Alpha

# Alpha

**Category:** quantitative-methods · **Level:** intro

**Summary:** The excess return of a portfolio over a benchmark or risk-model expectation, attributed to manager skill rather than market exposure.

**Definition:** Alpha (α) is the intercept term in a regression of portfolio returns on factor returns. Operationally, it is the residual return that is not explained by the portfolio's exposure to systematic risk factors (beta to the market, size, value, momentum, etc.). A positive alpha implies the manager generated return beyond what passive exposure to those factors would predict; a negative alpha implies the opposite. Alpha is fragile — it shrinks as more factors are added to the model and as a strategy is replicated.

**Intuition:** Imagine you bet on horses and consistently beat the odds set by the bookies. Your edge is alpha. Beta, by contrast, is just betting at the odds — you might still win, but only because the favorites won.

**In practice:** Allocators rarely accept gross alpha at face value. They decompose it into factor alpha, strategy alpha, and style alpha, then haircut for capacity, crowding, and decay. A 'real' alpha is one that survives a Fama-French 5-factor regression and persists across regimes.

**Example:** A long/short equity fund returns 12% in a year. The benchmark (S&P 500) returns 10%. The fund has a beta of 0.4 to the market. Risk-free rate is 4%. α = R_p − [R_f + β(R_m − R_f)] = 12% − [4% + 0.4 × (10% − 4%)] = 12% − 6.4% = 5.6% → 5.6% Jensen's alpha. The fund earned 5.6 percentage points above what its market exposure justified.

**Pitfalls:** • Confusing total return with alpha — much of what looks like alpha is undisclosed beta to alternative risk factors. • Computing alpha on a too-short window (< 3 years) where it is dominated by noise. • Ignoring fees — gross alpha minus 2/20 often turns negative.


Beta

# Beta

**Category:** quantitative-methods · **Level:** intro

**Summary:** The sensitivity of an asset's return to a benchmark's return — the slope of a regression of asset returns on market returns.

**Definition:** Beta (β) measures systematic risk. A β of 1.0 implies the asset moves in lockstep with the benchmark; β of 2.0 implies it amplifies benchmark moves 2×; β of 0 implies independence; β of −1 implies it moves equal-and-opposite. In CAPM, β is the only priced risk: investors demand a premium proportional to β over the risk-free rate. Hedge funds are often marketed as 'low-β' or 'market-neutral' (β ≈ 0).

**Intuition:** Beta is the rope tying you to the boat. A high-β stock yanks you when the boat moves; a low-β stock barely tugs.

**In practice:** Beta is unstable. A stock's β shifts with leverage, sector rotation, and volatility regime. Fund-level β is computed rolling (typically 36-month) and can be decomposed by sector or factor.

**Example:** A stock has a covariance of 0.018 with the S&P 500. The S&P 500 has a variance of 0.012. β = Cov(R_i, R_m) / Var(R_m) = 0.018 / 0.012 = 1.5 → β = 1.5. The stock is expected to move 1.5% for every 1% move in the market.

**Pitfalls:** • Treating beta as constant — it changes regime by regime. • Confusing accounting beta with market beta. • Assuming low-β = low risk; idiosyncratic risk is invisible to β.


Sharpe Ratio

# Sharpe Ratio

**Category:** quantitative-methods · **Level:** intro

**Summary:** Risk-adjusted return: excess return per unit of total volatility. Sharpe = (R_p − R_f) / σ_p.

**Definition:** Defined by William Sharpe (1966), the Sharpe ratio is excess return over the risk-free rate divided by the standard deviation of excess returns. It is the single most quoted performance number in hedge funds. A Sharpe > 1 is acceptable; > 2 is institutional; > 3 over a long window is rare and merits scrutiny for return-smoothing or hidden tail risk.

**Intuition:** How much pain (volatility) did you suffer per dollar of reward (return)? Higher is better.

**In practice:** Annualize by multiplying monthly Sharpe by √12, daily by √252. Use the same return frequency for numerator and denominator. Always specify the window — Sharpe over 12 months is dominated by luck. Be wary of monthly-marked illiquid books; their reported σ is artificially low and Sharpe artificially high.

**Example:** A fund has monthly excess returns averaging 0.7% with a monthly standard deviation of 1.5%. Monthly Sharpe = 0.7% / 1.5% = 0.467. Annualized = 0.467 × √12 = 1.62 → Annualized Sharpe ≈ 1.62 — a respectable institutional-grade number.

**Pitfalls:** • Comparing Sharpe ratios across different frequencies without annualizing. • Trusting Sharpe > 3 without checking liquidity, return autocorrelation, and tail risk. • Ignoring that Sharpe penalizes upside volatility — use Sortino or Omega for skewed strategies.


Sortino Ratio

# Sortino Ratio

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** A Sharpe variant that divides excess return only by downside deviation, rewarding upside volatility.

**Definition:** The Sortino ratio replaces total standard deviation with downside deviation — the standard deviation of returns below a target (usually zero or the risk-free rate). It corrects Sharpe's blindness to skew: a strategy with frequent small wins and rare large losses can have an attractive Sharpe but a poor Sortino. Conversely, a long-vol strategy with occasional large gains will look better under Sortino than Sharpe.

**Intuition:** Volatility on the way up isn't risk — it's reward. Sortino only counts the volatility of losses.

**Example:** Same fund as Sharpe example, but the downside-only standard deviation is 0.9% per month. Monthly Sortino = 0.7% / 0.9% = 0.778. Annualized ≈ 2.69 → Sortino ≈ 2.69 — meaningfully higher than Sharpe because the fund's volatility is asymmetric (mostly upside).


Calmar Ratio

# Calmar Ratio

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Annualized return divided by absolute value of maximum drawdown over the same period.

**Definition:** The Calmar ratio (Terry Young, 1991) penalizes large drawdowns rather than volatility. It speaks to investors who care less about wiggles and more about peak-to-trough pain. Typical institutional thresholds: > 0.5 acceptable, > 1.0 strong, > 3.0 elite-and-suspect. Computed over rolling 36-month windows by convention.

**Intuition:** How much annual return did you earn for each percentage point of worst-case loss?

**Example:** A fund returns 14% annualized over 5 years with a max drawdown of 8%. Calmar = 14% / 8% = 1.75 → Calmar = 1.75 — strong on a drawdown-adjusted basis.


Information Ratio

# Information Ratio

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Active return over benchmark divided by tracking error — the Sharpe of relative performance.

**Definition:** The information ratio (IR) measures the consistency with which a manager beats a benchmark, scaled by the volatility of that outperformance. IR = (R_p − R_b) / σ(R_p − R_b). It is the standard metric for benchmarked managers (long-only equity, smart-beta, factor funds). Grinold's 'fundamental law of active management' decomposes IR into IC × √breadth, where IC is the per-bet information coefficient and breadth is the number of independent bets per year.

**Intuition:** Skill (IC) times opportunity (breadth) equals information ratio. A weak signal applied across thousands of names can beat a strong signal on a few.


Treynor Ratio

# Treynor Ratio

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Excess return per unit of systematic risk: (R_p − R_f) / β.

**Definition:** Like Sharpe but uses beta in the denominator instead of total volatility. Appropriate for diversified portfolios where idiosyncratic risk has been diversified away — only systematic risk remains. Less useful for concentrated hedge fund books.


Omega Ratio

# Omega Ratio

**Category:** quantitative-methods · **Level:** advanced

**Summary:** Probability-weighted ratio of gains versus losses above and below a threshold return.

**Definition:** Ω(τ) = ∫_τ^∞ (1 − F(r)) dr / ∫_{-∞}^τ F(r) dr, where F is the cumulative distribution of returns and τ is a target. Unlike Sharpe and Sortino, Omega uses the entire return distribution — it is not blind to higher moments. Omega(0%) > 1 means more probability-weighted gain than loss above zero.


Maximum Drawdown

# Maximum Drawdown

**Category:** risk-management · **Level:** intro

**Summary:** The largest peak-to-trough percentage decline in NAV over a specified window.

**Definition:** MDD = max over t,s≤t of (NAV_s − NAV_t) / NAV_s. It is the single most psychologically meaningful risk measure: investors redeem on drawdowns, not on volatility. A 50% drawdown requires a 100% gain to recover, so MDD asymmetry is severe. Hedge funds typically report MDD over the strategy's full life, plus rolling 12- and 36-month windows.

**Intuition:** Worst pain ever felt. The number that triggers redemptions and ends careers.

**In practice:** Allocators model 'time to recovery' alongside MDD: a 15% drawdown that recovers in 3 months is acceptable; the same 15% that takes 3 years is fatal.

**Example:** Fund NAV path: 100 → 110 → 130 → 100 → 120 → 95 → 140 Peaks: 130 then 120. Trough after 130 is 95. (95 − 130)/130 = −26.9% → MDD = 26.9%


Ulcer Index

# Ulcer Index

**Category:** risk-management · **Level:** advanced

**Summary:** Quadratic-mean of percentage drawdowns from running highs — captures depth and duration of pain.

**Definition:** UI = √(Σ D_t² / N), where D_t is the percentage drawdown from the running high at time t. Unlike MDD which is a single point, the Ulcer Index integrates over the entire drawdown experience. Peter Martin (1987) named it for the gastric distress investors feel during prolonged underwater periods.


Value at Risk (VaR)

# Value at Risk (VaR)
_(VaR)_

**Category:** risk-management · **Level:** intermediate

**Summary:** The loss threshold that will not be exceeded with a specified probability over a specified horizon.

**Definition:** 1-day 99% VaR of $10m means: 'On 99 of 100 trading days, we expect to lose less than $10m.' VaR is computed three ways: (1) parametric (assume normal returns, use σ × Z-score), (2) historical (read the percentile off actual return history), (3) Monte Carlo (simulate from a fitted distribution). All three are coherent only under restrictive assumptions; none captures tail dependence well. VaR's most cited critique: it tells you nothing about *how bad* the 1% looks. That's where Expected Shortfall steps in.

**Intuition:** On a 'normal bad day', this is the most you should lose. On an abnormal bad day, all bets are off.

**Example:** Portfolio value $100m, daily volatility 1.2%, normal distribution assumed, 99% confidence. VaR_99 = $100m × 1.2% × 2.326 = $2.79m → 1-day 99% VaR ≈ $2.79m

**Pitfalls:** • Treating VaR as a worst-case loss — it is explicitly NOT the worst case. • Using a normal distribution for fat-tailed return series. • Ignoring that VaR is not subadditive — it can violate diversification logic.


Expected Shortfall

# Expected Shortfall
_(ES / CVaR)_

**Category:** risk-management · **Level:** advanced

**Summary:** Average loss in the worst α% of cases — the conditional expectation of loss given that loss exceeds VaR.

**Definition:** ES_α = E[L | L > VaR_α]. Unlike VaR, ES is coherent (subadditive) and sensitive to tail shape. Basel III FRTB replaced VaR with ES at the 97.5% level for market risk capital. For a normal distribution at the 99% level, ES ≈ 1.146 × VaR.


