Hedge Funds

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Prateek Biyani (Querist)
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20 November 2007 What do u mean by hedge funds ? How does they affect indian stock market ? What is the crisis of Sub-mortgage (loan) crisis in US economy which has effected indian share market recently ?

R.V.RAO

R.V.RAO (Expert)
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20 November 2007 HEDGING IS PLAYING ON DIFFERENCES.
HEDGE FUNDS SIT ON WALL AND READY TO JUMP WHICH EVER EMERGING MARKETS OFFER BETTER RETURN IN THE WORLD ( BRIC MARKETS-BRAZIL-RUSSIA,INDIA,CHINA).
UNLESS ONE IS REGISTERED WITH SEBI , ONE CANNOT INVEST IN OUR STOCK MARKETS.SO THOSE WHO ARE REGD AS FII( FORIEGN INSTTUTIONAL INVESTOR) IN INDIA OFFER P.N OR PARTICIPATORY NOTES( WITH UNDERLYING STOCKS THEREIN) TO NON REGISTRANTS TO INVEST HERE.SO WHOEVER HAS PN CAN PLAY UP OUR MARKETS. THIS IS WHAT HEDGE FUNDS DO TO MAKE MONEY HERE.
BUT THE ORIGINAL INVESTMENTS MADE BY HEDGE FUNDS CAME IN FOR TROUBLE in THE WESTERN (PARTICULARLY USA MARKETS)DUE TO SUBPRIME OR SUBMORTGAGE LOANS.
THE SUBPRIME CRISIS MEANS IF A LENDER LENDS MONEY FOR HIGHER INTEREST RATES BY GREED WITHOUT BOTHERING FOR SECURITY OR MORTGAGE ,IT IS A CASE OF SUB-PRIME ( BELOW STANDARD LOANS).
IN HOUSING SECTOR MORTGAGE LOANS IN USA SUCH MANY CASES HAPPENED AND THE LENDERS INCLUDING HEDGE FUNDS WHO LENT IN MONEY THERE( DUE TO GREED AND DUE TO NOT CARING FOR SECURITY) ARE LOST ALREADY AND IN GITTERS AND THEIR ABILITY TO PUMP MONEY INTO OUR MARKETS GOT AFFECTED AND AS THERE IS NO FOREIGN INFLOW OF MONEY INTO OUR STOCK MARKETS , OUR MARKEST WENT DOWN.
( THIS IS ALSO AN EXCUSE BY SOME STOCK MARKET OPERATORS WHO EXPLOT SUCH ATMOSPHERE TO HAVE BEAR GRIP AND SEND STOCKS LOWER ,THEN BUY AT LOWER LEVELS AND THEN SELL THESE STOCKS AT HIGHER LEVELS LATER).
R.V.RAO

KAAPIL

KAAPIL (Expert)
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20 November 2007 Indian markets are affected actually by overpricing in certain scrips and phobia of let us make money fast. It is witnessing crisis due to year ending of FII. We call ourselves developed economy but still are dependent on foreign funds who are affected by various crisis.
PN criteria introduced by SEBI will affect hedge funds.

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Late CA Sampat Jain

Late CA Sampat Jain (Expert)
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20 November 2007 There is no exact definition to the term "hedge fund", it is undefined in federal or state securities laws. There is neither an industry-wide definition nor a universal meaning for "hedge fund" according to the SEC. Since hedge funds do not register with SEC, their actual data cannot be independently followed; therefore hedge fund data is self-reported. There are over 9,000 hedge funds in the U.S. today. Hedge Fund assets are estimated to manage $1.3 trillion in assets. Estimates of new assets flowing into hedge funds exceed $25 billion on average for the last few years.

