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1.
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Definition
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Market
risk is the risk that the value of an investment will decrease due
to moves in market factors.
Volatility frequently refers to the standard deviation of the change
in value of a financial instrument with a specific time horizon. It
is often used to quantify the risk of the instrument over that time
period. Volatility is typically expressed in annualized terms, and
it may either be an absolute number ($5) or a fraction of the
initial value (5%).
Other Resources:
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Commerce Capital Markets:
The chance that a security's value will decline. With
fixed income securities, market risk is closely tied to interest
rate risk--as interest rates rise, prices decline and vice
versa.
More…
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Key.com:
Also
called systematic risk. The portion of a security's risk common
to all securities in the same asset class, and that cannot be
eliminated through diversification.
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Stanlake Search:
The sensitivity of the market value of a portfolio to changes in
financial asset prices such as: interest rates, foreign exchange
rates, equity prices, and commodity prices.
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HSBC:
The risk to stocks, bonds and other financial instruments
resulting from a decline in the market.
More…
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Reliance Mutual Fund:
The risk that the price of a security will rise or fall
due to changing economic, political, or market conditions, or
due to a company's individual situation.
More…
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2.
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Examples, Types, or
Variations
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The four standard market risk factors include:
Sometimes,
a fifth risk factors is also considered:
Equity
index risk, or the risk that stock or other index
prices will change adversely.
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3.
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Formula
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Market
risk is typically measured using a Value at Risk methodology. Value
at risk is well established as a risk management technique, but it
contains a number of limiting assumptions that constrain its
accuracy. The first assumption is that the composition of the
portfolio measured remains unchanged over the single period of the
model. For short time horizons, this limiting assumption is often
regarded as acceptable. For longer time horizons, many of the
transactions in the portfolio may mature during the modeling period.
Intervening cash flow, embedded options, changes in floating rate
interest rates, and so on are ignored in this single period modeling
technique.
Market risk can also be contrasted with Specific risk, which
measures the risk of a decrease in ones investment due to a change
in a specific industry or sector, as opposed to a market-wide move.
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4.
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Related Terms
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Beta
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Diversification
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Systematic Risk
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Unsystematic Risk
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Equity Risk
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Currency Risk
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Portfolio Theory
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Portfolio Insurance
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Credit Risk
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Commodity Risk
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Legal Risk
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Liquidity Risk
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Operational Risk
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Volatility
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5.
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As
Used in the Hedge Fund World
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Hedge
fund managers argue that performance fees help to align the
interests of manager and investor better than flat fees that are
payable even when performance is poor. However, performance fees
have been criticized by many people including notable investor
Warren Buffett for giving managers an incentive to take risk,
possibly excessive risk, as opposed to high long-term returns. In an
attempt to control these problems, fees are usually limited by high
water marks and sometimes by hurdle rates.
Other Resources:
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Financial Engineering
Associates:
Recent experience has clearly shown that measurement and
management of extreme event and tail risk is paramount for hedge
funds. Traditional market risk management applications rely on
risk estimation methodologies only suitable for normal market
conditions, and risk managers play a limited role in the risk
measurement process.
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6.
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Applications
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In the
United States, a section on market risk is mandated by the SEC in
all annual reports submitted on Form 10-K. The company must detail
how its own results may depend directly on financial markets. This
is designed to show, for example, an investor who believes he is
investing in a normal milk company, that the company is in fact also
carrying out non-dairy activities such as investing in complex
derivatives or foreign exchange futures.
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7.
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Misused
& Abused
see:
due diligence
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8.
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Additional Sources of Information
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Books
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News
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Scholarly Papers
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Back to Terms
| HEDGE FUND RISK AND OTHER
DISCLOSURES |
Hedge funds, including fund of funds (“Hedge
Funds”), are unregistered private investment partnerships, funds or
pools that may invest and trade in many different markets,
strategies and instruments (including securities, non-securities and
derivatives) and are NOT subject to the same regulatory requirements
as mutual funds, including mutual fund requirements to provide
certain periodic and standardized pricing and valuation information
to investors. There are substantial risks in investing in Hedge
Funds. Persons interested in investing in Hedge Funds should
carefully note the following:
- Hedge Funds represent speculative investments and involve a
high degree of risk. An investor could lose all or a substantial
portion of his/her investment. Investors must have the financial
ability, sophistication/experience and willingness to bear the
risks of an investment in a Hedge Fund.
- An investment in a Hedge Fund should be discretionary capital
set aside strictly for speculative purposes.
- An investment in a Hedge Fund is not suitable or desirable for
all investors. Only qualified eligible investors may invest in
Hedge Funds.
- Hedge Fund offering documents are not reviewed or approved by
federal or state regulators
- Hedge Funds may be leveraged (including highly leveraged) and
a Hedge Fund’s performance may be volatile
- An investment in a Hedge Fund may be illiquid and there may be
significant restrictions on transferring interests in a Hedge
Fund. There is no secondary market for an investor’s investment in
a Hedge Fund and none is expected to develop.
