By Dimitris N. Chorafas (auth.)
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Extra resources for Alternative Investments and the Mismanagement of Risk
Call option on stock, foreign currency, or interest rate contracts (premium paid up front): Covered option Naked option Yes Yes Yes Yes 5. Loan commitments: Fixed rate Variable rate Yes Yes Yes Yes 6. Interest rate caps Yes Yes 7. Interest rate floors Yes Yes 8. Financial Guarantees Yes Yes 9. Note issuance facilities at floating rates 10. Letters of credit and standby letters of credit at floating rates a Yes Yes Yes Yes Market risk Yes Yes Yes Yes Yes Issuers refer to both the trust and the sponsor.
The bold letters of this statement are a warning against taking high risks. A different reviewer agreed with the message in this text about the risks in general – lack of transparency, problems with valuation, and so on. He added, however, that most hedge funds instruments are bought by professional investors, institutions and high net worth people and ‘it is quite clear that funds of funds put together by banks, SAIVs etc. ’ Leaving aside the fact that alternative investments are now marketed retail, it is wrong to assume that professional investors have a first class Alternative Investments Defined 25 risk management system.
LTCM had a leverage of 350 when it crashed. Even if this is an extreme value, the fact it can be done did not get lost among hedge funds. Neither is there a ‘best’ leverage figure. Every hedge fund makes its own decision on that matter. The rule is that the higher the gearing, the greater the amount of assumed risk. Indeed the reviewer himself reached this conclusion when he stated: Markets are markets. They are difficult things to read, no matter what “expert” you claim to be. We should not damn the hedge funds industry particularly for failing to read the markets.
Alternative Investments and the Mismanagement of Risk by Dimitris N. Chorafas (auth.)