The term "hedge fund" is loosely defined and does not always imply a hedging technique is being used. Hedge funds today employ all different types of strategies, and the appropriate description could simply be conveyed as “any unregistered, privately-offered, managed pool of capital for wealthy, financially sophisticated investors.” Hedge funds are usually structured as partnerships, with the general partner being the portfolio manager, making the investment decisions, and the limited partners as the investors. Hedge fund managers attempt to produce targeted returns or absolute performance, regardless of the underlying trends in the financial markets. They implement a wide array of trading strategies, from equity, fixed-income, CTA portfolios, or mathematical algorithms, however they each strive to capture market inefficiencies.

Hedge funds are subject to the same market rules and regulations as any trader. The strategies they utilize are not as easily accessible, especially for other regulated entities, such as mutual funds. To achieve this "absolute return", hedge fund managers have the flexibility to incorporate different strategies and techniques that may include:

Short-selling: Sale of a security that you do not own, with the anticipation of purchasing it in the future, at a reduced cost.

Arbitrage: Simultaneous buying and selling of a financial instrument in different markets to profit from the difference between the prices

Hedging: Buying/selling a security to offset a potential loss on an investment.

Leverage: Borrowing money for investment purposes.

Hedge funds do not afford protection for the investor, which typically applies to most registered investment products. This includes the full set of protections applicable under federal and state securities laws. Simply, you will not get the same disclosure and transparency from a hedge fund than you would from a registered product, like a mutual fund

Late CA Sampat Jain

Late CA Sampat Jain (Expert)
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20 November 2007 Subprime lending, also called B-paper, near-prime, or second chance lending, is the practice of making loans to borrowers who do not qualify for the best market interest rates because of their deficient credit history. The term also refers to paper taken on property that cannot be sold on the primary market, including loans on certain types of investment properties and certain types of self-employed individuals. Subprime lending is risky for both lenders and borrowers due to the combination of high interest rates, poor credit history, and adverse financial situations usually associated with subprime applicants. A subprime loan is offered at a rate higher than A-paper loans due to the increased risk.

Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others. The term "subprime" refers to the credit status of the borrower (being less than ideal), not the interest rate on the loan itself.

Subprime lending is highly controversial. Opponents have alleged that the subprime lending companies engage in predatory lending practices such as deliberately lending to borrowers who could never meet the terms of their loans, thus leading to default, seizure of collateral, and foreclosure. There have also been charges of mortgage discrimination on the basis of race.[1] Proponents of the subprime lending maintain that the practice extends credit to people who would otherwise not have access to the credit market.[2]

The controversy surrounding subprime lending has expanded as the result of an ongoing lending and credit crisis both in the subprime industry, and in the greater financial markets which began in the United States. This phenomenon has been described as a financial contagion which has led to a restriction on the availability of credit in world financial markets. Hundreds of thousands of borrowers have been forced to default and several major American subprime lenders have filed for bankruptcy.

Subprime lending evolved with the realization of a demand in the marketplace and businesses providing a supply to meet it. With bankruptcies and consumer proposals being widely accessible, a constantly fluctuating economic environment, and consumer debt loan on the rise, traditional lenders are more cautious and have been turning away a record number of potential customers.[citation needed] Statistically, approximately 25% of the population of the United States falls into this category (credit score < 620).[citation needed]

Since 2004, 20% of mortgages in the United States have been subprime.[citation needed]

[edit] Definition of subprime lending
While there is no official credit profile that describes a subprime borrower, most in the United States have a credit score below 620. [3]

[edit] Subprime lenders
To access this increasing market, lenders often take on risks associated with lending to people with poor credit ratings. Subprime loans are considered to carry a far greater risk for the lender due to the aforementioned credit risk characteristics of the typical subprime borrower. Lenders use a variety of methods to offset these risks. In the case of many subprime loans, this risk is offset with a higher interest rate. In the case of subprime credit cards, a subprime customer may be charged higher late fees, higher over limit fees, yearly fees, or up front fees for the card. Subprime credit card customers, unlike prime credit card customers, are generally not given a "grace period" to pay late. These late fees are then charged to the account, which may drive the customer over their credit limit, resulting in over limit fees. Thus the fees compound, resulting in higher returns for the lenders. It is plain that these increased fees compound the difficulty of the mortgage for the subprime borrower, who is defined as such by their unsuitability for credit.

