Hedge funds get their name from the practice of “hedging”: using securities or investment strategies to ensure that one investment’s gain counteracts another investment’s loss. Modern hedge funds, however, have evolved from conservative portfolios of investments to highly speculative, highly volatile global funds.
Most hedge funds make a profit by borrowing enormous amounts of money to pay for speculative investments-usually in parts of world economy that banks and other traditional investors shy away from. Hedge funds have become so big that the U.S Federal Reserve has had to step in, on occasion, to bail them out.
In the late 1990s, for example. The collapse of Long-Term Capital Management’s hedge fund threatened to upset the global banks and securities houses had loaned the hedge fund enormous amounts of money-and probably wasn’t going to get their money back. Some Hedge funds, however, have had spectacular success investing in such areas as Russian currency markets, oil prices, or yield differentials between different kinds of U.S Treasury bonds.
Hedge funds can earn billions, or lose billions, overnight –often through the use of computer models that oversee a complex web of interrelated investments. By borrowing large amounts of money, hedge funds can invest in a wide variety of bonds, commodities, currencies, and stock markets around the world- always attempting to “beat the market.” When speculators are all moving in one direction, often a hedge fund will step in to exploit discrepancies in the market and take “bets” on a different direction for the markets.