Hedge Fund

The term hedge fund is used to indicate a 'hedge' against investment deterioration. Hedge fund can be defined as a managed portfolio that has targeted a specific return goal regardless of market conditions. Hedge funds specialize in gaining maximum returns for minimum risk. Hedge funds use a wide variety of different investing strategies to achieve this goal and generally these strategies are managed and executed by a portfolio manager.

Strategies that can be used by the portfolio manager of a hedge fund include short selling, arbitrage, hedging and leverage. The portfolio manager uses these options to remain flexible and weather the various storms of the market.

Short selling means borrowing a security (or commodity futures contract) from a broker and selling it, with the understanding that it must later be bought back (hopefully at a lower price) and returned to the broker. Short selling (or "selling short") is a technique used by investors who try to profit from the falling price of a stock.

Arbitrage means attempting to profit by exploiting price differences of identical or similar financial instruments, on different markets or in different forms.

Hedging is the practice of offsetting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. A long hedge involves buying futures contracts to protect against possible increase in prices of commodities. A short hedge involves selling futures contracts to protect against possible decline in prices of commodities.

Leverage is the use of borrowed funds at a fixed rate of interest in an effort to boost the rate of return from an investment. Increased leverage causes the risk and return on an investment to also increase.