[edit] Subprime borrowers
Subprime offers an opportunity for borrowers with a less than ideal credit record to gain access to credit. Borrowers may use this credit to purchase homes, or in the case of a cash out refinance, finance other forms of spending such as purchasing a car, paying for living expenses, remodeling a home, or even paying down on a high interest credit card. However, due to the risk profile of the subprime borrower, this access to credit comes at the price of higher interest rates. On a more positive note, subprime lending (and mortgages in particular), provide a method of "credit repair"; if borrowers maintain a good payment record, they should be able to to refinance back onto mainstream rates after a period of time. Credit repair usually takes twelve months to achieve; however, in the UK, most subprime mortgages have a two or three-year tie-in, and borrowers may face additional charges for replacing their mortgages before the tie-in has expired. An Independent Financial Adviser should be able to provide information about the costs of switching mortgages.

Generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:

Two or more loan payments paid past 60 days due in the last 12 months, or one or more loan payments paid past 90 days due the last 36 months;
Judgment, foreclosure, repossession, or non-payment of a loan in the prior 48 months;
Bankruptcy in the last 7 years;
Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 620 or below (depending on the product/collateral), or other bureau or proprietary scores with an equivalent default probability likelihood.

[edit] Types of subprime lending

[edit] Subprime mortgages
As with subprime lending in general, subprime mortgages are usually defined by the type of consumer to which they are made available. According to the U.S. Department of Treasury guidelines issued in 2001, "Subprime borrowers typically have weakened credit histories that include payment deliquencies, and possibly more severe problems such as charge-offs, judgments, and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, debt-to-income ratios, or other criteria that may encompass borrowers with incomplete credit histories."

In addition, many subprime mortgages have been made to borrowers who lack legal immigration status in the United States [1]

Subprime mortgage loans are riskier loans in that they are made to borrowers unable to qualify under traditional, more stringent criteria due to a limited or blemished credit history. Subprime borrowers are generally defined as individuals with limited income or having FICO credit scores below 620 on a scale that ranges from 300 to 850. Subprime mortgage loans have a much higher rate of default than prime mortgage loans and are priced based on the risk assumed by the lender.

Although most home loans do not fall into this category, subprime mortgages proliferated in the early part of the 21st Century. About 21 percent of all mortgage originations from 2004 through 2006 were subprime, up from 9 percent from 1996 through 2004, says John Lonski, chief economist for Moody's Investors Service. Subprime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market.

There are many different kinds of subprime mortgages, including:

interest-only mortgages, which allow borrowers to pay only interest for a period of time (typically 5-10 years);
“pick a payment” loans, for which borrowers choose their monthly payment (full payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan);
and initial fixed rate mortgages that quickly convert to variable rates.
This last class of mortgages has grown particularly popular among subprime lenders since the 1990s. Common lending vehicles within this group include the "2-28 loan", which offers a low initial interest rate that stays fixed for two years after which the loan resets to a higher adjustable rate for the remaining life of the loan, in this case 28 years. The new interest rate is typically set at some margin over an index, for example, 5% over a 12-month LIBOR. Variations on the "2-28" include the "3-27" and the "5-25".

[edit] Subprime credit cards
Beginning in the 1990s, credit card companies in the United States began offering subprime credit cards to borrowers with low credit scores and a history of defaults or bankruptcy. These cards usually begin with low credit limits and usually carry extremely high fees and interest rates as high as 30% or more.[4] In 2002, as economic growth in the United States slowed, the default rates for subprime credit card holders increased dramatically, and many subprime credit card issuers were forced to scale back or cease operations.[5]

Recently, starting in 2007, many new subprime credit cards have begun to sprout forth in the market. As more vendors have emerged, the market has become more competitive and issuers have now been forced to make the cards more attractive to consumers. Interest rates on subprime cards now start at 9.9% but in some cases still range up to 24% APR.

