May 26, 2006

Hedge Fund and Financial Stability

There is no ambiguity that investors are looking for huge success for hedge fund business. However, the recent rout in financial markets has sparked talk of possible hedge fund failures. It might pose threat to financial stability. In the past fortnight, European stocks have tumbled more than 10 percent. In the Asian market, Indian shares have taken a downward turn with the BSE Sensex losing 1100 points in a day's trading.

Emerging market currencies are also encountering the same problem. The most important that is doing round is could a hedge fund collapse? There is also a suspicion whether the financial market could withstand the hedge fund collapse or not. Experts did not rule out this possibility. They believe that the biggest risk lies with the hedge fund counterparties.

What are Counterparties?

Counterparties include brokers and bank's prime brokerage divisions. They act as custodians and offer settlement services. They also lend money to hedge funds so that they can leverage up their investments. If hedge funds lose the money, the primary broker also loses money.

Emerging Markets

Emerging markets can be liquid at times of turmoil. Most emerging market hedge funds usually buy, sell and leverage to make bigger investments. If the derivatives markets are not well developed, they might pose problems for hedge funds, but they will not pose any problem for financial stability.

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