me a blonde-laymen's primer. KIS4SS, please.
     
  2. Buckeye

    Buckeye Member

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    Go to Wikipedia for a start.
     
  3. Hauxfan

    Hauxfan Well-Known Member

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    When someone says they have a "hedge fund"..........

    That means they are saving their money up to buy a hedge to put up........generally around their house or maybe their property line.... ;)

    Hauxfan!
     
  4. pendennis

    pendennis Well-Known Member

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    Recurvy, here's the link to Wikipedia. It provides a good, basic, description of how funds work, and their history.

    Hedge funds are very risky, high-dollar investments, and the downside risk is very substantial. Coupled with the limits on trading, you have to have a stout heart to watch hedge funds function. You also can't just dump them like a mutual fund (daily trading). You're usually in them to the end of the quarter (end of March, June, September, and December).

    Hedge fund managers usually take Rolaids and Tums by the barrel. <|:)

    Best,
    Dennis
     
  5. WNCRob

    WNCRob Member

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    More highly leveraged, less regulation. Huge fees to managers. But often quite successful. For very high net worth, knowledgeable investors who are able to absorb significant market price volatility or out right loss.

    WNCRob
     
  6. timb99

    timb99 Well-Known Member

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    Its when you save up to buy one of these little guys.
     
  7. recurvyarcher

    recurvyarcher Well-Known Member

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    Thank you for the responses.

    "More highly leveraged"... This is the kind of "investment speak" that I don't understand, and why it was difficult for me to fully understand Wikipedia.

    I read some of the Wikipedia pages late last night after a challenging day at the office. My mind was completely frazzled, but even then I can usually follow ideas, but this stuff seemed challenging to understand for some reason. I don't think the pages are written for a complete layperson.

    From what I read, short selling is used to balance the risk. When an investor chooses his "short sell", does s/he choose that with the idea that is the most likely investment to either decrease in value or have the lowest gain?

    When writing your responses, pretend like you are trying to teach a high schooler who has no investment experience, please. I am an engineer with little knowledge/experience of/in the financial trades industry.
     
  8. texasaggie2000

    texasaggie2000 Member

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    Short selling is the practice of borrowing money based in stock today, and paying it back later in stock...thus, you are betting on a decline in the price.

    For example, say that stock ABC is selling for $10 today. If I sell it short today (assume 10 shares), I sell 10 shares of ABC for $10 per share for a total of $100 today...but I did not actually own the stock...so I just got the money.

    Then, at some predetermined date, I have to replace the 10 shares that I sold...so assume that 1 month from the borrowing date, the stock price has decreased to $5 per share. In this case, I buy 10 shares at $5 per share to replace the shares I sold short a month earlier. Thus, I borrowed $100 and paid back $50, making $50 in the process.

    Inherently short selling is betting on a decline in stock prices, as an increase in the price would result in you paying back more than you "borrowed" under this arrangement.

    I have kept this simple, but that is one of the issues with our financial system, it is difficult to understand at times and has a lot of moving parts that touch a lot of other moving parts, that is why they don't touch on a lot of this in high school!

    Also, "highly leveraged" is just business speak for "up to my eyeballs in debt." Not always a bad thing in business, until times like this.
     
  9. pendennis

    pendennis Well-Known Member

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    The ability to sell short requires a margin account with funds equal to a percentage of the transaction. Right now, the margin rates on stocks are about 80%. In other words, you can't go into the market with no personal risk. The Securities and Exchange act of 1934 also requires that stocks be delivered within three days of a short sell.

    Short selling requires that the available shares actually exist for purchase. A term referred to as "naked short selling" has arisen, when there is no verification that the available shares actually exist. As of September, naked short selling was outright banned.

    There have been examples of amounts of stock equal to 30% over the total capitalization of companies being naked short sold as the company was headed into the tank. Lehman Brothers is an example of this occurence. As Lehman Brothers headed down, more short sellers got into the game, thus "piling on", and driving share prices down faster and faster. This is supposedly illegal, but is very difficult to prove. Lehman Brothers said they were "piled on", but the SEC is skeptical.

    You also get into trouble if the stock goes up in price. You have to be able to settle at the higher price. The term "margin call" means you have to replenish the difference between 80% and 100%.

    A humorous story about margins, commodities, and markets is in the movie "Trading Places", starring Eddie Murphy and Dan Ackroyd. It's somehwhat dated (1983), but shows how the markets work.

    Best,
    Dennis
     
  10. hmb

    hmb Well-Known Member

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    Don't forget the up tick rule. It used to be that you could only sell short when the stock was going up in value(uptick rule). They did away with that rule recently. This allows speculators to force the price of a stock down by short selling, like a snow ball going downhill, without the uptick rule things can get out of control. HMB
     
  11. halfmile

    halfmile Well-Known Member

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    The most important part:

    When you sit up in bed in the middle of the night with chest pains, that's a signal to liquidate the position.

    Please don't ask how I know this.

    Curvey, short means you sell something you don't have. That's why you have a short position.

    I can sell you a flat of shells for 30 bucks to be delivered in January.

    I am short (don't have) the shells.

    I have to deliver the shells, so if they cost 50 I buy them and lose 20 by delivering.

    Unless I find someone selling for 20. Then I can make 30. I sold at 50. the person I bought them from will be obligated to deliver them to you for 30.

    Clear as mud, right?

    HM
     
  12. V10

    V10 Well-Known Member

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    Devi,

    That Wiki article and the links are pretty thorough. That should give you a pretty good idea of what's going on.