- A Hedge Fund may have little or no operating history or
performance and may use hypothetical or pro forma performance
which may not reflect actual trading done by the manager or
advisor and should be reviewed carefully. Investors should not
place undue reliance on hypothetical or pro forma performance.
- A Hedge Fund’s manager or advisor has total trading authority
over the Hedge Fund.
- A Hedge Fund may use a single advisor or employ a single
strategy, which could mean a lack of diversification and higher
risk.
- A Hedge Fund (for example, a fund of funds) and its managers
or advisors may rely on the trading expertise and experience of
third-party managers or advisors, the identity of which may not be
disclosed to investors
- A Hedge Fund may involve a complex tax structure, which should
be reviewed carefully.
- A Hedge Fund may involve structures or strategies that may
cause delays in important tax information being sent to investors.
- A Hedge Fund may provide no transparency regarding its
underlying investments (including sub-funds in a fund of funds
structure) to investors. If this is the case, there will be no way
for an investor to monitor the specific investments made by the
Hedge Fund or, in a fund of funds structure, to know whether the
sub-fund investments are consistent with the Hedge Fund’s
investment strategy or risk levels.
- A Hedge Fund may execute a substantial portion of trades on
foreign exchanges or over-the-counter markets, which could mean
higher risk.
- A Hedge Fund’s fees and expenses-which may be substantial
regardless of any positive return- will offset the Hedge Fund’s
trading profits. In a fund of funds or similar structure, fees are
generally charged at the fund as well as the sub-fund levels;
therefore fees charged investors will be higher that those charged
if the investor invested directly in the sub-fund(s).
- Hedge Funds are not required to provide periodic pricing or
valuation information to investors.
- Hedge Funds and their managers/advisors may be subject to
various conflicts of interest.
The above general
summary is not a complete list of the risks and other important
disclosures involved in investing in Hedge Funds and, with respect
to any particular Hedge Fund, is subject to the more complete and
specific disclosures contained in such Hedge Fund’s respective
offering documents. Before making any investment, an investor should
thoroughly review a Hedge Fund’s offering documents with the
investor’s financial, legal and tax advisor to determine whether an
investment in the Hedge Fund is suitable for the investor in light
of the investor’s investment objectives, financial circumstances and
tax situation.
All performance information is believed
to be net of applicable fees unless otherwise specifically noted. No
representation is made that any fund will or is likely to achieve
its objectives or that any investor will or is likely to achieve
results comparable to those shown or will make any profit at all or
will be able to avoid incurring substantial losses. Past performance
is not necessarily indicative, and is no guarantee, of future
results.
The information on the Site is intended for
informational, educational and research purposes only. Nothing on
this Site is intended to be, nor should it be construed or used as,
financial, legal, tax or investment advice, be an opinion of the
appropriateness or suitability of an investment, or intended to be
an offer, or the solicitation of any offer, to buy or sell any
security or an endorsement or inducement to invest with any fund or
fund manager. No such offer or solicitation may be made prior to the
delivery of appropriate offering documents to qualified investors.
Before making any investment, you should thoroughly review the
particular fund’s confidential offering documents with your
financial, legal and tax advisor and conduct such due diligence as
you (and they) deem appropriate. We do not provide investment advice
and no information or material on the Site is to be relied upon for
the purpose of making investment or other decisions. Accordingly, we
assume no responsibility or liability for a ny investment decisions
or advice, treatment, or services rendered by any investor or any
person or entity mentioned, featured on or linked to the Site.
The information on this Site is as of the date(s) indicated,
is not a complete description of any fund, and is subject to the
more complete disclosures and terms and conditions contained in a
particular fund's offering documents, which may be obtained directly
from the fund. Certain of the information, including investment
returns, valuations, fund targets and strategies, has been supplied
by the funds or their agents, and other third parties, and although
believed to be reliable, has not been independently verified and its
completeness and accuracy cannot be guaranteed. No warranty, express
or implied, representation or guarantee is made as to the accuracy,
validity, timeliness, completeness or suitability of this
information.
Any indices and other financial benchmarks
shown are provided for illustrative purposes only, are unmanaged,
reflect reinvestment of income and dividends and do not reflect the
impact of advisory fees. Investors cannot invest directly in an
index. Comparisons to indexes have limitations because indexes have
volatility and other material characteristics that may differ from a
particular hedge fund. For example, a hedge fund may typically hold
substantially fewer securities than are contained in an index.
Indices also may contain securities or types of securities that are
not comparable to those traded by a hedge fund. Therefore, a hedge
fund’s performance may differ substantially from the performance of
an index. Because of these differences, indexes should not be relied
upon as an accurate measure of comparison.
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