Stress Test

# Stress Test

**Category:** risk-management · **Level:** intermediate

**Summary:** Re-pricing the book under hypothetical or historical shock scenarios to estimate tail loss.

**Definition:** Stress tests bypass distributional assumptions and ask 'what if?' Common scenarios: (1) historical replays — Oct 1987, Aug 1998 LTCM, Sep 2008 Lehman, Feb 2018 Volmageddon, March 2020 COVID, Sep 2022 UK gilts. (2) hypothetical — rates +200bp, oil −50%, USD/JPY +10%. (3) reverse stress — find the smallest shock that breaches a survival threshold. Regulators (Form PF, AIFMD) require regular stress reporting.


Two-and-Twenty

# Two-and-Twenty

**Category:** fund-operations · **Level:** intro

**Summary:** The classic hedge fund fee structure: 2% annual management fee plus 20% of profits above a hurdle.

**Definition:** Originated with A.W. Jones in 1949 (who took 20% but no management fee, mirroring 16th-century Phoenician sea-captain shares). Standard for decades, now under sustained pressure: industry-average effective fees by 2025 sat closer to 1.4 / 17. Multi-strat pod shops use 'pass-through' expense structures that often exceed 2/20 in absolute cost. The 20% is typically subject to a high-water mark and sometimes a hurdle rate.

**Intuition:** Two cents on the dollar each year just for showing up. Twenty cents on every dollar of profit you make.

**In practice:** Allocators negotiate fees down via founder share classes (1/10), seed deals (revenue share), and capacity rights. Pod shops counter with pass-through fees that may run 5-8% all-in but produce uncorrelated 12-15% net returns.


High-Water Mark

# High-Water Mark
_(HWM)_

**Category:** fund-operations · **Level:** intro

**Summary:** The highest NAV per share an investor's capital has ever reached, above which performance fees may again be charged.

**Definition:** Performance fees are charged only on NAV increases above the investor's HWM. After a drawdown, the manager must first earn back to the HWM before any further incentive fee accrues. HWMs are typically computed per investor (or per contribution lot) and per share class. After deep drawdowns, HWMs become unattainable and PMs/teams often spin off to reset them — 'HWM washout' is a common cause of fund closures post-crisis.


Hurdle Rate

# Hurdle Rate

**Category:** fund-operations · **Level:** intro

**Summary:** A minimum return that must be achieved before performance fees accrue.

**Definition:** Two flavors: (1) hard hurdle — performance fees only on returns above the hurdle (e.g., return = 12%, hurdle = 6%, fee on 6%); (2) soft hurdle with catch-up — once the hurdle is cleared, performance fee applies to the entire return. Hurdles are commonly set at the risk-free rate, T-bills + a spread, or a benchmark index. Increasingly common in private credit, infrastructure, and 2020s vintage hedge funds raising in a high-rate world.


Crystallisation

# Crystallisation

**Category:** fund-operations · **Level:** intermediate

**Summary:** The point at which accrued performance fees become payable to the manager and the high-water mark resets.

**Definition:** Most hedge funds crystallise annually (Dec 31), but quarterly and monthly crystallisations exist for higher-frequency vehicles. Once crystallised, the performance fee leaves investor capital permanently — even a subsequent drawdown does not claw it back. This mechanic is a key source of GP–LP friction in volatile years.


Net Asset Value

# Net Asset Value
_(NAV)_

**Category:** accounting-valuation · **Level:** intro

**Summary:** Total fund assets minus liabilities, divided by units outstanding — the per-share value of the fund.

**Definition:** NAV is struck by the fund administrator on each valuation date (monthly is standard; weekly or daily for liquid strategies). It uses the fair-value hierarchy (Level 1: quoted prices, Level 2: observable inputs, Level 3: model-based). NAV drives subscriptions, redemptions, performance fees, and investor reporting. NAV manipulation — typically via Level 3 mark stuffing — has been the proximate cause of multiple high-profile blowups.


Side Pocket

# Side Pocket

**Category:** fund-operations · **Level:** intermediate

**Summary:** A separate accounting bucket within a hedge fund holding illiquid or hard-to-value investments, segregated from the main NAV.

**Definition:** When a position becomes illiquid (e.g., delisted, restricted, in litigation), it can be moved to a side pocket. New investors do not participate; existing investors hold their pro-rata share until realization. Side pockets prevent stale-mark dilution between subscribers and redeemers. They proliferated during 2008 — by mid-2009 over 20% of hedge fund assets sat in side pockets — and have since been governed more tightly by SEC guidance and offering documents.


Gate

# Gate

**Category:** fund-operations · **Level:** intermediate

**Summary:** A redemption restriction limiting the percentage of the fund that may be withdrawn on any single redemption date.

**Definition:** Two main types: (1) investor-level gate — caps each LP's redemption at, say, 25% of their stake per quarter; (2) fund-level gate — caps total redemptions at, say, 10% of fund AUM per quarter, pro-rated across redemption requests. Gates protect remaining LPs from a fire-sale that would crystallize losses. Gating is a powerful but reputationally costly tool — once a fund gates, expectations are reset and brand value rarely recovers fully.


Lock-up

# Lock-up

**Category:** fund-operations · **Level:** intro

**Summary:** A period during which an investor cannot redeem capital from the fund.

**Definition:** Hard lock-up: no redemptions permitted; soft lock-up: redemptions permitted with a fee (typically 2–5%) that is returned to the fund. Standard hedge fund lock-ups are 1 year; activist and credit funds run 2–5 years; PE-style hybrids 5–10 years. Founder share classes often offer lower fees in exchange for longer lock-ups. Lock-ups help managers run higher gross exposure without forced-selling risk.


Side Letter

# Side Letter

**Category:** fund-operations · **Level:** intermediate

**Summary:** A bilateral agreement between the fund and a specific investor granting bespoke terms not in the LPA.

**Definition:** Common side-letter terms: most-favored-nation (MFN), fee discounts, capacity rights, additional reporting (transparency, position-level), shorter notice/lock-up, reduced redemption fees, key-person provisions. The MFN is the central feature — when one LP gets a better term, MFN'd LPs receive it automatically. SEC Rule 206(4)-8 prohibits side letters that materially disadvantage other investors.


Master-Feeder

# Master-Feeder

**Category:** fund-operations · **Level:** intermediate

**Summary:** Two or more feeder funds in different jurisdictions that pool assets in a single master fund where trading actually occurs.

**Definition:** Standard structure: (1) Onshore feeder — Delaware LP, for US taxable investors; (2) Offshore feeder — Cayman Ltd, for US tax-exempt and non-US investors; (3) Master — Cayman Ltd, where assets are held and trades booked. Each feeder owns shares of the master proportional to its capital. The structure achieves tax neutrality (US LPs get K-1s, offshore investors get blocker treatment), avoids UBTI for tax-exempts, and allows a single trading book.


Fund of Funds

# Fund of Funds
_(FoF)_

**Category:** fund-operations · **Level:** intro

**Summary:** A fund that allocates to a portfolio of underlying hedge funds rather than trading directly.

**Definition:** FoFs offer diversification, manager-selection expertise, and (for smaller LPs) access to capacity-constrained funds. They charge an additional fee layer (historically 1/10 on top of underlying 2/20). The post-2008 era saw mass FoF redemptions; the model survives in OCIO, retirement, and emerging-manager seeding contexts. Modern variants: 'multi-manager' (single-shop pod platform like Citadel/Millennium/Point72) which is the structural successor to traditional FoF.


Prime Broker

# Prime Broker

**Category:** fund-operations · **Level:** intro

**Summary:** A bank that provides hedge funds with execution, financing, securities lending, custody, and reporting under one roof.

**Definition:** Core services: (1) execution & DMA, (2) margin financing for long positions, (3) securities lending for short positions, (4) custody, (5) consolidated reporting (the 'PB report'). Top-tier PBs in 2026: Goldman, Morgan Stanley, JPMorgan, BofA, Barclays, UBS. Funds typically run 2–4 PBs to diversify counterparty risk after Lehman 2008, when hundreds of funds had assets frozen at Lehman International (London Rule 7).


Long/Short Equity

# Long/Short Equity

**Category:** hedge-fund-strategies · **Level:** intro

**Summary:** A strategy that holds long positions in expected outperformers and short positions in expected underperformers.

**Definition:** Originating with A.W. Jones (1949), L/S equity is the prototypical hedge fund strategy. Net exposure varies from market-neutral (≈0%) to directional (60–80% net long). Gross exposure typically 150–300%. Alpha sources: stock-picking, sector rotation, timing of net exposure. The strategy's beta is tunable: the manager chooses how much market risk to retain. ~30% of global hedge fund AUM in 2026 follows some L/S equity variant.


Market Neutral

# Market Neutral

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** A long/short strategy structured so that net market beta is approximately zero.

**Definition:** Three main flavors: (1) dollar-neutral (long $ = short $); (2) beta-neutral (Σ β_long w_long = Σ β_short w_short); (3) factor-neutral (additional constraints to zero out exposure to size, value, momentum, sector). Returns come from idiosyncratic stock selection, not from market direction. Modern multi-manager pods almost always run beta-neutral and increasingly factor-neutral.


Merger Arbitrage

# Merger Arbitrage

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** Capturing the spread between an announced acquisition price and the target's market price by going long the target (and short the acquirer in stock deals).

**Definition:** Cash deal: long target only. Stock deal: long target, short acquirer in the announced exchange ratio. P&L = deal price − purchase price, less hedge cost, less the probability-weighted loss if the deal breaks. Skill is in handicapping break risk: regulatory (HSR, FTC, EU, CFIUS, NSIA in UK), shareholder vote, financing condition, MAC clauses. 2024–2026 saw deal-break volatility spike on antitrust scrutiny under FTC Khan and EU Vestager 2.0.


Convertible Arbitrage

# Convertible Arbitrage

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** Long the convertible bond, short the underlying stock in delta-equivalent quantity, harvesting gamma, vega, and credit spread carry.

**Definition:** A convertible bond decomposes into a straight bond plus a long equity call. Convert arbs hedge the equity component (delta-hedging the embedded call) and isolate exposures to: (1) realized vs implied volatility (vega), (2) credit spread tightening, (3) gamma scalping income, (4) bond floor. The strategy nearly died in 2008 when forced deleveraging crushed the asset class, then recovered as new issuance returned. Capacity: limited by issuance pace (~$80–120bn/yr globally).


Global Macro

# Global Macro

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** Top-down directional and relative-value bets across rates, FX, equities, and commodities driven by macroeconomic theses.

**Definition:** The classical 'big bet' strategy associated with Soros, Druckenmiller, Bacon, Tudor Jones. Trade expression typically uses futures, swaps, and options for capital efficiency. Sub-styles: discretionary macro, systematic macro, EM-focused, rates-focused, commodity-focused. Has historically excelled in regime-change markets (1992 ERM, 2008 GFC, 2022 inflation) and underperformed in compressed-vol bull markets (2014–2019).


Managed Futures

# Managed Futures

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** Systematic trading of liquid futures contracts, predominantly using trend-following or short-term mean-reversion signals.

**Definition:** Regulated by the CFTC under the CTA (Commodity Trading Advisor) registration. The classic strategy is medium-term trend following across 100+ futures markets (rates, FX, equity indices, commodities). The 2022 inflation surge produced the strategy's best year since 2008 (SG Trend Index +27%); the post-2009 zero-rate era was the worst. Capacity is enormous (multi-trillion in liquid futures), but crowding into similar trend signals creates synchronized drawdowns.


Statistical Arbitrage

# Statistical Arbitrage
_(Stat Arb)_

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** High-breadth, short-horizon mean-reversion or relative-value trading driven by statistical signals.