    Based on your second post, one thing you might be confused on is the fact that you as an investor in a hedge fund don't have to make any of the decisions other than which fund you want to invest in and how much you want to invest. Of course you'll need a pretty high net worth (something around $10M) and the minimum investment might be something like $1M. All you would do is give that money to the fund manager and wait for your quarterly statement. :)

    That being said, you should have a knowledge of what you would be getting into. But your knowledge doesn't need to approach that of the people who are actually running the fund. (Truth be told, most of them really couldn't explain the intricacies of the some of the strategies that they use - hence our current situation.)

    On the subject of "leverage:" In finance it's analogous to mechanical leverage, i.e., using a small input to generate a larger output. "More highly leveraged" just means that their small input is controlling a larger quantity than you or I could in a brokerage margin account. In a margin account your "leverage" might be 2:1. Hedge funds might be leveraged 30:1 or better. That's "highly leveraged." And that's where the risk becomes greatly magnified. When things go their way, the returns are high, very high. When things don't go their way, they can lose everything in a matter of days.

    Much of the selling last week has been attributed to hedge funds having to liquidate due to margin calls. Typically you don't want to meet a margin call. You get a margin call when your "bet" is going the wrong way. So if you don't meet the call you have to sell your position, at whatever price you can get.

    Speaking of engineering, today's problems can basically be laid at the feet of the "financial engineers." Mathematicians, physicists, and engineers who gravitated to finance and used probability theory, calculus, and numerical methods to model risk, spreads, and trades in order to generate out-sized gains. A good book that covers this history is "A Demon of Our Own Design" by Richard Bookstaber. Bookstaber has been involved with derivatives since the early '80s.

    Here are two more books that are worth reading:

    "When Genius Failed" by Roger Lowenstein (the story of Long-Term Capital Management (LTCM), a hedge fund that failed in 1998 and was bailed out by the Fed and a collection of Wall Street banks. Sound familiar? Incidentally, when LTCM failed it was leveraged roughly 55:1)

    "Traders, Guns & Money" by Satyajit Das (a book about the "world of derivatives")

    Unfortunately there's no way that to cover this subject and it's related subjects in really plain language, so you just have to keep reading. Eventually, through shear repetition, it becomes a little more understandable.


    enjoy
     
  13. GARMASTERS

    GARMASTERS TS Member

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    I like Fiocchi primers......................
     
  14. dbcook

    dbcook TS Member

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    recurvy , i watch mad money on cnbc at 5 & 11 east coast time. the host ,jim cramer used to run a large hedge fund. one oct .he was 90 million in the red. by years end he was millions ahead. that is what i know about hedge funds. although people cuss him.i have learned a lot from him. he is an entertainer as well as a teacher. if you watch this show you can learn a lot. my advice on hedge funds is ,unless you have gazzilions of bucks & extremely knowledgeable & have access to gazzilions more,i would treat hedge funds like leprosy,the farther you stay away,the better off you will be. dwain
     
  15. ricks1

    ricks1 TS Member

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    you said layman terms hedge funds are for the multimillon airs short sell is for the gambler-if you get lucky you win. regular stocks --dont jump off the coaster cash in your pocket--priceless rick
     
  16. recurvyarcher

    recurvyarcher Well-Known Member

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    Thank you all...all of you, very much! I have a very good basic understanding now, as you have cleared things up a lot. Some of you should be good teachers!

    I would never say that a high school student would not be able to comprehend these things...they could if given a chance. I bet a lot of kids would take the course if it were taught in simple language with examples, as in your posts. Combine that with some hands-on experience (mock investing via a computer simulation...a computer game), and I bet you find some kick-a$$ little investors.

    Sooooo...

    Now I can see how hedge funds and short selling could be used as a means of attack on our economy, if someone (or a group of "someones") had been studying the market for a while.

    We are vulnerable in many ways.
     
  17. pendennis

    pendennis Well-Known Member

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    Recurvy - Markets have always acted this way. Today's occurrences are no exception. It happens when financial institutions and markets operate in "self-regulating" manners. It's why many finanical institutions have lawyers at the top, instead of financial experts. These institutions master arbitrage as a way of either skirting, or avoiding entirely, controls put in place to discourage such behavior. As profits mount, management looks for ways to further accelerate profits. No one thinks they'll get caught when things cool down.

    Regulation is always behind, exactly the same as with criminal behavior. It took over thirty years for RICO statutes to be put in place, even though organized crime acted in this manner since the turn of the twentieth century. While not comparing financial markets to organized crime, there are parallels.

    The "Roaring Twenties" was not named that for nothing. Commercial banks lent money to people to invest in a booming stock market, sure that they would be repaid. The Federal Reserve System and Treasury Department had very little in the way of regulatory powers. Today is no different from then, except the medium, mortgage-backed securities. No one expected the market to drop so precipitously then, or now.

    When the stock market crashed, people using stocks as collateral suddenly had their portfolios go in the tank. As stock prices plummeted, banks holding these loans had to revalue them downward, and suddenly didn't have enough cash to remain solvent, especially when depositors demanded their funds. People holding stocks in companies suddenly saw their wealth disappear, and banks called in what would eventually be worthless loans.

    Contrary to economic sanity, Congress then passed the Smoot-Hawley Tariff Act, which put punitive tariffs on foreign goods. As was expected, other nations retaliated with their own protective tariffs, and the world economy which was starting to grow, collapsed. Banks didn't loan money to either other banks, or individuals. The economy didn't recover until the start of World War II.

    Nothing is new in the financial markets.

    Best,
    Dennis
     
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