Exam Focus

This topic explores the events that transpired in the hedge fund industry during August of 2007. Liquidity, leverage, and herding behavior played a role in die significant losses that occurred during August 7-9. For the exam, be able to discuss the impact hedge fund growth has had on performance, leverage, and risk and understand how significant hedge fund losses occurred in August of 2007.

During the week of August 6, 2007, numerous long/short hedge funds generated inexplicable losses. Subsequently, losses seemed to carry over to other hedge fund strategies. It is suggested that these losses were the result of hedge fund managers unwinding their portfolios to meet liquidity requirements. This wave of losses and unwinding then triggered another wave of de-leveraging and stop/loss trading. On Thursday, August 9, the S&P 500 lost almost 3% of its value. A sizable rebound was recorded on Friday, August 10, but a number of funds, having'already reduced their risk exposure, missed out on a portion of those gains. After the week, month-to-date losses for quantitative hedge fund strategies were in the neighborhood of -5% to -30%.

AIM 78.1: Explain how liquidity and leverage may have played a role in the sharp losses quantitative hedge funds experienced in early 2007.

AIM 78.2: Discuss the growth of hedge funds, particularly long/short equity funds, and its effect on performance, leverage and potential for greater systemic risk.

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