**Definition:** Originated at Morgan Stanley's APT group (Bamberger, Tartaglia) in the 1980s, then commercialized by D.E. Shaw, Renaissance, and PDT. Modern stat arb runs thousands of positions, holding period seconds-to-days, with portfolio-level Sharpe targets of 4–6 net of costs. The original pairs-trading signal has decayed; today's signals come from order-book microstructure, alternative data, and ML-derived embeddings.


Pairs Trading

# Pairs Trading

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** Long one security, short a closely related security, betting on convergence of their relative price.

**Definition:** The simplest stat-arb form: identify two cointegrated securities (often within the same sector — Coke/Pepsi, Exxon/Chevron), trade the spread when it diverges from its long-run mean. Signal generation typically uses an Ornstein-Uhlenbeck model. The strategy decayed sharply post-2003 as competition compressed spreads; modern variants use baskets of dozens of names rather than single pairs.


Multi-Strategy Pod

# Multi-Strategy Pod

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** A platform that allocates capital across many independent portfolio managers (pods), each with strict risk limits, diversifying alpha across uncorrelated bets.

**Definition:** The dominant institutional hedge fund model of the 2020s. Examples: Citadel, Millennium, Point72, ExodusPoint, Balyasny, Schonfeld, Walleye. Each PM (or 'pod') runs a sub-book under a tight stop-loss (typically 5–8% peak-to-trough), with risk and execution centralized. Pass-through expense structures (often 5–8% gross) fund infrastructure, technology, and PM compensation. Net returns of 10–15% with Sharpe of 2–4 have made the model an LP favorite, but capacity is increasingly constrained.


Delta (Δ)

# Delta (Δ)

**Category:** derivatives-options · **Level:** intro

**Summary:** The change in option price per unit change in the underlying asset's price.

**Definition:** Δ = ∂V/∂S. For a vanilla call, Δ ranges from 0 (deep OTM) to 1 (deep ITM); for a put, from −1 to 0. ATM options have |Δ| ≈ 0.5. Delta also approximates the risk-neutral probability that the option finishes in the money. Hedgers maintain delta-neutral books by trading the underlying in quantity Δ × N (where N is the option position size).


Gamma (Γ)

# Gamma (Γ)

**Category:** derivatives-options · **Level:** intermediate

**Summary:** The rate of change of delta with respect to the underlying — the option's convexity.

**Definition:** Γ = ∂²V/∂S² = ∂Δ/∂S. Maximum at the strike, decreasing away from it. Long gamma = profit from realized volatility (gamma scalping); short gamma = collect theta but lose if vol arrives. The 'gamma squeeze' phenomenon (e.g., GameStop Jan 2021): dealer short-gamma positioning forces them to buy as price rises, amplifying the move. Dealer gamma positioning (the 'gamma map') has become a watched intraday signal.


Vega (ν)

# Vega (ν)

**Category:** derivatives-options · **Level:** intermediate

**Summary:** The change in option price per 1-percentage-point change in implied volatility.

**Definition:** ν = ∂V/∂σ. Vega is highest for ATM options with longer maturities. Vega is not a Greek letter but the convention persists. Vega-trading strategies isolate exposure to implied volatility level and term structure: long vega = long IV; vega-neutral = isolate other Greeks.


Theta (Θ)

# Theta (Θ)

**Category:** derivatives-options · **Level:** intro

**Summary:** The rate at which an option loses value with the passage of time, holding everything else constant.

**Definition:** Θ = ∂V/∂t. Almost always negative for long option positions: each day, time value decays. Decay accelerates as expiry approaches (theta is roughly proportional to 1/√(T−t)). Short premium strategies (covered calls, iron condors, short straddles) collect theta but pay realized vol; the trade-off is the central tension of premium selling.


Rho (ρ)

# Rho (ρ)

**Category:** derivatives-options · **Level:** advanced

**Summary:** The change in option price per 1-percentage-point change in the risk-free rate.

**Definition:** ρ = ∂V/∂r. Calls have positive rho; puts have negative rho. Rho exposure is small for short-dated equity options but significant for long-dated rate options and FX options where the rate differential drives the forward.


Implied Volatility

# Implied Volatility
_(IV)_

**Category:** derivatives-options · **Level:** intro

**Summary:** The volatility input to an option pricing model that makes the model's output equal the option's market price.

**Definition:** IV is what the market 'thinks' future realized volatility will be — it is forward-looking and embedded in option prices. The IV surface is a 2D function of strike (skew) and maturity (term structure). The CBOE VIX is the 30-day SPX IV. Hedge funds trade IV vs realized (vol arb), trade IV term structure (calendar spreads), and trade IV skew (risk reversals). When realized > implied, premium sellers lose; when realized < implied, they win.


VIX

# VIX

**Category:** derivatives-options · **Level:** intro

**Summary:** The CBOE Volatility Index — 30-day implied volatility of the S&P 500, derived from a strip of SPX options.

**Definition:** Computed continuously from out-of-the-money SPX option prices using a model-free formula related to the variance swap rate. Often called the 'fear index': spikes during equity selloffs (87 in Oct 2008, 82 in March 2020). Tradable via VIX futures (VX), VIX options, and ETPs (VXX, UVXY). The VIX term structure (front to back) typically slopes upward (contango) — leading to negative roll yield in long-vol ETPs, the source of long-vol's structural drag.


Volatility Skew

# Volatility Skew

**Category:** derivatives-options · **Level:** advanced

**Summary:** The pattern by which implied volatility varies with strike, holding maturity constant.

**Definition:** In equity index options, OTM puts trade at higher IV than OTM calls — a 'put skew' or 'risk reversal' that reflects demand for downside hedging. Single stocks often show smile (high IV both wings). FX options show smile or smirk. Skew is itself tradeable: long the wings vs short the body (a butterfly). The skew steepened structurally after Black Monday 1987.


Carry Trade

# Carry Trade

**Category:** global-markets · **Level:** intro

**Summary:** Borrow in a low-yielding currency, invest in a high-yielding one, harvest the rate differential.

**Definition:** The canonical FX carry trade: short JPY, long AUD or BRL or TRY, earn the rate differential. The trade is profitable on average (covered interest parity is violated empirically) but suffers periodic violent unwinds when risk-off triggers reversal — the so-called 'carry crash'. The 1998 LTCM/Russia and 2008 GFC carry unwinds were textbook. Generalized 'carry' applies to fixed income (long the curve), commodities (long backwardated assets), and equities (long high-dividend names).


Contango

# Contango

**Category:** commodities-futures · **Level:** intro

**Summary:** A futures curve in which longer-dated contracts trade at higher prices than nearer-dated ones.

**Definition:** Typical of storable commodities where storage costs and convenience yield combine to produce upward-sloping curves. Long-only commodity holders (passive ETFs, index funds) suffer negative roll yield in contango: each month they sell the front month cheap and buy the next month expensive. The infamous April 2020 WTI front-month went negative on storage saturation while the back of the curve stayed positive — extreme contango.


Backwardation

# Backwardation

**Category:** commodities-futures · **Level:** intro

**Summary:** A futures curve in which longer-dated contracts trade at lower prices than nearer-dated ones.

**Definition:** Typical when near-term supply is tight (high convenience yield) — physical holders pay a premium for immediate delivery. Long futures holders earn positive roll yield in backwardation. Crude oil, copper, and natural gas frequently exhibit backwardation in tight markets.


Duration

# Duration

**Category:** fixed-income-credit · **Level:** intermediate

**Summary:** The price sensitivity of a bond to a 1-percentage-point change in interest rates, expressed in years.

**Definition:** Macaulay duration is the weighted average time to a bond's cash flows. Modified duration = Macaulay / (1 + y/n) and approximates % price change for a 1% rate move: ΔP/P ≈ −D_mod × Δy. Effective duration accounts for embedded options (callable/puttable bonds, MBS). Portfolio duration aggregates by market-value weights. The 2022 bond rout (US Aggregate −13%) was a textbook duration shock as 30-year Treasuries fell ~30% on a 200bp rate move.


Convexity

# Convexity

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** The second-order rate sensitivity of a bond price — captures the curvature of the price-yield relationship.

**Definition:** ΔP/P ≈ −D × Δy + ½ × C × (Δy)². Convexity is positive for vanilla bonds (price rises faster than it falls for symmetric yield moves), negative for callable bonds and MBS at certain yields. Long convexity is a structural advantage; convexity hedging by mortgage portfolios drives episodic 'convexity events' — large rate moves that force MBS holders to rebalance, amplifying the move.


Credit Default Swap

# Credit Default Swap
_(CDS)_

**Category:** fixed-income-credit · **Level:** intermediate

**Summary:** An OTC contract in which the protection buyer pays a periodic premium and receives a payout if a reference entity defaults.

**Definition:** Protection buyer pays the running spread (in bps/yr); seller pays par minus recovery upon a credit event (failure to pay, restructuring, bankruptcy). Standardized post-2009 with Big Bang and Small Bang protocols, central clearing via ICE Clear Credit / LCH. The CDS market (≈$8tn notional in 2026) is dominated by index trades on CDX (US) and iTraxx (Europe). Single-name CDS volumes have shrunk dramatically since 2014. CDS pricing implies default probability under risk-neutral measure: PD ≈ spread / (1 − R).


Distressed Debt

# Distressed Debt

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** Investing in the debt of companies trading at deeply discounted prices due to actual or perceived financial distress.

**Definition:** Sub-strategies: (1) trading distressed — buying secondary debt in stressed names; (2) loan-to-own — accumulating fulcrum debt to convert to equity through restructuring; (3) DIP financing — providing capital during Chapter 11. Returns driven by event timing (file/exit), recovery analysis, fulcrum security identification, and committee work. Major practitioners: Oaktree, Apollo, Elliott, Davidson Kempner, King Street, Silver Point.


Form ADV

# Form ADV

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** The SEC registration form for investment advisers, with public disclosures (Part 1) and a brochure (Part 2).

**Definition:** Required of all SEC-registered investment advisers. Part 1A: structured data on AUM, employee count, advisory business, custody, disciplinary history. Part 1B: state filers. Part 2A: client-facing brochure on services, fees, conflicts. Part 2B: brochure supplement on supervised persons. Part 3 (Form CRS): retail-relationship summary. Filed annually within 90 days of fiscal year end via IARD. Public access via SEC IAPD.


Form PF

# Form PF

**Category:** regulatory-compliance · **Level:** advanced

**Summary:** Confidential SEC filing by private fund advisers reporting fund-level risk, leverage, and exposure data.

**Definition:** Required of investment advisers with > $150m in private fund AUM. Frequency depends on size: large hedge fund advisers (> $1.5bn) file quarterly; large liquidity fund advisers monthly; others annually. Reports gross/net assets, exposures by asset class, leverage, counterparty concentrations, liquidity terms, performance. Confidential — used by SEC and FSOC for systemic risk monitoring. Significantly expanded in 2024 amendments requiring 72-hour event reporting on stress (e.g., 20% drawdown, large redemptions, prime broker termination).


Regulation D

# Regulation D

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** SEC rules permitting private placement of securities to accredited investors without full SEC registration.

