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Case Study (Hedge fund by Imperial Capital Management) Executive Summary

Case is about a Sydney based capitalist named Thomas Wilson who started a hedge fund named Imperial Capital Management. This fund is open for all investors with an annual management fee and whose basic function is to invest funds in a range of financial assets in diversified areas while minimizing risk. Thomas is using different hedging techniques for reducing risk and sets a vision about future returns; Thomas also predicts about current scenario of economic growth and also decides to invest funds in different debt markets of bonds and common stocks. While making a view Thomas future vision is based upon one segment of Australian housing market, where he thinks that it is possible a negative growth in the future, hence makes a conclusion that economic growth will stop. While making an inference about economic growth, he concludes that Oil prices will shoot up and there is an opportunity to invest funds in oil and energy sector. Hence, Thomas decides to purchase debts of Treasury bonds and common stock in energy sector. While making a view of this case text we have to evaluate that the investment made by Imperial Capital Management in debt market of Treasury bonds and common share market of energy sector is termed ad direct or indirect securities? Also from an investor perspective, which money is invested in Imperial Capital Management is holding as direct security? An approach for solution of this case is designed in such a way that terms used in this text of case are explained in the end and their reference notes are also mentioned with hyperlinks.

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Case Study (Hedge fund by Imperial Capital Management) Case Text


Thomas Wilson is an affluent venture capitalist based in Sydney. In 2002 Thomas founded a hedge fund called imperial Capital Management. A hedge fund is an investment fund whose aim is to deliver positive returns on money invested while minimizing risk. A hedge fund can be thought of as a company whose main activity is to invest in a range of financial assets. Thomass hedge fund adopts a macro investment strategy that aims to profit from significant shifts in the economy. Apart from his own money which he uses to invest in a range of financial assts, the fund is also open to investors who can participate in the fund for an annual management fee. Although hedge funds aim at reducing risk by employing different hedging techniques, there is still a certain element of risk as there are periods where the returns on investments are negative. Thomass vision of the future is that the strong growth in the Australian housing market will come to an end, economic growth will stall and the price of oil will escalate. Thus, Thomas is currently buying Treasury bonds in the debt market and energy stocks in the share market.

Required
1. From the point of view of Imperial Capital Management, are Treasury bonds and energy stocks direct or indirect securities? Solution As Imperial Capital Management starts a hedge fund which is pooled by different investors, this pooled fund is then invested by Imperial Capital Management which is founded by Thomas. Hence Imperial Capital Management is working as financial intermediary between investor and securities purchased by this hedge fund. While taking into consideration the concept of direct or indirect investment in securities as explained in following: Imperial Capital Management is holding direct security if it purchases securities like Treasury bond and common stock in the market. During contract between corporations issuing treasury bonds, firm issuing common stock in energy sector a hedge fund of Imperial Capital Management is used hence it is a direct contract among Imperial Capital Management and corporations issuing securities. Hence as per Imperial Capital Management securities purchased in debt market of treasury bonds and in common stock market in energy sector is direct holding of securities. From the point of view of Imperial Capital Management Treasury Bonds and Energy stocks are direct securities.

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Case Study (Hedge fund by Imperial Capital Management)

2. Consider an investor who invests money in Imperial Capital Management. The money ends up being invested in treasury bonds and energy stocks. From the perspective of the investor, does she hold direct securities by investing in Imperial Capital Management? Explain. Solution If an investor who invests money in Imperial Capital Management is actually taking services of financial intermediary which is Imperial Capital Management in this case. As per investor perspective she is providing funds to Imperial Capital Management which is responsible to use risk mitigates to minimize risk and make efficient mix of portfolio by using hedge fund, so to be able to get lucrative returns. While investing funds in Treasury bond debt market or commons stock market in energy sector, it is prime responsibility of Imperial Capital Management to make strong prediction while basing facts and economic indicators. As investors have focus on management of Imperial Capital Management which strives towards positive growth of hedge fund which is pooled by investors. From investors perspective treasury bonds and common stock in energy sector is an indirect security which is actually directly traded by Imperial Capital Managements hedge fund. Hence this mix of portfolio of Imperial Capital Management is responsible for direct contract with corporations issuing these debt instruments. From the Investor perspective securities hold is indirect while making an investment in hedge fund of Imperial Capital Management.

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Case Study (Hedge fund by Imperial Capital Management) Things Learned


Hedge Fund
A hedge fund is like a mutual fund, the basic idea behind hedge fund is investment pooling. Hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. Investors buy shares in these funds, which then invest the pooled assets on their behalf. The primary aim of most hedge funds is to reduce volatility and risk while attempting to increase returns and preserve capital in all market conditions. There are certain characteristics of hedge funds few of them are explained below.
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To reduce risk hedge funds use variety of financial instruments, increase returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options. They can use short selling, leverage, derivatives such as puts, calls, options, futures, etc. Hedge funds are differentiated in terms of investment returns, volatility and risk. Many, but not all, hedge fund strategies tend to hedge against downturns in the markets being traded. Many hedge funds have as an objective and make consistent approach of returns and capital security rather than magnitude of returns. Most hedge funds are managed by experienced investment professionals who are generally disciplined and diligent and have sound knowledge of investment and portfolio management. Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns. Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage they have in their fields. Hedge funds benefit by heavily weighting hedge fund managers remuneration towards performance incentives, thus attracting the best brains in the investment business. In addition, hedge fund managers usually have their own money invested in their fund.