Subprime credit cards however can help a consumer improve poor credit scores. Most subprime cards report to major credit reporting agencies such as TransUnion and Equifax. Consumers that pay their bills on time should see positive reporting to these agencies within 90 days.

[edit] Proponents of subprime lending
Individuals who have experienced severe financial problems are usually labelled as higher risk and therefore have greater difficulty obtaining credit, especially for large purchases such as automobiles or real estate. These individuals may have had job loss, previous debt or marital problems, or unexpected medical issues, usually these events were unforeseen and cause a major setback in finances. As a result, late payments, charge-offs, repossessions and even foreclosures may result.

Due to these previous credit problems, these individuals may also be precluded from obtaining any type of loan for an automobile. To meet this demand, lenders have seen that a tiered pricing arrangement, one which allows these individuals to pay a higher interest rate, may allow loans which otherwise may not occur.

From a servicing standpoint, these loans have higher collection defaults and experience higher repossessions and charge offs. Lenders use the higher interest rate to offset these anticipated higher costs.

Provided a consumer will enter into this arrangement with the understanding that they are higher risk, and must make diligent efforts to pay, these loans do indeed serve those who would otherwise be underserved. The consumer must purchase an automobile which is well within their means, and carries a payment well within their budget.

[edit] Criticisms of subprime lending
Capital markets operate on the basic premise of risk versus reward. Investors taking a risk on stocks expect a higher rate of return than do investors in risk-free Treasury bills, which are backed by the full faith and credit of the United States. The same goes for loans. Less creditworthy subprime borrowers represent a riskier investment, so lenders will charge them a higher interest rate than they would charge a prime borrower for the same loan.

To avoid the initial hit of higher mortgage payments, most subprime borrowers take out adjustable-rate mortgages (or ARMs) that give them a lower initial interest rate. But with potential annual adjustments of 2% or more per year, these loans can end up charging much more. So a $500,000 loan at a 4% interest rate for 30 years equates to a payment of about $2,400 a month. But the same loan at 10% for 27 years (after the adjustable period ends) equates to a payment of $4,470. A 6-percentage-point increase in the rate caused slightly more than an 85% increase in the payment. [2]

On the other hand, interest rates on ARMs can also go down - in the US, the interest rate is tied to federal government-controlled interest rates, so when the Fed cuts rates, ARM rates go down, too. ARM interest rates usually adjust once a year, and the rate is based on an average of the federal rates over the last 12 months. Also, most ARMs limit the amount of change in a rate. [3]

The cycle of increased fees due to default-prone borrowers defaulting is a vicious cycle. Though some subprime borrowers may be able to repair their credit rating, many default and enter the vicious cycle. While this enhances the profits of the subprime lender, it also leads to further vicious cycling as the subprime lenders are unable to recover what has been lent to subprime borrowers. Hence the current subprime mortgage crisis.

[edit] Mortgage discrimination
Main article: Mortgage discrimination
Some subprime lending practices have raised concerns about mortgage discrimination on the basis of race.[1] African Americans and other minorities are being disproportionately led to sub-prime mortgages with higher interest rates than their white counterparts.[6] Even when median income levels were comparable, home buyers in minority neighborhoods were more likely to get a loan from a subprime lender.[1] Because interest rates and the availability of credit are often tied to credit scores, this may be due to a finding that "black policyholders had average credit scores that were 10% to 35% worse than those of white policyholders. Hispanics' average scores were 5% to 25% worse, while Asians' scores were roughly the same as whites" [7]

[edit] U.S. subprime mortgage crisis
This article or section contains statements that may date quickly and become unclear.
Please improve the article or discuss this issue on the talk page. This article has been tagged since August 2007.