**Definition:** Most hedge funds rely on Rule 506(b) (no general solicitation, sold to accredited investors) or 506(c) (general solicitation permitted, all purchasers must be verified-accredited). Rule 504 covers smaller offerings up to $10m. Filing requirement: Form D within 15 days of first sale. Most hedge funds simultaneously rely on Section 3(c)(1) or 3(c)(7) of the Investment Company Act to avoid registration as investment companies.


Accredited Investor

# Accredited Investor

**Category:** regulatory-compliance · **Level:** intro

**Summary:** Per SEC Rule 501, an investor meeting income, net-worth, professional, or entity thresholds qualifying for unregistered securities.

**Definition:** Individual: $200k income (single, $300k joint) for 2 years with expectation of same OR $1m net worth ex primary residence. Professional: holders of Series 7, 65, 82 licenses; knowledgeable employees of the issuer. Entity: $5m in assets OR all owners are accredited. The 2020 SEC amendment expanded the professional path. ~13% of US households qualify (2024 estimate).


Qualified Purchaser

# Qualified Purchaser
_(QP)_

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** Per ICA Section 2(a)(51), an investor with $5m+ in investments (individual) or $25m+ (entity) eligible for 3(c)(7) funds.

**Definition:** QP is a higher bar than accredited investor. Funds relying on 3(c)(7) (rather than 3(c)(1)) can take an unlimited number of QPs and avoid the 100-investor cap. Most institutional-grade hedge funds are 3(c)(7) QP-only. The QP threshold ($5m investments, not assets — primary residence excluded, retirement accounts include only direct vested portion) has not been indexed to inflation since 1996.


AIFMD

# AIFMD

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** EU directive (2011/61/EU) governing managers of non-UCITS funds — the European hedge fund regulatory regime.

**Definition:** Effective July 2013. Requires AIFMs to be authorized, hold capital, employ independent depositaries, comply with leverage and remuneration rules, and report risk and exposure data to national regulators. Marketing in the EU requires either an EU AIFM with passport or compliance with national private placement regimes (NPPR) under Article 42. AIFMD II (2024 amendments) tightens rules on loan-originating funds, delegation, and liquidity management.


MiFID II

# MiFID II

**Category:** regulatory-compliance · **Level:** advanced

**Summary:** EU framework regulating trading venues, transparency, best execution, and (most contentiously) research unbundling.

**Definition:** Effective Jan 2018. The unbundling rule required asset managers to pay for sell-side research separately from execution — slashing sell-side research budgets by 30–50% and reducing analyst headcount industry-wide. The 2024 EU Listing Act partially reversed unbundling, allowing rebundling by manager election. Other MiFID II provisions: MTF/OTF venue categories, systematic internalisers, Best Ex reporting, transaction reporting (RTS 22).


Dodd-Frank Act

# Dodd-Frank Act

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** 2010 US legislation overhauling financial regulation post-GFC; required hedge fund advisers > $150m AUM to register with the SEC.

**Definition:** Signed July 2010. Key hedge fund provisions: (1) Title IV — eliminated the 'private adviser' exemption, mandating SEC registration for advisers > $150m; (2) Form PF reporting; (3) Volcker Rule limiting bank prop trading and hedge fund sponsorship; (4) Title VII — derivatives clearing and reporting (CFTC/SEC). Subsequent rollbacks under EGRRCPA (2018) raised some thresholds but left the core hedge fund provisions intact.


Material Non-Public Information

# Material Non-Public Information
_(MNPI)_

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** Information about a security that is both material (would influence a reasonable investor) and not yet public.

**Definition:** Trading on MNPI is insider trading under US securities law (Rule 10b-5). The Newman/Salman/Blaszczak line of cases shapes tipper/tippee liability — the tipper must receive a personal benefit, real or implied, for the tippee to be liable. Hedge funds maintain MNPI controls: restricted lists, watch lists, expert network protocols, information barriers. Compliance training and surveillance have become enormous fund-level investments since the 2009–2014 SAC Capital era.


Expert Network

# Expert Network

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** A firm that connects investors with industry experts for paid consultations, tightly governed to prevent MNPI transfer.

**Definition:** Major firms: GLG, AlphaSights, Guidepoint, Third Bridge. Calls are typically scheduled, recorded (or not), and chaperoned by the network's compliance team. Funds maintain pre-clearance protocols and avoid current employees of the consult subject. The expert network industry was implicated in the SAC Capital prosecution and has since adopted heavy MNPI controls — but the practice remains a regulatory hotspot.


Unrelated Business Taxable Income

# Unrelated Business Taxable Income
_(UBTI)_

**Category:** regulatory-compliance · **Level:** advanced

**Summary:** Income that subjects otherwise tax-exempt entities (pensions, foundations, IRAs) to US federal income tax.

**Definition:** UBTI arises from income from debt-financed property and trade/business activities. Hedge fund use of leverage generates UBTI for tax-exempts unless they invest through a 'corporate blocker' — typically the offshore Cayman feeder of a master-feeder structure. The blocker absorbs the UBTI at the entity level (paying ~21% US corporate tax on US-source income) while the tax-exempt LP receives a clean dividend. The 2017 TCJA's silo rule (Section 512(a)(6)) requires UBTI to be computed separately per activity.


VWAP

# VWAP

**Category:** trading-execution · **Level:** intro

**Summary:** The intraday average price weighted by volume — a standard execution benchmark.

**Definition:** VWAP = Σ(P_i × V_i) / Σ V_i over the trading session. VWAP-targeting algos slice an order through the day in proportion to historical volume curves to minimize tracking error to the day's VWAP. Beating VWAP is a standard execution-quality metric. Caveat: a manager can game VWAP by trading patiently when their own order moves the market — improving against VWAP at the cost of opportunity.


TWAP

# TWAP

**Category:** trading-execution · **Level:** intro

**Summary:** The simple time-weighted intraday average price — slices orders evenly through a window.

**Definition:** TWAP = mean(prices sampled at equal time intervals). TWAP algos break an order into equal-sized child slices over a chosen window. Useful when minimizing market impact in a single name with steady volume; less optimal in U-shaped intraday volume curves. Both TWAP and VWAP are 'naive' algos relative to optimal execution under a transient market impact model (Almgren-Chriss).


Implementation Shortfall

# Implementation Shortfall

**Category:** trading-execution · **Level:** intermediate

**Summary:** The difference between the price at which a trading decision is made and the average price actually realized, including all costs.

**Definition:** IS = (P_decision − P_avg_executed) × side + commissions + opportunity cost on unfilled. The Perold (1988) formulation broke it into delay cost, market impact, and opportunity cost. IS is the institutional standard for execution quality because it captures the full cost — including the 'paper' loss from price drift while the order works. TCA reports decompose IS by asset, venue, algo, and PM.


Transaction Cost Analysis

# Transaction Cost Analysis
_(TCA)_

**Category:** trading-execution · **Level:** intermediate

**Summary:** Post-trade analysis of execution quality against benchmarks like VWAP, arrival price, and implementation shortfall.

**Definition:** Standard TCA reports include: spread cost, market impact, timing cost, opportunity cost. Pre-trade TCA forecasts these costs to inform broker/algo selection. Post-trade TCA evaluates outcomes. Algo-wheel TCA randomly routes orders across competing algos and measures relative performance — the institutional way to keep brokers honest. MiFID II Article 27 requires Best Ex monitoring and reporting (RTS 27/28, partially repealed 2024).


Dark Pool

# Dark Pool

**Category:** market-microstructure · **Level:** intermediate

**Summary:** An off-exchange trading venue that does not display quotes pre-trade; trades print to the consolidated tape post-trade.

**Definition:** Dark pools serve institutions wanting to trade size without signaling. Major US ATSs: UBS ATS, Sigma X, IEX, MS Pool, Liquidnet. Trades execute typically at NBBO midpoint. Dark pool share of US equity volume has hovered around 12–15% for the past decade. Regulatory scrutiny intensified after the Barclays LX case (2014) and Pipeline Trading (2011) settlements over misleading liquidity claims.


Bid-Ask Spread

# Bid-Ask Spread

**Category:** market-microstructure · **Level:** intro

**Summary:** The difference between the best buy quote (bid) and best sell quote (ask) in an order book.

**Definition:** The spread compensates market makers for inventory risk, adverse selection, and operating costs. Effective spread (paid spread, accounting for hidden liquidity and price improvement) is typically narrower than quoted. Quoted spread is a noisy proxy for liquidity; effective spread, realized spread, and queue depth are better. Spreads have compressed dramatically since decimalization (2001) and the rise of HFT.


Adverse Selection

# Adverse Selection

**Category:** market-microstructure · **Level:** advanced

**Summary:** The risk that a market maker's counterparty has private information, causing the maker to systematically lose to informed flow.

**Definition:** Glosten-Milgrom (1985) modeled the market maker's spread as compensation for adverse selection from informed traders. PIN (Probability of Informed Trading), VPIN (Volume-synchronized PIN, Easley/López de Prado/O'Hara), and order flow toxicity metrics estimate adverse selection in real time and are used by HFTs to manage quote width and depth.


Kelly Criterion

# Kelly Criterion

**Category:** portfolio-construction · **Level:** advanced

**Summary:** The bet-sizing fraction that maximizes the long-run logarithm of wealth.

**Definition:** For a binary bet with edge e and odds o: f* = e / o. For continuous returns with mean μ and variance σ²: f* = (μ − r) / σ². Full Kelly is volatile (drawdowns of 80–90% are routine); fractional Kelly (typically half-Kelly) is the practitioner's compromise. The criterion underlies many quant fund risk allocation frameworks and is the foundational concept of Edward Thorp's Princeton/Newport Partners.


Risk Parity

# Risk Parity

**Category:** portfolio-construction · **Level:** intermediate

**Summary:** An allocation framework that sizes positions so each asset contributes equally to total portfolio risk.

**Definition:** Equal-risk contribution: w_i × MRC_i = constant for all i, where MRC is marginal risk contribution. Often levered to match a target volatility (e.g., 10% annualized). Bridgewater's All Weather pioneered the institutional version in the 1990s; AQR, PanAgora, and many others followed. Performance: strong in 2000s (positive bond/equity correlation regime), weak in 2022 when bonds and equities sold off together. Sensitive to leverage availability and rate-vol regime.


Mean-Variance Optimization

# Mean-Variance Optimization
_(MVO)_

**Category:** portfolio-construction · **Level:** intermediate

**Summary:** Markowitz's framework: choose portfolio weights to maximize expected return for a given level of variance (or vice versa).

**Definition:** Markowitz (1952) introduced the efficient frontier. The unconstrained tangency portfolio is w ∝ Σ⁻¹(μ − r). Famously sensitive to inputs: small estimation errors in μ produce extreme weights. Practical fixes: shrinkage (Ledoit-Wolf, James-Stein), Black-Litterman blending of priors with views, resampling, robust optimization, and direct constraints (long-only, position limits).


Black-Litterman Model

# Black-Litterman Model

**Category:** portfolio-construction · **Level:** advanced

**Summary:** A Bayesian framework that combines an equilibrium prior (CAPM-implied returns) with investor views to produce stable optimal portfolios.

**Definition:** Developed at Goldman in 1990 by Fischer Black and Robert Litterman. The posterior expected return vector is a weighted blend of the implied equilibrium return Π = δΣw_mkt and the analyst's view portfolios P with confidence Ω. The result: weights that deviate from market caps only in proportion to view strength, eliminating MVO's corner-solution pathology.


