Question

Explain the role of the hedge funds in 2008 Global Crisis.

Answer 1

Apart from Big investment banks hedge funds are one of the causes who added too much risk to the financial system.

Theoretically hedge funds should be able to find such discrepancies that happened in financial market in 2008, but their aggressive nature to gain profit and wrong interpretation of the market paid a big price.

Some of the factors that caused this are listed below

• Use of leverage by hedge funds make them purchase assets that is more than their total worth and they agressively sold options to eat up the premiums . This made a significant loss when market bubble was bursted
• They hold 10% of total shares of US market and adds up major volume during daily transactions. They also actively participated in MBS buying as well as short selling. Many hedge funds had significant portion of short positions which made many aware about the financial situation of MBS and CDOs
• Hedge funds withdrawed billions of dollars from prime brokers and investment thinking that their assets could be frozen if the banks declared bankruptcy which destabilized the markets
• They are highly unregulated and public has lack of information on their operations and the margin limit provided by the companies. Especially in a crisis hedge funds can sell in bulk which if unregulated can lead to big panic and crash of the market.