Reference site: http://www.magnum.com/hedgefunds/abouthedgefunds.asp

Macro Investment strategy of Hedge fund


A strategy, in which a fund manager attempts to predict vast trends in the economy and its stakes, makes findings while using his inferences. Based on these forecasts, the manager chooses investments from a wide variety of markets -- i.e. stocks, bonds, currencies & commodities. The findings are then evaluated based on certain assumptions with practical approach and certain economy trends. The approach typically involves a medium-term holding period and produces
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Case Study (Hedge fund by Imperial Capital Management)


high volatility. Many of the largest hedge funds follow global-macro strategies. They are sometimes called "macro" or "global directional-investment" funds.
Reference site: http://richard-wilson.blogspot.com/2004/08/macro-investing-strategy-hedge-fund.html

Macro Strategy Investments provides a range of actively managed, multi-asset class portfolios across the risk/return spectrum, including very conservatively, moderately and aggressively managed funds. These are available in pooled and segregated portfolios, as well as unit trusts and life funds for retail investors. Asset allocation is strengthened in the widest range of global and local asset classes not only in the broad asset class but also allocating exposure to its underlying components, such as inflationlinked bonds. These building blocks are combined into integrated portfolios, based on the relative and absolute values of the full range of global and local asset classes.
Reference site: http://www.oldmutual.co.za/corporate/asset-management/om-investment-group-%28sa%29/boutiques-andunits/macro-strategy-investments.aspx

Hedging Techniques
A wide range of hedging techniques is available to hedge funds. For example:
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Selling Short - selling shares without owning them, and making a judgment that to buy them back at a future date at a lower price in the expectation that their price will drop. Hence once sold shares at high price are again purchased at lower price. Trading Options or Derivatives - contracts whose values are based on the performance of any underlying financial asset, index or other investment. Investing in Anticipation of a Specific Event - merger transactions opportunity to make high returns while merging with lucrative fund, hostile takeover of a good security which can be in good position in the future while making efficient financial approach, exiting of bankruptcy proceedings, etc. Investing in deeply Discounted Securities - of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.

Reference site: http://www.magnum.com/hedgefunds/abouthedgefunds.asp

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Case Study (Hedge fund by Imperial Capital Management)

Treasury Bonds
These are debt instruments having treasury coupon securities issued with original maturities greater than ten years. A bond is a security that is issued in connection with a borrowing arrangement. The borrower issues (i.e. sells) a bond to the lender for some amount of cash to the investor (in our case Imperial Capital Management) with a future decided coupon (profit) rate. Although bonds usually are sold in denominations of $1000, the prices are quoted as percentage of par value. The return received on bond is normally called yield to maturity, yield is a measure of average rate of return to an investor (Imperial Capital Management) who purchases the bond for the asked price and holds the bond until its maturity date.
Reference Book: Investments (By Zvi Bodie, Alex Kane, Alan J Marcus, Pitabas Mohanty) 8th Addition Chapter 14th

Common Stock
Equity or equity securities, issued as ownership shares in a publicly held corporation. Share holders have voting rights and many receive dividend based on their proportionate ownership. A security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure. In the event of liquidation, common shareholders have rights to a company's assets only after bondholders; preferred shareholders and other debt holders have been paid in full.
Reference site: http://www.investopedia.com/terms/c/commonstock.asp#axzz1jMtxLomr

A common stock represents a small ownership piece of a company. For example, if a public company had 10 shares of common stock available and you owned 1 share, you'd basically own 10% of the company. In reality, most public companies have millions of shares. Owning some common stock in a company allows you to partake of the profits from the company via dividends. However, the company is not required to pay dividend. In fact, many major companies do not pay a dividend. As a part owner, you're also entitled to voting on company matters. Votes can be held for many reasons - such as electing people to executive positions. Owning common stocks also gives you legal rights to the assets of the company.
Reference site: http://www.beginner-investing-made-easy.com/common-stock-definition.html

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Case Study (Hedge fund by Imperial Capital Management)

Direct Security
Security, which is also known as a financial asset, is a piece of paper representing a claim on an asset which is purchased in term of security. Securities can be classified into two categories. Direct securities include stocks and bonds. If an investor who invests in a security directly without taking an option of financial intermediary is called direct security. While direct securities are valuated by discounted cash flow techniques. These discounted cash flows techniques are often used to valuate the future anticipated value of a stock or bond at present scenario.

Indirect Securities
Indirect securities include derivatives, Futures and Options. These securities are purchased by financial intermediaries like banks, brokerage houses, and financial trusts. These securities do not generate any cash flow to the investor but have fixed amount of return attached with the security; however, its value depends on the value of the underlying asset.

Reference site:

http://mba.zainbooks.com/terms/management/what-is-the-definition-of-indirect-securities.shtml

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