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Hedge fund

A hedge fund is a term used to describe any fund that isn't a conventional investment fund - that is, any fund using strategies other than investing long in bonds, equities or money markets.

The term 'hedge' is used because the firms are supposed to hedge against loss in favour of stable and reliable returns. To do this you can use a variety of strategies that link related securities.

For instance, one common hedge strategy is to buy shares of a company that is in the process of a merger and acquisition[?]. The stock of the company has an announced price that it will be worth on the date of the merger, so if the stock is currently under that value, its a safe investment to purchase it and wait. The risk is that the merger will not go through and the stock will be left at its current value.

Most of the early hedge funds did just this. They became very popular as a way of seeing gains better than the investment grade bond market, while still having low risk.

However the side effect of this popularity was to dramatically increase the interest in all of the non-standard investment strategies, and soon other funds were being set up with new strategies aimed primarily at high growth. Although there is no hedging in these cases, the term is still used for these funds as well.

Hedge funds use alternative strategies such as selling short, arbitrage, trading options or derivatives, using leverage, investing in seemingly undervalued securities, and attempting to take advantage of the spread between current market price and the ultimate purchase price in situations such as mergers. They can be extremely risky investments as illustrated by the example of Long-Term Capital Management.

In the United States, regulations by the Securities and Exchange Commission do not allow hedge funds to be offered to the general public and the funds are limited to purchases by qualified investors[?], whose investment is more than US$100,000, or who have total incomes of over US$200,000 per year or a net worth of over US$1,000,000.

See also: Derivatives market



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