What is the meaning of hedge fund and how they are worked in bulls and bare market?

Answer 1

a hedge fund is an investment fund where the fund manager will use a derivative such as a futures contract to lock in the value of it's securities. this is primarily used for funds valued in foreign currency, the fund manager will hedge the fund back to the currency of it country of origin. For example Canadian fund manager A has 1000 shares of American company ABC currently trading at $10 dollars a share for his US Equity fund. Assuming that the value of the shares didn't change, (unlikely) the primary concern will be exchange rate to convert Cdn dollars to US dollars and back again. The fund manager can make a contract with another investor (fund manager B) to exchange the currency at a given price. So in our example will say the 2 currencies are trading at par but fund manager A think the the Cdn dollar will drop in price compared to the US so he makes a contract with manager B to exchange $10,000 (1000 shares x $10 a share) at $0.95 meaning he would end up with $9500. if the value of the Cdn dollar dropped below $0.95 US (as in a cdn Bear Market) He is safe because he is guaranteed the $0.95. If however the cdn dollar were to shoot up to say $1.10 US, manager has lost out on the growth because he is obligated to sell his money at the $0.95. hope that makes sense.

AnswerHedge funds are mutual funds for the rich.

There are two differences between hedges and mutuals: the investors allowed to participate, and the kinds of investments they can hold. Mutual funds can be open to anyone who has enough money to buy shares, but in exchange they're only allowed to hold long positions on stocks.

Hedge funds are allowed to accept a limited pool of "accredited investors," who are people or trust funds who have millions of dollars. IIRC about seven percent of all Americans qualify to play in the hedge market. In exchange for dealing only with people who can afford to lose their ass over a hedge investment gone bad, these funds can buy into basically anything they want, including short positions on stocks, selling naked calls, junk bonds...you could PROBABLY establish a hedge fund to make massive bets on horse races.

The "hedging" part comes in because the paper the funds buy is so speculative. My least favorite investment, as you guys may be aware, is the naked call. It is insanely risky--let's say I am shorting Acme shares. If it's at $10 and I think Acme's going to be at $5 next month because the Coyote is suing them, I could sell a naked call for 100,000 of Acme at $6 with a premium of $3. If I'm right, I make $300,000 by keeping the premium. If I'm wrong and the stock goes to $25 because the Coyote lost, I am supremely screwed. I would therefore hedge this by purchasing a naked call on 50,000 shares. This way, I'm only half as screwed if I blow the call.