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Ask Dave

How A Hedge Fund Works

What's the deal with hedge funds; what are they and how do they work?

QUESTION: Tyson wants to know what a hedge fund is, and what it is for, and how it plays into the current economic situation, in this call from September 24, 2008.

ANSWER: The term hedge fund comes from hedging your bets or hedging risk. You do that by doing the opposite of what the market is doing, or some extra risk. An example is extremely high risk mutual funds. You can’t participate unless you are very rich, because you could lose. It’s so high risk that the government wouldn’t allow an old lady to put her life savings into it.

They were the first people who were bundling together the subprime loans together and selling them as a bond. They can then sell it as a bond rather than individual mortgages. When you take many of these and put them together, that’s when it starts affecting the economy. They are the Petri dish from which this whole mess came from.