Fama-French Factors

# Fama-French Factors

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Multi-factor models extending CAPM with size (SMB), value (HML), profitability (RMW), investment (CMA), and momentum (MOM).

**Definition:** Fama-French 3-factor (1992): Market, SMB, HML. 5-factor (2015): adds RMW and CMA. Carhart (1997): adds MOM. Hedge fund performance attribution increasingly uses these factors plus alternative-risk premia (carry, defensive, low-vol) to identify true alpha. Many strategies marketed as alpha are simply long known factor exposures.


Cointegration

# Cointegration

**Category:** quantitative-methods · **Level:** advanced

**Summary:** A statistical relationship in which two or more non-stationary series share a common stochastic trend, so their linear combination is stationary.

**Definition:** Engle-Granger (1987) and Johansen (1991) tests detect cointegration. Cointegrated pairs/baskets form the basis of pairs trading and stat-arb: the spread mean-reverts to its long-run equilibrium. Cointegration is fragile — relationships break in regime shifts (M&A, sector rotation, fundamental change). Robust strategies use rolling re-estimation and statistical-significance gates.


Ornstein-Uhlenbeck Process

# Ornstein-Uhlenbeck Process

**Category:** quantitative-methods · **Level:** advanced

**Summary:** A continuous-time mean-reverting stochastic process used to model spreads, vol, rates, and basis.

**Definition:** dX_t = θ(μ − X_t)dt + σ dW_t. Parameters: θ (mean-reversion speed), μ (long-run mean), σ (volatility). Half-life of mean reversion = ln(2)/θ. Used in pairs trading (spread), Vasicek/CIR rate models, and vol modeling. Fitting via OLS on ΔX_t = α + βX_{t-1} + ε; θ = −β/Δt, μ = α/(−β), σ from residuals.


Monte Carlo Simulation

# Monte Carlo Simulation

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Numerical method that estimates outcomes by repeated random sampling from input distributions.

**Definition:** In hedge fund risk: simulate thousands of forward paths under a fitted model (geometric Brownian, jump-diffusion, regime-switching, GARCH), then read percentiles for VaR/ES, drawdown distributions, and capacity. In option pricing: simulate underlying paths, average discounted payoffs. Variance reduction techniques (antithetic variates, control variates, importance sampling, quasi-MC) materially cut compute requirements.


Leverage

# Leverage

**Category:** risk-management · **Level:** intro

**Summary:** The use of borrowed capital to amplify portfolio exposure beyond invested equity.

**Definition:** Measured several ways: (1) gross leverage = (long + |short|) / equity; (2) net leverage = (long − |short|) / equity; (3) regulatory leverage (CFTC commitments method, AIFMD gross/commitment methods, SEC Form PF method). Equity L/S typically 2–4× gross; macro 5–15×; rates relative-value 20–60×; convertible arb 4–8×. Leverage is procyclical — margin calls force selling at the worst time, creating the deleveraging cascade pattern of 2008 and March 2020.


Gross Exposure

# Gross Exposure

**Category:** risk-management · **Level:** intro

**Summary:** The sum of long market value plus the absolute value of short market value, as a percentage of NAV.

**Definition:** Gross = (L + |S|) / NAV. Captures the total economic capital at risk regardless of direction. Equity L/S 150–250%; multi-strat pods 400–800%; rates RV 10–60×.


Net Exposure

# Net Exposure

**Category:** risk-management · **Level:** intro

**Summary:** Long market value minus absolute value of short market value, as a percentage of NAV.

**Definition:** Net = (L − |S|) / NAV. Approximates portfolio's directional market beta if longs and shorts have similar betas. A market-neutral fund targets net ≈ 0; a directional L/S fund 30–80% net long.


Counterparty Risk

# Counterparty Risk

**Category:** risk-management · **Level:** intermediate

**Summary:** The risk that the other side of a trade or contract fails to perform its obligations.

**Definition:** Hedge funds face counterparty risk in OTC derivatives, prime brokerage, securities lending, and tri-party repo. Mitigants: ISDA Master + CSA with daily VM/IM, central clearing where mandated (UMR phases 1–6 since 2016), netting, multi-PB diversification, and segregated custody. The 2008 Lehman bankruptcy froze ~$70bn of hedge fund assets at LBIE under the UK 'Rule 7' insolvency regime — the moment that ended single-PB practice for the institutional industry.


Liquidity Risk

# Liquidity Risk

**Category:** risk-management · **Level:** intermediate

**Summary:** The risk of being unable to exit a position at a fair price within a needed timeframe.

**Definition:** Two dimensions: (1) market liquidity — bid-ask, market depth, time-to-liquidate; (2) funding liquidity — access to financing, margin terms, redemption pressure. Mismatches between asset liquidity and fund redemption terms cause runs (LTCM, Bear Stearns hedge funds 2007, Woodford 2019, Archegos 2021). Standard metrics: average daily volume coverage, ETF/index inclusion, bid-ask, time-to-15%-impact. Funds maintain liquidity ladders matching asset liquidity to investor terms.


Rehypothecation

# Rehypothecation

**Category:** fund-operations · **Level:** advanced

**Summary:** A prime broker's right to re-pledge or re-lend assets posted by its hedge fund clients as collateral.

**Definition:** US: Reg T limits rehyp to 140% of customer debit balance. UK historically (pre-Lehman) had no limit, which is why ~$70bn of hedge fund assets at Lehman International were unrecoverable for years. EU: under MiFID II/CRR, requires explicit client consent and disclosure. Funds today negotiate hard rehyp limits and often elect 'segregated' (Type 1 SIPC or fully-segregated cash custody) for excess collateral.


ISDA Master Agreement

# ISDA Master Agreement

**Category:** fund-operations · **Level:** advanced

**Summary:** The standardized bilateral agreement governing OTC derivatives between two counterparties.

**Definition:** Published by the International Swaps and Derivatives Association. The Master, supplemented by a Schedule (negotiated bilaterally), Credit Support Annex (CSA, governing collateral), and trade-level Confirmations, governs every OTC derivatives relationship. Key concepts: netting (single net obligation under default), close-out (early termination on event of default), set-off, and cross-default. The 2002 Master replaced the 1992 Master and is the standard.


UCITS

# UCITS

**Category:** fund-operations · **Level:** intermediate

**Summary:** EU regulated investment fund vehicle with passporting across the EEA — used for liquid alternative strategies.

**Definition:** UCITS V (2014) is the current framework. Constraints: daily liquidity, max 10% in any single security (5/10/40 rule), max 200% gross VaR-based leverage, no direct commodity exposure. 'Liquid alts' / 'newcits' adapted hedge fund strategies (L/S equity, market neutral, macro, managed futures) into UCITS. AUM in alternative-UCITS reached €700bn in 2025.


Perpetual Futures

# Perpetual Futures

**Category:** crypto-digital-assets · **Level:** intermediate

**Summary:** Crypto futures contracts with no expiry, with a periodic funding rate paid between longs and shorts to anchor price to spot.

**Definition:** Invented by BitMEX (Hayes) in 2016 and now the dominant crypto derivative ($100tn+ annual notional in 2025). Funding rate ≈ (perp price − spot index price) / spot, paid every 8 hours from the side at premium to the side at discount. Fundings can persist at 30–100% annualized in bull markets. Hedge funds run cash-and-carry (long spot / short perp) to harvest funding, generating one of the highest-Sharpe crypto trades when funding is positive.


Funding Rate

# Funding Rate

**Category:** crypto-digital-assets · **Level:** intermediate

**Summary:** Periodic payment between longs and shorts in a perpetual futures contract that anchors the perp price to spot.

**Definition:** Each exchange (Binance, OKX, Bybit, Deribit) computes its own funding rate from the perp-vs-index basis plus an interest-rate component. Settled every 8 hours on most venues, every 1 hour on Hyperliquid. Annualized funding rates have ranged from −50% (extreme bearish) to +200% (mania) over the past 5 years. Funding-rate arbitrage runs cash-and-carry (long spot, short perp) when funding is positive.


Basis Trade

# Basis Trade

**Category:** crypto-digital-assets · **Level:** intermediate

**Summary:** Long spot / short futures (or vice versa) to harvest the spread between spot and futures prices.

**Definition:** In crypto: long spot BTC, short BTC perpetual or quarterly future, earn the basis. In Treasuries: long cash bond, short futures, harvest the cheapest-to-deliver basis (the canonical hedge fund trade now ~$1tn in size, the focus of Fed and Treasury concerns about market stability since 2020). In commodities: cash-and-carry where storage cost < contango.


Level 3 Asset

# Level 3 Asset

**Category:** accounting-valuation · **Level:** intermediate

**Summary:** Per ASC 820 / IFRS 13, an asset whose fair value is determined using significant unobservable inputs (model-based marks).

**Definition:** Fair value hierarchy: Level 1 (quoted prices in active markets — equities), Level 2 (observable inputs — most fixed income, swaps), Level 3 (unobservable inputs — private equity, illiquid loans, esoteric structured credit). Level 3 marks are subject to model risk and management bias. Independent pricing services (IHS Markit, Solve Advisors, Bloomberg BVAL) and audit valuation committees provide checks. Funds with > 30% Level 3 typically run side pockets and impose long lock-ups.


Fair Value

# Fair Value

**Category:** accounting-valuation · **Level:** intermediate

**Summary:** Per ASC 820, the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

**Definition:** An exit-price standard, not entry. Applies to all financial instruments held by US private funds. The hierarchy (Level 1/2/3) determines disclosure requirements but not the measurement standard itself. Fair value uses 'highest and best use' for non-financial assets, 'unit of account' as defined by the asset class, and a 'principal market' (or absent that, 'most advantageous market') determination.


J-Curve

# J-Curve

**Category:** alternative-investments · **Level:** intermediate

**Summary:** The pattern of negative early returns followed by rising returns over time, characteristic of private fund vintages.

**Definition:** PE/VC funds draw capital and pay fees in early years (the dip of the J), then realize gains as portfolio companies mature (the rising leg). Hedge fund extensions: long-dated activist funds, distressed-debt vehicles, and credit lockups exhibit shallow J-curves. NAV-based metrics (DPI, RVPI, TVPI) are designed to evaluate funds across the J-curve.


Internal Rate of Return

# Internal Rate of Return
_(IRR)_

**Category:** alternative-investments · **Level:** intermediate

**Summary:** The discount rate that makes the NPV of a cash flow stream equal to zero — the standard PE/VC return metric.

**Definition:** Solved iteratively from Σ CF_t / (1+r)^t = 0. IRR is sensitive to timing — early distributions inflate IRR. Practitioners pair IRR with multiple-on-invested-capital (MOIC/TVPI) and DPI to triangulate true performance. Pitfall: IRR assumes reinvestment at the IRR itself, often unrealistic — Modified IRR (MIRR) corrects this.


TVPI

# TVPI

**Category:** alternative-investments · **Level:** intermediate

**Summary:** Sum of distributions plus residual value, divided by paid-in capital — the 'multiple' on invested capital.

**Definition:** TVPI = (Distributions + NAV) / Paid-In Capital. Decomposes into DPI (realized) + RVPI (unrealized). Less time-sensitive than IRR — a TVPI of 2.0× is unambiguous regardless of when cash flowed. Together with IRR, TVPI is the standard PE/VC performance pair.


