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Financial Risk Manager Handbook + Test Bank: FRM Part I / Part II, 6th Edition by Philippe Jorion

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Chapter 30

Hedge Fund Risk Management*

The first hedge fund was started by A. W. Jones in 1949. Unlike the typical equity mutual fund, the fund took long and short positions in equities. Over the subsequent decades, the hedge fund industry has undergone exponential growth. As of December 2009, hedge funds accounted for more than $1,600 billion in equity capital, called assets under management (AUM).

Hedge funds are organized as private partnerships and as a result differ in a number of essential ways from mutual funds. They provide more flexible investment opportunities and are less regulated. They have very few limitations on their investment strategies. In particular, they can take long and short positions in various markets and can use leverage. Due to this leverage, the assets they control are greater than their AUMs. Hedge funds have become an important force in financial markets, accounting for the bulk of trading in some markets.

Unlike mutual funds, which are open to any investor, hedge funds are accessible only to accredited investors, perhaps due to their perceived risks. To control their risk, most hedge funds have adopted risk controls using position-based, value at risk (VAR)-type techniques. Because some types of hedge fund strategies are very similar to those of proprietary trading desks of commercial banks, it was only natural for hedge funds to adopt similar risk management tools.

The purpose of this chapter is to provide an overview of risk management for the ...

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