Hedge Funds background information

From CUP resources:

What is it?

A hedge fund is an investment fund which uses high-risk investment techniques. Many other investment funds are regulated in order to protect investors from severe risks, but because hedge funds have only a small number of large investors, they are not subject to the usual restrictions. High-risk techniques such as short-selling (i.e. selling assets before you’ve actually bought them, in expectation of a lower price later) and leverage (i.e. using the money put into the fund by investors to borrow much larger sums of money) allow hedge funds to generate excellent profits during good times, but may have disastrous consequences during a crisis.

Ironically, the verb ‘to hedge’ means to reduce or manage risks by focusing on several alternative options, as in the idiom “to hedge one’s bets”. Many hedge funds do in fact hedge their risks by making several diverse investments, although such diversity may not be enough to protect them when the whole economy is struggling.

Why was the term in the news?

A prominent Wall Street hedge fund run was at the centre of a huge fraud scandal. Prosecutors allege that the fund made fraudulent losses of $50 billion, and was merely a Ponzi scheme, which pays earlier investors out of money invested by later clients. Many of the scheme’s alleged victims are themselves hedge funds.

More generally, hedge funds have been particularly badly hit by the current economic crisis, with many making huge losses which their investors never thought possible.

How can I use it in class?

Discussion:

Elicit from the class if any students have experience of hedge funds, and what they know about them. Discuss whether high-risk, high-profit investment is something to encourage or to fear.

Research and presentation:

If students are unfamiliar with the expression, they could research aspects of hedge funds (e.g. short selling, leverage, hedging one’s investments, regulation of investment funds, etc.) as a homework task (e.g. on Wikipedia and newspaper articles), followed by mini-presentations of their findings in class.

Class debate:

Divide the class into two teams. One should argue in favour of unregulated hedge funds; the other should argue that the disadvantages outweigh the advantages.

Role play:

Members of the class play the roles of members of a wealthy family planning how to invest their billions during the current financial crisis. Options include property (real estate), regulated investment funds, hedge funds, shares in banks or other companies, etc. If they decide to invest in a hedge fund, by what criteria should they choose the best fund?

Where can I read about it?

• Top investors 'hit by $50bn con', BBC, 13th December 2008. 
• Private equity must self-regulate or suffer from 'indiscriminate' rethink, EU commissioner warns, Guardian, 11th December 2008.
• Hedge funds 'facing credit storm', BBC, 28th October 2008.
• Hedge fund (excellent introduction to Hedge Funds), Wikipedia.