Prop traders move to hedge funds
In the most basic sense, arbitrage is defined as taking advantage of a price discrepancy through the purchase or sale of certain combinations of securities to lock in a market-neutral profit. The trade will remain subject to various non-market risks, such as settlement risk and other operational risks.
Investment banks, which are often active in many markets around the world, constantly watch for arbitrage opportunities. One of the more-notable areas of arbitrage, called risk arbitrage or merger arbitrage, evolved in the s. When a company plans to buy another company, often the share price of the buyer falls because the buyer will have to pay money to buy the other company and the share price of the purchased company rises because the buyer usually buys those shares at a price higher than the current price.
When an investment bank believes a buyout is imminent, it often sells short the shares of the buyer betting that the price will go down and buys the shares of the company being acquired betting the price will go up.
There are a number of ways in which proprietary trading can create conflicts of interest between a bank's interests and those of its customers. As investment banks are key figures in mergers and acquisitions, it is possible though prohibited for traders to use inside information to engage in merger arbitrage. Investment banks are required to have a Chinese wall separating their trading and investment banking divisions; however, in recent years, especially since the Enron scandal , these have come under closer scrutiny.
One example of an alleged conflict of interest can be found in charges brought by the Australian Securities and Investment Commission against Citigroup in Famous proprietary traders have included Ivan Boesky , Steven A. Some of the investment banks most historically associated with trading were Salomon Brothers and Drexel Burnham Lambert. Trader Nick Leeson took down Barings Bank with unauthorized proprietary positions. Another trader, Brian Hunter , brought down the hedge fund Amaranth Advisors when his massive positions in natural gas futures went bad.
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Arbitrage pricing theory Assets under management Black—Scholes model Greeks finance: Vulture funds Family offices Financial endowments Fund of hedge funds High-net-worth individual Institutional investors Insurance companies Investment banks Merchant banks Pension funds Sovereign wealth funds.
Fund governance Hedge Fund Standards Board. Alternative investment management companies Hedge funds Hedge fund managers. Primary market Secondary market Third market Fourth market.
Common stock Golden share Preferred stock Restricted stock Tracking stock. Authorised capital Issued shares Shares outstanding Treasury stock. Most are highly successful former traders or fund managers who've decided to go it alone with a hedge fund career.
The name 'hedge fund' comes from the idea that money managers can hedge their bets to ensure they make money - whether the market goes up or down. One method of making money in a falling market is through so-called, 'short-selling. When the price hopefully falls, they buy the stock back at the lower price and return it to the lender. Hedge funds typically fall into one of several categories, depending upon their investment strategy. Global macro funds funds focused on global trends rather than movements in particular stocks ; event driven funds funds that attempt to profit from one-off events such as mergers and acquisitions or bankruptcies ; or relative arbitrage funds funds that aim to exploit differences in prices for the same products.
A relative arbitrage fund would buy where it's cheaper and simultaneously sell where it's more expensive. Because hedge funds are considered risky, investors can also put their money into 'funds of hedge funds'. These invest money across several different hedge funds with the intention of spreading the risk. Various hedge fund jobs are listed under this sector, including analysis analysing the companies, markets and financial products a hedge fund invests in ; sales and marketing and investor relations liaising with investors and helping sell the merits of the fund.
Hedge fund traders are often pure execution traders, who operate largely according to an analyst's recommendations. Hedge funds also employ an array of people to work in risk and in functions like HR and compliance in order to help their business operate effectively. Many hedge funds are based in Switzerland, particularly in Zurich.
London's Mayfair area is a centre for hedge fund recruitment in the UK. And Singapore is a growing hedge fund centre in Asia. As the hedge fund industry has grown, it has become more open to institutional investors.