In this chapter, we will discuss the various options available to credit hedge funds to use leverage as part of their investment program. The practice of using leverage to enhance the return from various asset classes is a feature that has been popular with many investors in hedge funds. If one of the attractive features of a hedge fund structure is greater flexibility in the use of leverage, it is prudent to understand how this flexibility works not just in good but also in difficult times.
When asset prices fall, many investors are aware that the leverage will magnify the losses. However, that is not the only risk inherent in leverage. Whether the investor obtains leverage via explicit borrowing or through inherently levered ...