Yield Curve Inversion

# Yield Curve Inversion

**Category:** macroeconomics · **Level:** intermediate

**Summary:** When short-term rates exceed long-term rates — historically a leading indicator of US recession.

**Definition:** The 2s10s and 3M-10Y spreads have been the most reliable recession signals: every US recession since 1970 was preceded by inversion of one or both. The 2022–2024 inversion was the deepest (peak −108bp on 2s10s) and longest (~22 months) on record, eventually un-inverted ahead of growth slowdown in 2024. Mechanism debate: signal of Fed tightness, signal of falling future inflation/growth, or self-fulfilling via bank lending margin compression.


Treasury Basis Trade

# Treasury Basis Trade

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** Long cash Treasury, short Treasury futures, financed via repo — earning the basis at high leverage.

**Definition:** Hedge funds (primarily relative-value rates funds) hold long cash bonds and short the cheapest-to-deliver Treasury futures, financed in tri-party repo at 50–100× leverage. P&L = (carry on bond − futures roll cost − repo cost), typically a few bps × leverage. Estimated $1.0–1.2tn outstanding in 2026, concentrated at Citadel, Millennium, ExodusPoint, and a handful of others. Identified by FSOC and the BIS as a systemic vulnerability — the March 2020 'dash for cash' saw forced unwinds amplify Treasury market dysfunction. Subject to escalating regulatory scrutiny: SEC's UST clearing mandate (effective 2026 for cash, 2027 for repo) materially changes the trade's economics.


Trend Following

# Trend Following

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** Systematic strategy that buys assets with positive past returns and sells assets with negative past returns.

**Definition:** The dominant CTA strategy. Signal generation: moving-average crossovers (e.g., 50/200 day), breakout systems (Donchian channel), or smoothed momentum (e.g., 12-month return ex-recent-month). Position sizing: inverse volatility, equalized risk contribution. Returns historically positive across asset classes and centuries (Hurst et al., 'Two Centuries of Trend Following'). Crisis alpha: trend tends to outperform in extended bear markets (2008, 2022) when sustained moves develop.


Momentum

# Momentum

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** The tendency for assets that have outperformed in the recent past to continue outperforming in the near future.

**Definition:** Established as a robust factor by Jegadeesh-Titman (1993) for cross-sectional equity momentum (12-1 month return). Time-series momentum (Moskowitz-Ooi-Pedersen 2012) showed it works across asset classes. Behavioral explanations: under-reaction to news, herding, anchoring. Risk explanations: business-cycle exposure. Momentum suffers severe crashes (2009 'momentum crash' as junk rallied) and is typically combined with value, quality, and trend filters in practice.


Capital Asset Pricing Model

# Capital Asset Pricing Model
_(CAPM)_

**Category:** quantitative-methods · **Level:** intro

**Summary:** Sharpe-Lintner-Mossin model: expected return = risk-free rate + β × (market return − risk-free rate).

**Definition:** E[R_i] = R_f + β_i (E[R_m] − R_f). The simplest factor model; β is the sole priced source of risk. Empirically rejected as the sole driver of cross-sectional returns (size, value, momentum all add explanatory power), yet survives as a useful baseline and the foundation of the cost-of-capital calculation. Hedge fund attribution still begins with a CAPM regression before adding factors.


Black-Scholes Model

# Black-Scholes Model

**Category:** derivatives-options · **Level:** intermediate

**Summary:** A continuous-time model for European option pricing assuming geometric Brownian underlying and constant volatility.

**Definition:** C = S Φ(d1) − K e^{−rT} Φ(d2), where d1 = [ln(S/K) + (r + σ²/2)T] / (σ√T), d2 = d1 − σ√T. The model assumes: no dividends (or continuous yield q), constant r and σ, no transaction costs, continuous trading, log-normal returns. Despite known violations (vol smile, jumps, fat tails), Black-Scholes remains the lingua franca for options — quotes are routinely expressed in implied vol terms via inversion of the formula.


Smart Beta

# Smart Beta

**Category:** portfolio-construction · **Level:** intermediate

**Summary:** Rules-based strategies that systematically tilt portfolios toward known risk factors (value, size, momentum, quality, low-vol).

**Definition:** The packaging of academic factor research into low-cost, transparent products. The category exploded post-2010 ($2tn+ AUM by 2024) but performance has been mixed: the post-2018 'value drought' challenged the canonical multi-factor pitch. Hedge funds increasingly view smart beta as a benchmark for true alpha — anything a $5bp ETF can replicate is not paying 2/20.


Alternative Risk Premia

# Alternative Risk Premia
_(ARP)_

**Category:** portfolio-construction · **Level:** advanced

**Summary:** Systematic strategies that harvest persistent risk premia (carry, momentum, value, defensive, volatility) across asset classes.

**Definition:** ARP unbundles hedge-fund-style returns into transparent, replicable building blocks at lower fees (typically 50–100bp). Carry, momentum, value, low-vol, and quality across equities, FX, rates, and commodities are the standard sleeves. Performance has been disappointing post-2018 (extended drawdowns in cross-asset value, FX carry crashes), prompting questions about premia decay versus genuine premium variation. Major providers: AQR, Man AHL, Goldman QIS, JPMQIS.


Tracking Error

# Tracking Error

**Category:** quantitative-methods · **Level:** intro

**Summary:** The standard deviation of the return difference between a portfolio and its benchmark.

**Definition:** TE = σ(R_p − R_b), annualized. Index funds target TE near 0; enhanced-index funds 50–150bp; active managers 300–800bp; hedge funds typically don't measure TE because they aren't benchmark-constrained. The denominator of the information ratio.


Deal Spread

# Deal Spread

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** In merger arbitrage, the percentage gap between the announced acquisition price and the target's current trading price.

**Definition:** Spread = (Deal Price / Target Price − 1) × 100%. Reflects the market's probability-weighted view of deal completion, time to close, and downside if the deal breaks. Wider spreads imply more break risk; narrower spreads imply higher confidence (or less return). Annualized spread = (Deal Price/Current Price − 1) × (365/Days to Close), useful for sizing.


Break Risk

# Break Risk

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** The risk that an announced merger or acquisition fails to close.

**Definition:** Major drivers: regulatory (HSR/FTC, EU Commission, CMA, CFIUS, NSIA), shareholder vote, financing condition, MAC/MAE invocation, hostile interloper. Break-risk modeling estimates: P(close), P(retrade), P(broken), expected price under each scenario. Recent break-risk shocks: Microsoft/Activision (CMA initial block, ultimately approved); Adobe/Figma (EU/UK objections, abandoned); Albertsons/Kroger (FTC blocked).


Material Adverse Change Clause

# Material Adverse Change Clause
_(MAC / MAE)_

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** A merger agreement provision allowing the buyer to walk if a 'material adverse change' occurs at the target between signing and closing.

**Definition:** MAC clauses are heavily negotiated and typically carve out market-wide, industry-wide, and pandemic-related events. Delaware courts have rarely upheld MAC invocations (Akorn v. Fresenius, 2018, was the landmark exception). The COVID-era cases (Tiffany/LVMH, Forescout/Advent, etc.) largely settled or were resolved by closing. Merger arbs assess MAC risk by reading the agreement's exact carve-out language.


Fulcrum Security

# Fulcrum Security

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** The class of securities in a distressed company's capital structure that will be converted to equity in a restructuring.

**Definition:** Identifying the fulcrum (typically the most senior class to take a haircut and receive equity) is the central skill of distressed investing. Practitioners build a 'waterfall' of expected recoveries from EV at exit, working down the cap stack until residual value runs out. Loan-to-own strategies accumulate fulcrum debt at distressed prices to control the post-reorg equity. Famous fulcrum trades: Caesars 2017 (TPG/Apollo battle), J.Crew 2020 (PIK toggles), Frontier 2020 (unsecured bonds → 100% equity).


Credit Spread

# Credit Spread

**Category:** fixed-income-credit · **Level:** intro

**Summary:** The yield premium of a credit-risky bond over a risk-free benchmark of the same maturity.

**Definition:** Common spread measures: G-spread (over interpolated Treasury), I-spread (over interpolated swap), Z-spread (zero-volatility static spread), OAS (option-adjusted spread, removing the value of embedded options). Credit spreads compensate investors for default risk, liquidity premium, and risk premium. Decomposition: PD × (1−R) + risk premium.


Option-Adjusted Spread

# Option-Adjusted Spread
_(OAS)_

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** The constant spread added to the risk-free rate path that equates a bond's model price with its market price, after stripping out embedded options.

**Definition:** Computed via Monte Carlo or lattice over a calibrated interest rate model. OAS isolates pure credit/liquidity premium from the value of callability, prepayment, or putability. For MBS, OAS is the standard relative-value metric. Negative OAS occasionally appears for highly negative-convexity MBS in low-rate regimes — model artifact more than economic insight.


Volatility Surface

# Volatility Surface

**Category:** derivatives-options · **Level:** advanced

**Summary:** The two-dimensional grid of implied volatilities by strike (skew) and maturity (term structure).

**Definition:** Constructed from market prices of liquid options. Used for pricing exotic options (interpolation), risk reporting (vega bucketing), and trading (skew/term-structure RV). Common parametrizations: SABR, SVI (Stochastic Volatility Inspired, Gatheral), Heston. Dynamics — how the surface moves when spot moves — matters for hedging: 'sticky strike' vs 'sticky delta' assumptions yield different vega hedges.


Realized Volatility

# Realized Volatility

**Category:** derivatives-options · **Level:** intermediate

**Summary:** The actual volatility of an asset's returns over a historical window.

**Definition:** RV = √(252/N × Σ r_t²) for daily log returns. High-frequency realized variance estimators (5-min, jump-robust) are more accurate than daily for short horizons. The realized-vs-implied spread (the 'variance risk premium') is positive on average — selling vol is a positive-EV but negatively-skewed strategy.


Primary Research

# Primary Research

**Category:** equities-analysis · **Level:** intermediate

**Summary:** Original investigative work — channel checks, satellite imagery, alternative data, expert calls — conducted directly by the fund, not sourced from sell-side reports.

**Definition:** The differentiating activity of fundamental hedge funds. Standard tools: alternative data (credit card panel data, web-scraped pricing, satellite/aerial imagery, app downloads, foot traffic), expert network calls, channel checks (calling distributors, suppliers, customers), industry conference attendance, management meetings. Compliance scrutinizes for MNPI risk; data-vendor diligence is a multi-month process.


Alternative Data

# Alternative Data
_(Alt Data)_

**Category:** equities-analysis · **Level:** intermediate

**Summary:** Non-traditional datasets used as inputs to investment decisions — credit card transactions, satellite imagery, app usage, web scraping, geolocation.

**Definition:** Industry from $0 in 2010 to $10bn+ vendor revenue by 2025. Major categories: consumer (Yodlee, Earnest, Second Measure), web (similarweb, semrush), location (advan, placer), satellite (Planet, Maxar, Orbital Insight), supply chain (Panjiva, ImportGenius), social (Estimize, BotsForge, sentiment scoring). Compliance: MNPI screening, GDPR/CCPA review, vendor T&Cs review. Alpha decay is steep — datasets that produced 5% alpha in 2018 typically produce < 1% by 2024.


Alpha Decay

# Alpha Decay

**Category:** quantitative-methods · **Level:** advanced

**Summary:** The phenomenon by which an alpha signal's predictive power degrades as it is discovered and traded by more participants.

