Chapter 14 – Risk, Regulation and Organizational Structure
Q1. Which two core hedge fund activities can either create incremental risk or act as a
risk mitigator?
A. Short selling and derivatives: both can be used for either speculating or hedging.
Q2. Explain the importance of hedge funds to investment banks, including revenue,
types of business, and which investment banking division is most relevant. In
addition, with which investment banking areas do hedge funds principally complete?
A. Answer: Hedge funds provide signiticant revenue for investment banks through
trading, lending and prime brokerage services. The prime brokerage area in the
Q3. Suppose a hedge fund manager buys $15 million of ABC shares on 20% margin. The
maximum allowable leverage ratio is 4.0x. The next day, unexpected negative news
about ABC is released and its stock closes down 7%. One day later, the hedge fund’s
prime broker noti$es the manager that leverage ratios now need to come down to
3.0x. What percentage of the original balance of ABC shares is le7 in the investment
fund at the end of the day a7er selling shares to comply with the new leverage
requirement? (assume the fund’s sales of ABC stock does not further depress its
share price)
A.
Q4. What are two of the key checks and balances in place to help manage the
incremental risks associated with the hedge fund industry?
A. Leverage: most banks have set limits on amount of credit exposure to any one
counterparty (or industry); much of leverage collateralized by assets. Regulation:
Q5. What are some of the major market events in the last three decades that have raised
the issue of systemic risk?
A. Asian currency crisis, 9/11, S&L crisis, Black Monday – October ’87, LTCM,
Q6. Under historical U.S. laws, when did a fund (and its advisors) need to register with
the SEC? What is the regulatory requirement under the Dodd-Frank Act?
A. Funds with >500 investors and >$10mm in equity (’34 Act); Funds with >100
investors (’40 Act) or funds with investors who are not qualified purchasers.
Advisors/managers with >$30mm AUM (unless <15 clients). U.S. hedge funds
