As Mallaby is at pains to point out on a regular basis, hedge funds in fact have less leverage – a lot less – than banks. Many have none at all; those who do lever up tend to do so only by a factor of two or three, compared to leverage ratios in the 30 to 40 range for many investment banks and even commercial banks, in Europe.
That is Felix Salmon and there is more here.
kind of a silly comparison. a lot of the products that hedge funds hold have a lot of leverage packaged inside them. a lot of hedge funds hold a lot of swaps too, where the concept of leverage is not necessarily valid.
To illustrate babar’s point simply, think about a hedge fund that decides to go all-in on bank stocks: 35x leverage x 3x leverage = 105x leverage.
For those of us who like economics, but don’t know finance, could someone describe or point me to a primer on “leverage” and what it means in this case.
“To illustrate babar’s point simply, think about a hedge fund that decides to go all-in on bank stocks: 35x leverage x 3x leverage = 105x leverage.”
But you can only lose 3x your investment.
“To illustrate babar’s point simply, think about a hedge fund that decides to go all-in on bank stocks: 35x leverage x 3x leverage = 105x leverage.”
This is true on a macro level but the solution is to limit the bank leverage. I rather have 3x levearge x 5x leverage = 15x leverage.
Two types of risk:
(i) investing with borrowed funds. Even with a long time to repay the loan you magnify potential losses (and gains). You increase your chances of wiping out your capital if your investment strategy is bad or voatile (the more borrowing the more risk and the relationship is probably exponential).
(ii) using short term borrowing. All of the above is true, and you have the added risk that your lenders can cut off your credit in their discretion, wiping you out even if you have an otherwise good investment strategy. It’s all in “It’s a Wonderful Life.”
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