Potential Benefits of Alternative Investments
Diversification is a well-known strategy used to improve returns and lower risk. Alternative investments manifest different characteristics and returns compared to traditional investments. Illiquidity in the underlying investments is common. A low correlation of returns with traditional investments offers opportunities…
Description of Alternative Investments
Hedge Funds Hedge funds employ strategies to offer their investors absolute returns (net of fees and taxes). These private funds are actively managed (often by “star investors”) and employ aggressive strategies across asset classes. Many will use derivatives, high leverage,…
Hedge Fund Fees
Management and Incentive Fees Hedge fund fees are usually two-fold: management fees and incentive fees. For example, a “2 and 20” fee structure bills a client 2% of funds under management as an annual fee and takes 20% of the…
Valuating and Calculating Returns on Alternative Investments
Hedge Funds Valuating and calculating returns for hedge funds include issues such as the difference between fund performance and investor performance (net-of-fees, redemption issues). The use of high leverage in hedge funds can amplify gains and losses. Investors must, therefore,…
Risk Management and Due Diligence for Alternative Investments
Due diligence for hedge fund selection includes looking at the track record (if any), investment strategies, redemption rules, and many other qualitative and quantitative factors. Private equity funds require investors to look at the track record. The investment horizon is…
Exercise Value, Time Value, and Moneyness of an Option
The exercise value, time to expiry, and price of the underlying relative to the option’s exercise price all affect the price of the option. Exercise Value of an Option The exercise value of American and European options is different because…
Derivatives – Exchange Traded & OTC
Derivatives are a class of financial instruments that derive their value from the performance of basic underlying assets. These underlying assets can be equities (stocks), fixed income instruments (bonds), currencies, or commodities traded in cash or spot markets at cash…
Forward Commitments versus Contingent Claims
Derivatives typically fall into one of two classifications, either forward commitments or contingent claims. The primary difference between the two is around obligations. Forward commitments carry an obligation to transact, whereas contingent claims confer the right to transact, but not…
Types of Derivative Contracts
There are multiple types of derivative contracts that are classified as forward commitments or contingent claims. Within the forward commitment universe, we find forward contracts, futures contracts, and swaps. On the other side of the spectrum, options (calls and puts),…
Purpose and Controversies of Derivative Markets
The primary purpose behind derivative contracts is the transfer of risk without the need to trade the underlying. This allows for more effective risk management within companies and the broader economy. In addition, the derivatives market plays a role in…
