A hedge fund is a pooled investment fund that holds liquid assets and that makes use of complex trading and risk management techniques to improve investment performance and insulate returns from market risk. Among these portfolio techniques are short selling and the use of leverage and derivative instruments. In the United States, financial regulations require that hedge funds be marketed only to institutional investors and high-net-worth individuals.
A Ponzi scheme is a form of fraud that lures investors and pays profits to earlier investors with funds from more recent investors. Named after Italian businessman Charles Ponzi, this type of scheme misleads investors by either falsely suggesting that profits are derived from legitimate business activities, or by exaggerating the extent and profitability of the legitimate business activities, leveraging new investments to fabricate or supplement these profits. A Ponzi scheme can maintain the illusion of a sustainable business as long as investors continue to contribute new funds, and as long as most of the investors do not demand full repayment or lose faith in the non-existent assets they are purported to own.
In finance, speculation is the purchase of an asset with the hope that it will become more valuable shortly. It can also refer to short sales in which the speculator hopes for a decline in value.
An index fund is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that it can replicate the performance ("track") of a specified basket of underlying investments. While index providers often emphasize that they are for-profit organizations, index providers have the ability to act as "reluctant regulators" when determining which companies are suitable for an index. Those rules may include tracking prominent indexes like the S&P 500 or the Dow Jones Industrial Average or implementation rules, such as tax-management, tracking error minimization, large block trading or patient/flexible trading strategies that allow for greater tracking error but lower market impact costs. Index funds may also have rules that screen for social and sustainable criteria.
Investment banking pertains to certain activities of a financial services company or a corporate division that engages in providing advisory-based services on financial transactions for clients, such as institutional investors, corporations, and governments. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by underwriting or acting as the client's agent in the issuance of debt or equity securities. An investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities, FICC services or research. Most investment banks maintain prime brokerage and asset management departments in conjunction with their investment research businesses. As an industry, it is broken up into the Bulge Bracket, Middle Market, and boutique market.
The 2003 mutual fund scandal was the result of the discovery of illegal late trading and market timing practices on the part of certain hedge fund and mutual fund companies.
Paul Adolph Volcker Jr. was an American economist who served as the 12th chairman of the Federal Reserve from 1979 to 1987. During his tenure as chairman, Volcker was widely credited with having ended the high levels of inflation seen in the United States throughout the 1970s and early 1980s, with measures known as the Volcker shock. He previously served as the president of the Federal Reserve Bank of New York from 1975 to 1979.
Financial services are economic services tied to finance provided by financial institutions. Financial services encompass a broad range of service sector activities, especially as concerns financial management and consumer finance.
Proprietary trading occurs when a trader trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money to make a profit for itself. Proprietary trading can create potential conflicts of interest such as insider trading and front running.
Prime brokerage is the generic term for a bundled package of services offered by investment banks, wealth management firms, and securities dealers to hedge funds which need the ability to borrow securities and cash in order to be able to invest on a netted basis and achieve an absolute return. The prime broker provides a centralized securities clearing facility for the hedge fund so the hedge fund's collateral requirements are netted across all deals handled by the prime broker. These two features are advantageous to their clients.
Front running, also known as tailgating, is the practice of entering into an equity (stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security. In essence, it means the practice of engaging in a personal or proprietary securities transaction in advance of a transaction in the same security for a client's account. Front running is considered a form of market manipulation in many markets. Cases typically involve individual brokers or brokerage firms trading stock in and out of undisclosed, unmonitored accounts of relatives or confederates. Institutional and individual investors may also commit a front running violation when they are privy to inside information. A front running firm either buys for its own account before filling customer buy orders that drive up the price, or sells for its own account before filling customer sell orders that drive down the price. Front running is prohibited since the front-runner profits come from nonpublic information, at the expense of its own customers, the block trade, or the public market.
Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of computers relative to human traders. In the twenty-first century, algorithmic trading has been gaining traction with both retail and institutional traders. A study in 2019 showed that around 92% of trading in the Forex market was performed by trading algorithms rather than humans.
