HoangTT_ACC710_A5.docx - To From Date Re Prof Shapiro Thanh...

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To: Prof. Shapiro From: Thanh Hoang Date: March 2, 2020 Re: Assignment No. 5 This memorandum identifies hedge fund risk, and the liquidity and solvency of risk mitigators are assessed. Liquidity refers to the ability to convert to cash, and solvency refers to the cash flow’s ability to meet long-term liabilities. (Chen, 2020; Hayes, 2019) The Federal Reserve is responsible for monitoring systemic risk but works with other regulatory agencies to contain the risk. The material events between August 1998 and August 2007 clarified the effect liquidity and credit had on hedge fund risks. Hedge fund systematic risk is inherent in the market. Systematic risk is an assumed risk that investors understand are the volatile nature of the market. (“Systematic Risk”, 2018) Since systematic risk is the aggregate of unavoidable risks, such as natural disasters or political regime changes, they can be mitigated by “ultra-safe investments” in stable securities. (“Systematic Risk”, 2018) There are no direct measures of systematic risk. (Lo, 2010, p. 97) However, it can be indirectly measured through: 1. Liquidity risk, 2. risk models for hedge funds, 3. Industry dynamics, 4. Hedge-fun liquidations, 5. Network models. (p. 98) The beta coefficient of the Treynor Ratio reflects systematic risk. (Jan, June 2019) Systematic risks can severely threaten liquidity. For example, the Argentinian default is an example of systematic risk that decreased vulture fund liquidity because these hedge funds were unable to convert any of these investments to cash. However, if a portfolio has mitigated systematic through ultra-safe investments, then the systematic risk should have little effect on solvency. On the other hand, high-risk hedge funds’ solvency is greatly affected by systemic risks as seen in August 1998 ( see the last section of this memo). The failure of hedge funds can, in themselves, be the cause of systemic risk that ripple throughout the financial system, as seen in August 2007 ( see the last section of this memo). For example, the lack of transparency of illiquidity in the Platinum Partners case caused investors to fraudulently invest which increased Platinum Partners’ leverage and credit. (Celarier, 2020) However, when the fund’s illiquid nature was revealed, the loss of fiduciary trust cast shade on other presumed short-term investments. The insolvency of Platinum Partners cost investors a collective $1.7 billion on which other components of the market were reliant that in turn took losses or collapsed. (Celarier, 2020) Hedge fund unsystematic risk is specific to the industry.

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