Alternative Investments and the Mismanagement of Risk

In this book Dimitris N. Chorafas has uncovered the hidden risks behind alternative investments through extensive research in the US, UK, Germany, France, Italy, Scandinavia, and Switzerland. He also provides solutions to the problems identified. This book is particularly important in light of recent scandals such as Enron and WorldCom. Cover......Page 1 Contents......Page 6 Preface......Page 10 1. Introduction......Page 14 2. Alternative investments and end-investor......Page 16 3. A definition of alternative investments terminology......Page 20 4. Back to basics: Investing in the financial markets......Page 23 Regulated financial institutions and non-banks......Page 25 Classification by financial instruments......Page 26 New capital adequacy requirements......Page 27 5. The participants in alternative investments......Page 28 Don't follow the herd. You will get burned......Page 30 6. Hedge funds and the lack of regulation......Page 31 7. The role of hedge funds in alternative investments......Page 34 The impact of hedge funds on financial markets......Page 36 Every institution is exposed to mismanagement of risk......Page 38 Appendix: the dead mule and the old country farmer......Page 39 1. Introduction......Page 41 2. Identifying the risks of alternative investments......Page 43 Illiquidity and volatility magnify the risks......Page 44 Are alternative investments liquid financial products......Page 45 Liquidity, transparency, and supervision......Page 48 3. Risks resulting from diversification and from absolute returns......Page 49 4. Lies associated with liquidity, high returns, and other propaganda......Page 53 5. An interesting meeting with one of the better managed hedge funds......Page 57 6. Everything changes, including the market and its performers......Page 61 A lot of homework needed for tax liability......Page 62 A guaranteed principal is one of the options......Page 63 7. An introduction to operational risk for alternative investments......Page 64 Beware of operational risks in a sales pitch......Page 67 The need to control operational risk......Page 68 1. Introduction......Page 71 2. Deregulation and globalisation propel the alternative investments......Page 73 3. End-investor activism and legal risk......Page 75 4. Banks, special alternative investment vehicles and brand name risk......Page 78 5. No investment policy should leave aside reputational risk......Page 81 The cover-up is worse than the crime......Page 83 Risk takers can lose track of their priorities......Page 84 6. Hedge funds and credit institutions should care about legal risk......Page 86 Any alternative investment can become a drag......Page 87 Paying for legal protection......Page 88 7. The need for high technology by alternative investment vehicles......Page 89 8. Technological leadership and end-investors......Page 93 1. Introduction......Page 97 2. Alternative investments and mutual funds fatigue......Page 98 The power of big mutual funds became a negative factor......Page 100 What makes venture capital a different species......Page 101 3. Emerging companies and emerging markets......Page 103 4. Securitised subprime credit and junk bonds......Page 106 5. Private equity and unlisted securities......Page 110 6. Structured approaches offered to investors......Page 115 7. Ginnie Mae and other debt instruments......Page 118 8. Investing in CATs and superCATs......Page 120 Basic characteristics of CAT bonds......Page 121 Instruments for alternative risk transfer......Page 122 1. Introduction......Page 124 2. Hedge funds' investment policies and leveraged strategies......Page 125 Asset selection and risk management......Page 126 The difficulty of obtaining performance metrics......Page 128 3. Funds of funds: the multimanagers of hedging......Page 131 4. Some of the better hedge fund managers and their macrostrategies......Page 135 5. Examples of strategies followed by macromanagers......Page 137 6. Capital flows, macroeconomy, and 'Tidal Wave XXI'......Page 140 7. The effects of speculative capital movements......Page 143 1. Introduction......Page 148 2. A sweet and sour taste of derivatives......Page 149 3. Demodulating the notional principal amount exposure......Page 152 4. The changing pattern of derivatives trades......Page 155 5. The current huge derivatives exposure......Page 160 6. Financial institutions and their derivatives risk......Page 162 7. Risks for hedge funds dealing in derivatives......Page 164 8. Can regulators control the risks of derivatives?......Page 167 1. Introduction......Page 172 2. Assessing the claims made on behalf of alternative investments......Page 173 3. The merchandising of risk: basic facts which are important to pension funds......Page 178 4. Appreciating the risks of going retail......Page 182 5. Leveraged trades and conflicts of interest......Page 185 6. Be careful what you wish for......Page 188 7. The experience of Quantum and Tiger......Page 191 8. Promises made with alternative investments and the lack of market discipline......Page 195 1. Introduction......Page 198 2. Leverage, strategic risk, and VAR......Page 200 3. Stress tests are a culture: not a bunch of tools......Page 204 God is in the detail......Page 206 Gicero's key questions......Page 207 The Fermi principle......Page 208 Rethink the cause and effect relationship......Page 210 The challenge of nonlinearities......Page 212 5. The mindset required for historical and hypothetical stress tests......Page 213 6. Stress testing different types of risk......Page 217 The breach in the teflon of hedge funds secrecy......Page 218 Beware of mispricing......Page 219 Problems of leveraging and of personal accountability......Page 220 7. Ways and means for exercising damage control......Page 221 8. Is delta hedging and gamma hedging a solution?......Page 224 1. Introduction......Page 228 2. Alternative investments and twenty-first century risks......Page 229 Regulation and the aftermath of excessive volatility......Page 230 The issue of personal accountability......Page 232 Correlation between different types of risks......Page 233 3. As a bad precedent, LTCM is a prognosticator of 21st century failures......Page 234 A mare's nest of self-made misfortunes......Page 235 Lack of supervision leads to conflict of interest......Page 237 4. Market discipline and self-discipline......Page 239 5. The regulation of global financial institutions, hedge funds, and alternative investments......Page 243 6. Conclusion......Page 246 Acknowledgements......Page 250 Notes......Page 264 C......Page 269 G......Page 270 M......Page 271 R......Page 272 Z......Page 273 "Investors beware" is good advice in any situation, especially when dealing with the control of risk and alternative investments. Often well-known banks selling an instrument whose performance is not correlated with the equity markets can seem risk free. In this book, Chorafas has uncovered the hidden risks behind alternative investments through extensive research in the US, UK, Germany, France, Italy, Scandinavia and Switzerland. He also provides solutions to the problems identified. This book is particularly relevant in light of scandals such as Enron and WorldCom 'Investors beware' is good advice in any situation, especially when dealing with the control of risk and alternative investments. In this book Chorafas has uncovered the hidden risks behind alternative investments through extensive research in the US, UK, Germany France, Italy Scandinavia and Switzerland. He also provides solutions to the problems identified. This book is particularly important in light of recent scandals such as Enron and WorldCom.