**Definition:** Alpha decay rates vary by signal type: microstructure signals decay in months; alt-data signals in 1–3 years; fundamental quality signals over decades or never. Hedge funds maintain rolling research pipelines that constantly seed new signals to replace decaying ones. Decay accelerates with: signal publication, vendor data commercialization, capacity additions to a strategy.


Capacity

# Capacity

**Category:** portfolio-construction · **Level:** intermediate

**Summary:** The maximum AUM at which a strategy can be deployed without meaningfully degrading expected returns.

**Definition:** Capacity is set by some combination of: market depth (% of ADV that can be traded without slippage), the number of independent bets available, and competition for the same signals. Stat arb capacity at a single shop: $5–15bn. Trend-following capacity: $100bn+ across many CTAs. Activist capacity: $20bn at a single fund. Closed-to-new-capital is the institutional credibility marker.


Pass-Through Expenses

# Pass-Through Expenses

**Category:** fund-operations · **Level:** intermediate

**Summary:** Multi-strat platform fee model where actual operating expenses (PM comp, technology, financing, infrastructure) are charged to the fund instead of (or in addition to) a fixed management fee.

**Definition:** Pass-through structures emerged at multi-strategy platforms (Citadel, Millennium, Point72) to fund the enormous cost of running pod businesses with elite PM compensation. Total expense ratios commonly run 5-8% gross. Investors receive itemized expense reports. The 2023 SEC Private Fund Adviser Rules sought to mandate enhanced disclosure; the rules were vacated by the Fifth Circuit in June 2024, but disclosure practices remain elevated. LP demand for the strategy has continued despite high gross fees because net Sharpe ratios of 2-4 still leave best-in-class net IRRs.


Roll Yield

# Roll Yield

**Category:** commodities-futures · **Level:** intermediate

**Summary:** The return component from rolling a futures position from one expiry to the next.

**Definition:** When a long position rolls a back-month future cheaper than it sells the front month (backwardation), it earns positive roll yield; in contango it earns negative roll yield. Annualized roll yield for a passive long-only commodity index can swing ±15% depending on regime. The dominant driver of long-only commodity ETF returns over the long run.


DPI (Distributions to Paid-In)

# DPI (Distributions to Paid-In)

**Category:** alternative-investments · **Level:** intermediate

**Summary:** Cumulative cash distributions divided by paid-in capital — the realized portion of TVPI.

**Definition:** DPI = Distributions / Paid-In. A DPI of 1.0× means investors have received their capital back in cash; DPI > 1.0× is realized profit. PE/VC funds aim for DPI > 1.0× by year 7-8 of a 10-year fund. DPI is the most rigorous performance metric because it measures only realized cash, free of mark-to-market judgment.


RVPI (Residual Value to Paid-In)

# RVPI (Residual Value to Paid-In)

**Category:** alternative-investments · **Level:** intermediate

**Summary:** Unrealized NAV divided by paid-in capital — the unrealized portion of TVPI.

**Definition:** RVPI = NAV / Paid-In. Together with DPI sums to TVPI. Subject to manager judgment on Level 3 marks; verified at exit but estimated until then.


Founders Share Class

# Founders Share Class

**Category:** fund-operations · **Level:** intermediate

**Summary:** A discounted share class (e.g., 1/10 vs 1.5/20) for early or large investors who anchor a new fund's launch in exchange for a longer lock-up.

**Definition:** Standard founders terms: 1% management / 10% performance, 2-year hard lock, capacity rights up to a threshold. Often capped at the lesser of 15% of fund or $25-50m. Some funds phase founders' investors into standard fees after a launch period; others offer perpetual founders economics.


Fund Administrator

# Fund Administrator

**Category:** fund-operations · **Level:** intro

**Summary:** Independent third-party that strikes NAV, processes subscriptions/redemptions, and provides investor reporting.

**Definition:** Major administrators in 2026: SS&C GlobeOp, Citco, Apex, NAV Consulting, IQ-EQ, MUFG. Independent administration is post-Madoff baseline. Functions: NAV calculation (typically T+5 to T+15), AML/KYC of investors, capital activity processing, P&L allocation across share classes. Adminstrator selection is a focus of LP operational due diligence.


Mean Reversion

# Mean Reversion

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** The tendency for a series to return toward its long-run average.

**Definition:** Statistical foundation of pairs trading, stat arb, and many short-horizon equity strategies. Tests: Augmented Dickey-Fuller (ADF), variance ratio (Lo-MacKinlay). Half-life in an OU process: ln(2)/θ. Mean reversion in returns coexists with long-horizon momentum — the term-structure of return autocorrelation matters.


Covered Interest Parity

# Covered Interest Parity
_(CIP)_

**Category:** global-markets · **Level:** intermediate

**Summary:** The forward FX rate equals the spot rate adjusted by the interest rate differential between the two currencies.

**Definition:** F/S = (1 + i_d) / (1 + i_f). Holds tightly in normal times (arbitrage by banks). CIP deviations have persisted post-2008 due to Basel III balance sheet costs, year-end window dressing, and FX swap market segmentation — measurable in cross-currency basis. The 'CIP failure' literature (Du-Tepper-Verdelhan) documents 30-100bp persistent deviations in major currency pairs.


Uncovered Interest Parity

# Uncovered Interest Parity
_(UIP)_

**Category:** global-markets · **Level:** intermediate

**Summary:** Theoretical equality where expected change in spot FX equals interest rate differential.

**Definition:** E[ΔS] = i_d − i_f. Fails empirically — the 'forward premium puzzle' (Fama 1984). High-yielding currencies do not depreciate as theory predicts on average, generating the carry trade premium.


Section 3(c)(1) Exemption

# Section 3(c)(1) Exemption

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** Investment Company Act exclusion for funds with no more than 100 beneficial owners.

**Definition:** Hedge funds rely on either 3(c)(1) (≤100 owners, all accredited) or 3(c)(7) (all QPs, no count cap) to avoid registering as investment companies. 3(c)(1) is suitable for emerging managers; 3(c)(7) for institutional scale.


Section 3(c)(7) Exemption

# Section 3(c)(7) Exemption

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** Investment Company Act exclusion for funds whose investors are all Qualified Purchasers.

**Definition:** QP-only exemption removes the 100-investor cap of 3(c)(1). Practical scale limit is the 1934 Act's Section 12(g) record-holder threshold (2,000 holders / 500 non-accredited). Standard for institutional-scale funds.


Almgren-Chriss Model

# Almgren-Chriss Model

**Category:** trading-execution · **Level:** advanced

**Summary:** Optimal execution framework that minimizes expected cost plus risk-aversion-weighted variance of cost.

**Definition:** Trader minimizes E[X] + λ Var[X], producing a closed-form trading schedule with sinh decay. The foundational model behind institutional execution algorithms. Extensions: stochastic vol, transient impact (Obizhaeva-Wang), self-financing constraints.


Algo Wheel

# Algo Wheel

**Category:** trading-execution · **Level:** intermediate

**Summary:** An execution-management system feature that randomly routes orders across competing broker algorithms to keep brokers honest via measured TCA.

**Definition:** Buy-side traders configure a wheel with eligible algos for each order type (e.g., low-touch IS, VWAP). Orders are randomly allocated according to weights; performance is measured ex-post by TCA; weights shift toward better-performing algos. Major EMS providers: Bloomberg EMSX, FlexTrade, Charles River, Liquidnet.


Iceberg Order

# Iceberg Order

**Category:** market-microstructure · **Level:** intermediate

**Summary:** An order that displays only a small portion of total size at the top of book, replenishing as fills occur.

**Definition:** Allows institutions to work large orders without revealing intention. Most exchanges support native iceberg functionality with configurable visible size. HFTs use iceberg-detection signals to identify and front-run hidden interest, eroding the strategy's edge over time.


Kyle's Lambda

# Kyle's Lambda

**Category:** market-microstructure · **Level:** advanced

**Summary:** The price-impact coefficient in Albert Kyle's (1985) microstructure model: ΔP = λ × Q.

**Definition:** λ measures market depth; higher λ implies thinner liquidity. Estimable via regression of price changes on signed order flow. Used in execution-cost forecasting and as a relative-liquidity metric across stocks or time.


VPIN (Volume-Synchronized PIN)

# VPIN (Volume-Synchronized PIN)

**Category:** market-microstructure · **Level:** advanced

**Summary:** Easley-López de Prado-O'Hara measure of order flow toxicity, designed for high-frequency markets.

**Definition:** VPIN sub-samples by volume-equal buckets and computes |buy − sell| / (buy + sell). High VPIN signals informed flow / toxic conditions. Easley et al. argued VPIN spiked ahead of the 2010 Flash Crash.


Geometric Brownian Motion

# Geometric Brownian Motion
_(GBM)_

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** Continuous-time stochastic process underlying the Black-Scholes model: dS = μS dt + σS dW.

**Definition:** Log-returns are normally distributed with mean (μ−σ²/2)dt. Used as the baseline asset-price model in option pricing. Empirical violations: fat tails, jumps, vol clustering — addressed by extensions (Heston, Bates, GARCH, Lévy processes).


Credit Support Annex

# Credit Support Annex
_(CSA)_

**Category:** fund-operations · **Level:** advanced

**Summary:** ISDA Master annex that governs collateral exchange between OTC derivatives counterparties.

**Definition:** CSA terms specify eligible collateral types, haircuts, thresholds, minimum transfer amounts, settlement currency, and dispute resolution. Variation Margin is exchanged daily based on MTM moves; Initial Margin (since UMR phases 1-6) protects against the 10-day MPOR. Standardizing CSAs (1995, 2016 VM CSA) has been the backbone of post-2008 counterparty risk reduction.


ASC 820

# ASC 820

**Category:** accounting-valuation · **Level:** advanced

**Summary:** FASB standard governing fair value measurement, including the Level 1/2/3 hierarchy and required disclosures.

**Definition:** Originally SFAS 157 (2006), now ASC 820. Defines fair value as exit price in the principal market (or most advantageous market). Requires hierarchy categorization, transfer disclosures, and Level 3 roll-forward. The IFRS analogue is IFRS 13.


Channel Checks

# Channel Checks

**Category:** equities-analysis · **Level:** intermediate

**Summary:** Direct outreach to a company's customers, suppliers, distributors, and former employees to validate or challenge management's narrative.

**Definition:** Standard fundamental research practice. Compliance regulates: who can be contacted, what may be discussed, how findings are documented. MNPI risk is non-trivial; some funds restrict channel checks to former-employee panels and aggregated data.


Crowding

# Crowding

**Category:** quantitative-methods · **Level:** intermediate

**Summary:** The phenomenon where many funds hold similar positions, creating fragility on coordinated unwinds.

**Definition:** Measured via 13F overlap, position concentration in alt-data, factor exposure regressions, and explicit broker crowding indices. Crowded shorts (high days-to-cover, high % of float) are more vulnerable to squeezes; crowded longs (high HF ownership %) underperform in deleveraging episodes. Goldman, Morgan Stanley, and JPM publish proprietary crowding indices used by macro overlay teams.


Catastrophe Bond

# Catastrophe Bond

**Category:** insurance-reinsurance · **Level:** intermediate

**Summary:** A risk-linked security in which principal repayment is contingent on a defined catastrophe (named storm, earthquake, etc.) not occurring.