Main article: 2007 Subprime mortgage financial crisis
Beginning in late 2006, the U.S. subprime mortgage industry entered what many observers have begun to refer to as a meltdown. A steep rise in the rate of subprime mortgage foreclosures has caused more than 100 subprime mortgage lenders to fail or file for bankruptcy, most prominently New Century Financial Corporation, previously the nation's second biggest subprime lender.[8] The failure of these companies has caused prices in the $6.5 trillion mortgage backed securities market to collapse, threatening broader impacts on the U.S. housing market and economy as a whole. The crisis is ongoing and has received considerable attention from the U.S. media and from lawmakers during the first half of 2007. [9][10]

Observers of the meltdown have cast blame widely. Some have highlighted the predatory practices of subprime lenders and the lack of effective government oversight.[11] Others have charged mortgage brokers with steering borrowers to unaffordable loans, appraisers with inflating housing values, and Wall Street investors with backing subprime mortgage securities without verifying the strength of the underlying loans. Borrowers have also been criticized for entering into loan agreements they could not meet.[12] Many accounts of the crisis also highlight the role of falling home prices since 2005. As housing prices rose from 2000 to 2005, borrowers having difficulty meeting their payments were still building equity, thus making it easier for them to refinance or sell their homes. But as home prices have weakened in many parts of the country, these strategies have become less available to subprime borrowers.[13]

Several industry experts have suggested that the crisis may soon worsen. Lewis "Lewie" Ranieri, formerly of Salomon Brothers, considered the inventor of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This is the leading edge of the storm. … If you think this is bad, imagine what it's going to be like in the middle of the crisis." [14] Echoing these concerns, consumer rights attorney Irv Ackelsberg predicted in testimony to the U.S. Senate Banking Committee that five million foreclosures may occur over the next several years as interest rates on subprime mortgages issued in 2004 and 2005 reset from the initial, lower, fixed rate to the higher, floating adjustable rate or "Adjustable rate mortgage". [15] Other experts have raised concerns that the crisis may spread to the so-called Alternative-A (Alt-A) mortgage sector, which makes loans to borrowers with better credit than subprime borrowers at not quite prime rates.[16]

Some economists, including former Federal Reserve Board chairman Alan Greenspan, have expressed concerns that the subprime mortgage crisis will affect the housing industry and even the entire U.S. economy. In such a scenario, anticipated defaults on subprime mortgages and tighter lending standards could combine to drive down home values, making homeowners feel less wealthy and thus contributing to a gradual decline in spending that weakens the economy. [17] Other economists, such as Edward Leamer, an economist with the UCLA Anderson Forecast, doubts home prices will fall dramatically because most owners won't have to sell, but still predicts home values will remain flat or slightly depressed for the next three or four years.[18]

In the UK, some commentators have predicted that the UK housing market will in fact be largely unaffected by the US subprime crisis, and have classed it as a localised phenomenon.[19] However, in September 2007 Northern Rock, the UK's fifth largest mortgage provider, had to seek emergency funding from the Bank of England, the UK's central bank as a result of problems in international credit markets attributed to the sub-prime lending crisis.

As the crisis has unfolded and predictions about it strengthening have increased, some Democratic lawmakers, such as Senators Charles Schumer, Robert Menendez, and Sherrod Brown have suggested that the U.S. government should offer funding to help troubled borrowers avoid losing their homes.[20] Some economists criticize the proposed bailout, saying it could have the effect of causing more defaults or encouraging riskier lending.

On August 15, 2007, concerns about the subprime mortgage lending industry caused a sharp drop in stocks across the Nasdaq and Dow Jones, which affected almost all the stock markets worldwide. Record lows were observed in stock market prices across the Asian and European continents[21]. The U.S. market had recovered all those losses within 2 days.

Now, the concerns are getting even worst than in August and all the recovery made by the stock markets are gone since the Fed cut interest rates by half a point (0.5%) on September 18 and by a quarter point (0.25%) on October 31. Stocks are testing their lows of August

KAAPIL

KAAPIL (Expert)
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21 November 2007 Sampat Sir has given very useful information. Also I agree with him that there is no definition of hedge fund. At the same time rules of the game in finance are diffeent every time. What is ZRed today is orange tommorrow. Keep in touch with CNBC for latest updates. Hedge Funds are fence sitters and run away in time lof crisis.