A commodity broker is a firm or an individual who executes orders to buy or sell commodity contracts on behalf of the clients and charges them a commission. A firm or individual who trades for his own account is called a trader. Commodity contracts include futures, options, and similar financial derivatives. Clients who trade commodity contracts are either hedgers using the derivatives markets to manage risk, or speculators who are willing to assume that risk from hedgers in hopes of a profit.
Direct market access (DMA) is a term used in financial markets to describe electronic trading facilities that give investors wishing to trade in financial instruments a way to interact with the order book of an exchange. Normally, trading on the order book is restricted to broker-dealers and market making firms that are members of the exchange. Using DMA, investment companies and other private traders use the information technology infrastructure of sell side firms such as investment banks and the market access that those firms possess, but control the way a trading transaction is managed themselves rather than passing the order over to the broker's own in-house traders for execution. Today, DMA is often combined with algorithmic trading giving access to many different trading strategies. Certain forms of DMA, most notably "sponsored access", have raised substantial regulatory concerns because of the possibility of a malfunction by an investor to cause widespread market disruption.
In finance, a dark pool is a private forum for trading securities, derivatives, and other financial instruments. Liquidity on these markets is called dark pool liquidity. The bulk of dark pool trades represent large trades by financial institutions that are offered away from public exchanges like the New York Stock Exchange and the NASDAQ, so that such trades remain confidential and outside the purview of the general investing public. The fragmentation of electronic trading platforms has allowed dark pools to be created, and they are normally accessed through crossing networks or directly among market participants via private contractual arrangements. Generally, dark pools are not available to the public, but in some cases, they may be accessed indirectly by retail investors and traders via retail brokers.
A synthetic CDO is a variation of a CDO that generally uses credit default swaps and other derivatives to obtain its investment goals. As such, it is a complex derivative financial security sometimes described as a bet on the performance of other mortgage products, rather than a real mortgage security. The value and payment stream of a synthetic CDO is derived not from cash assets, like mortgages or credit card payments – as in the case of a regular or "cash" CDO—but from premiums paying for credit default swap "insurance" on the possibility of default of some defined set of "reference" securities—based on cash assets. The insurance-buying "counterparties" may own the "reference" securities and be managing the risk of their default, or may be speculators who've calculated that the securities will default.
The Volcker Rule is § 619 of the Dodd–Frank Wall Street Reform and Consumer Protection Act. The rule was originally proposed by American economist and former United States Federal Reserve Chairman Paul Volcker in 2010 to restrict United States banks from making certain kinds of speculative investments that do not benefit their customers but not implemented until July 2015. Volcker argued that such speculative activity played a key role in the 2007–2008 financial crisis. The rule is often referred to as a ban on proprietary trading by commercial banks, whereby deposits are used to trade on the bank's own accounts, although a number of exceptions to this ban were included in the Dodd–Frank law.
In April and May 2012, large trading losses occurred at JPMorgan's Chief Investment Office, based on transactions booked through its London branch. The unit was run by Chief Investment Officer Ina Drew, who later stepped down. A series of derivative transactions involving credit default swaps (CDS) were entered, reportedly as part of the bank's "hedging" strategy. Trader Bruno Iksil, nicknamed the London Whale, accumulated outsized CDS positions in the market. An estimated trading loss of $2 billion was announced. However, the loss amounted to more than $6 billion for JPMorgan Chase.
There have been several efforts or appeals in the United States to reinstate repealed sections of the Glass–Steagall Act following the financial crisis of 2007-08, as well as elsewhere to adopt similar financial reforms.
Securities market participants in the United States include corporations and governments issuing securities, persons and corporations buying and selling a security, the broker-dealers and exchanges which facilitate such trading, banks which safe keep assets, and regulators who monitor the markets' activities. Investors buy and sell through broker-dealers and have their assets retained by either their executing broker-dealer, a custodian bank or a prime broker. These transactions take place in the environment of equity and equity options exchanges, regulated by the U.S. Securities and Exchange Commission (SEC), or derivative exchanges, regulated by the Commodity Futures Trading Commission (CFTC). For transactions involving stocks and bonds, transfer agents assure that the ownership in each transaction is properly assigned to and held on behalf of each investor.