**Definition:** Investor receives a coupon (typically T-bill + 4-12%) while the principal is held in a collateral trust. If a triggering event occurs (modeled, parametric, or industry-loss), principal is paid to the sponsor (typically a reinsurer or government). Outstanding cat bond market: ~$45bn (2025). Major sponsors: Munich Re, Swiss Re, USAA, FEMA, World Bank. ILS Capital Markets, Twelve Capital, Nephila are active investors.


Insurance-Linked Securities

# Insurance-Linked Securities
_(ILS)_

**Category:** insurance-reinsurance · **Level:** intermediate

**Summary:** Securities whose performance is linked to insurance risk — cat bonds, ILWs, sidecars, collateralized reinsurance.

**Definition:** Total ILS market ~$110bn (2025). Diversification appeal is genuine: catastrophe risk is uncorrelated with financial markets. The 'hard market' of 2023-24 (post 2017-22 loss-heavy years) produced multi-year double-digit returns. Key risk: model/parametric basis between modeled losses and actual claims.


CDX Index

# CDX Index

**Category:** fixed-income-credit · **Level:** intermediate

**Summary:** North American CDS index family: CDX.NA.IG (125 IG names), CDX.NA.HY (100 HY names). Standardized rolling on March 20 / September 20.

**Definition:** Most liquid expression of broad US credit risk. Index spread is a weighted average of constituent CDS spreads. Trading typically focuses on the on-the-run series (highest liquidity). European analogue: iTraxx (Europe Main, Crossover). Major participants: hedge fund credit, dealers, and crossover macro funds.


Delta Hedging

# Delta Hedging

**Category:** derivatives-options · **Level:** intermediate

**Summary:** Maintaining offsetting positions in the underlying so that the portfolio's delta is approximately zero.

**Definition:** Long Δ × N shares per option for short option positions, short for long option positions. Rehedge frequency trades off tracking error vs transaction cost. Continuous hedging is the BS assumption; discrete hedging produces P&L variance proportional to gamma × σ² × Δt² (gamma scalping when long gamma).


Gamma Scalping

# Gamma Scalping

**Category:** derivatives-options · **Level:** advanced

**Summary:** Actively delta-hedging a long-gamma position to monetize realized volatility.

**Definition:** When long gamma, the delta becomes longer as spot rises and shorter as spot falls — selling high and buying low at each rebalance. Cumulative P&L from gamma scalping ≈ ½ × Γ × Σ(ΔS)². Profitable when realized > implied vol; loses theta when realized < implied. The fundamental long-vol P&L mechanism.


Volmageddon

# Volmageddon

**Category:** derivatives-options · **Level:** intermediate

**Summary:** The Feb 5, 2018 vol spike that destroyed inverse-VIX ETPs (XIV, SVXY) overnight.

**Definition:** VIX spiked from 17 to 38 intraday on Feb 5, 2018. Short-vol ETPs that rebalanced near close had to buy VIX futures, accelerating the move. XIV lost 96% in minutes; Credit Suisse retired the product days later. ~$3bn unwound. Marked the high-water mark of pre-COVID short-vol popularity.


Risk Reversal

# Risk Reversal

**Category:** derivatives-options · **Level:** intermediate

**Summary:** Long an OTM call and short an OTM put (or vice versa) at equal delta — a synthetic forward exposure with vol-skew P&L.

**Definition:** FX market quotes vol skew explicitly as risk-reversal pricing. Equity-index risk reversals tend to be short on the call side / long on the put — reflecting the structural put bid. Trading risk reversals isolates skew exposure.


Vol of Vol

# Vol of Vol

**Category:** derivatives-options · **Level:** advanced

**Summary:** The volatility of implied volatility itself; quantified by indices like the VVIX.

**Definition:** When vol-of-vol is high, vega risk is large and the smile is more curved. CBOE publishes VVIX (vol of VIX). Stochastic vol models (Heston, SABR) parameterize vol-of-vol explicitly.


Premium Selling

# Premium Selling

**Category:** derivatives-options · **Level:** intermediate

**Summary:** Strategies that systematically sell options to harvest the variance risk premium.

**Definition:** Covered calls, cash-secured puts, iron condors, short straddles. Earns positive expected value (RV < IV on average) but with negatively-skewed payoff. Popular in retail (covered call ETFs ~$50bn AUM in 2025) and in institutional 'put-write' indexed strategies.


Interest Rate

# Interest Rate

**Category:** fixed-income-credit · **Level:** intro

**Summary:** The price of money over time, expressed as a percentage per period.

**Definition:** Multiple rate concepts: nominal vs real, short vs long, risk-free vs credit-risky, simple vs compound, spot vs forward. Hedge fund rates strategies trade across all these dimensions.


Carry

# Carry

**Category:** global-markets · **Level:** intermediate

**Summary:** The expected return of an asset assuming prices stay constant — yield, dividend, or roll income.

**Definition:** FX carry = rate differential. Bond carry = coupon + roll-down. Commodity carry = roll yield - storage cost. Equity carry = dividend yield. Cross-asset carry strategies (Koijen-Moskowitz-Pedersen-Vrugt 2018) deliver positive Sharpe on average across asset classes.


Convenience Yield

# Convenience Yield

**Category:** commodities-futures · **Level:** advanced

**Summary:** The non-monetary benefit of holding a physical commodity rather than a derivative on it.

**Definition:** Embedded in commodity term structure: F = S × e^((r + storage − convenience) × T). High convenience yield (tight physical) drives backwardation; low convenience yield drives contango.


Yield to Maturity

# Yield to Maturity
_(YTM)_

**Category:** fixed-income-credit · **Level:** intro

**Summary:** The single discount rate that equates a bond's PV of cash flows to its current price.

**Definition:** Solved iteratively (no closed form for coupon bonds). Assumes reinvestment of all coupons at YTM and holding to maturity. For zero-coupon bonds, YTM = (Face/Price)^(1/T) − 1.


Key Rate Duration

# Key Rate Duration

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** Sensitivity of a bond's price to a 1bp shift at a single point on the yield curve, holding other points fixed.

**Definition:** Decomposes total duration into rate-bucket contributions (typically 2y, 5y, 10y, 30y). Used for non-parallel curve risk management — a portfolio can be duration-neutral on average yet exposed to slope/curvature shifts.


Negative Convexity

# Negative Convexity

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** When a bond's price falls faster as rates rise than it rises as rates fall — the inverse of standard bond behavior.

**Definition:** Characteristic of MBS (prepayment option held by borrowers) and callable bonds (call option held by issuer). At low rates, prepayment/call option moves into the money, curtailing upside. Convexity-hedging by MBS portfolios drives episodic 'convexity events' that amplify rate moves.


Recovery Rate

# Recovery Rate

**Category:** fixed-income-credit · **Level:** intermediate

**Summary:** The fraction of par recovered by a bondholder after a default.

**Definition:** Standard recovery assumptions: 40% senior unsecured (US), 25% subordinated, 70% senior secured loans. Actual recoveries vary widely by industry and cycle. CDS settlement recovery is set by ISDA Determinations Committee auctions.


Vasicek Model

# Vasicek Model

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** Single-factor mean-reverting Gaussian short-rate model: dr = a(b − r)dt + σdW.

**Definition:** First widely-used short-rate model (Vasicek 1977). Closed-form bond and option pricing. Allows negative rates (a feature post-2014). Calibration via OLS on historical rates or to swap surfaces. Successors: CIR, Hull-White, Black-Karasinski, LIBOR Market Model, SABR.


Cash-and-Carry

# Cash-and-Carry

**Category:** fixed-income-credit · **Level:** intermediate

**Summary:** Long the cash asset, short the corresponding derivative, financed via repo to harvest the basis.

**Definition:** Classic Treasury basis trade: long cash bond, short futures, financed via tri-party repo. In commodities: buy spot, store, short futures (only profitable if contango exceeds storage cost). In crypto: long spot, short perp, harvest funding rate.


Crypto Cash-and-Carry

# Crypto Cash-and-Carry

**Category:** crypto-digital-assets · **Level:** intermediate

**Summary:** Long spot crypto, short perpetual or quarterly futures to harvest basis or funding rate.

**Definition:** When crypto perpetuals trade above spot (positive funding), longs pay shorts — a hedge fund running long spot / short perp earns the funding. Annualized rates of 10-50% have been common in bull markets. Returns to the basis trade collapse in bear markets when funding inverts.


Tri-Party Repo

# Tri-Party Repo

**Category:** fixed-income-credit · **Level:** advanced

**Summary:** A repo trade where a third-party agent (BNY Mellon, JPM) custodies and values collateral on behalf of both legs.

**Definition:** US tri-party market is ~$5tn outstanding (2025). Reduces operational friction and provides standardized eligibility schedules. The 2008 GFC exposed wholesale funding fragility — daily unwind reform in 2010-2014 improved resilience. Major counterparties: hedge funds (basis trade financing), MMFs (cash investors), bank dealers (intermediation).


DIP Financing

# DIP Financing

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** Debtor-in-possession financing: super-senior loans extended to a Chapter 11 debtor to fund operations during reorganization.

**Definition:** DIP loans are super-senior to all pre-petition debt. Court-approved priming. Yields typically 8-15% with hefty fees and warrants. Lenders are often the existing fulcrum holders (defensive DIP) or third parties (offensive DIP). Distressed funds compete aggressively for DIP roles — gaining information access and downstream restructuring leverage.


Loan-to-Own

# Loan-to-Own

**Category:** hedge-fund-strategies · **Level:** advanced

**Summary:** Distressed strategy of accumulating fulcrum debt with intent to convert to controlling equity through restructuring.

**Definition:** The 21st century replacement for Carl Icahn-style activist equity raids. Distressed funds (Apollo, Oaktree, Elliott, Centerbridge) buy in at distressed prices, drive a plan of reorganization that converts their position to majority equity, then sell or relist post-emergence.


Waterfall

# Waterfall

**Category:** hedge-fund-strategies · **Level:** intermediate

**Summary:** The order in which a company's enterprise value is distributed across capital structure on liquidation or restructuring.

**Definition:** Senior secured first, then senior unsecured, then subordinated, then preferred, then common. The fulcrum security is the class that runs out of recovery — the seniors above receive par, the juniors below receive nothing or new equity. Distressed waterfall analysis is the central skill of restructuring investing.


Schedule 13D Filing

# Schedule 13D Filing

**Category:** regulatory-compliance · **Level:** intermediate

**Summary:** SEC filing required within 5 business days of acquiring more than 5% of a public company with active intent.

**Definition:** 13D requires disclosure of identity, source of funds, purpose, and intentions (passive vs activist). Schedule 13G is a less-disclosure alternative for purely passive holders. The 2024 SEC amendment compressed the deadline from 10 to 5 business days. Activist funds typically time their position-build to file just inside the window for maximum surprise impact.


Proxy Contest

# Proxy Contest

**Category:** regulatory-compliance · **Level:** advanced

**Summary:** Solicitation of shareholder votes against management's slate, typically to elect dissident directors.

**Definition:** Activist primary tool. Mailings, websites, ISS/Glass Lewis recommendations. The 2022 SEC universal proxy card rule required all nominees on a single ballot, lowering the cost of contests. Major proxy battles 2024-26: Disney/Peltz, Salesforce/Starboard, Norfolk Southern/Ancora.