Expert: Gina Boykin - 9/5/2007

Question
what is a hedge fund, and why is it called that? What are the risks and rewards of them. How do you go about finding a hedge fund?

Answer
To hedge means to attempt to limit your risk in a business or investment and still maintain a reasonable return.  There are numerous hedging strategies - too many to go into here.  Here's one example, though.  Let's say you own Home Depot stock and you think that over a long period of time the company has good value and the stock will increase.  However, due to recent news/events, you expect the stock to decline.  To "hedge" the stock you own, you could enter into a separate transaction to purchase a "put option".  A put option gives you the right to SELL a stock at a certain price.  Puts increase in value if the stock goes down, because you can now sell stock at a higher price than it is worth.  Using options, derivatives, and even bonds can be considered a hedging strategy.

A hedge fund is just a company that uses a hedging strategy for its investors.

Hedge funds are ONLY open to accredited investors in the U.S.  An accredited investor is a person that has $1 Million of net worth, or who has made $200K each year for the past two years ($300K if you're married).  The reason for this limit is because most hedge funds are not registered with the S.E.C.  so they are not required to disclose a lot of information like public companies and mutual funds do.

However, individuals are not prohibited from "hedging" their own investments by using bonds, treasuries, stock options, or foreign currency.

Hedging is a pretty complicated subject.  I suggest that you visit the following websites for more information:

www.thehfa.org
http://mutualfunds.about.com/cs/hedgefunds/l/blhedgefunds.htm