Hedge funds are a special type of mutual funds, which refer to financial funds that combine financial derivatives such as financial futures and financial options with financial instruments for the purpose of profit. In layman's terms, hedge funds are funds that avoid or reduce risks through hedging. Moreover, hedge funds cover many fields and are showing an increasingly complex structural trend. It is estimated that their assets in the United States have exceeded 2.6 trillion US dollars. In recent years, Long-term Capital Management, once one of the most important hedge funds, has The imminent collapse of the economy has brought a severe impact to the financial system. Therefore, hedge funds have received widespread attention. Notable hedge funds include Moore Capital Management and George Soros' Quantum Fund collective. Investors in hedge funds are limited partners, who hand over their funds to partners who are responsible for management to carry out investment activities. Hedge funds differ from traditional mutual funds in certain characteristics. Hedge funds have minimum investment requirements ranging from $100,000 to $20 million, usually $1 million. Long-Term Capital Management requires a minimum investment of $10 million. Federal law requires a hedge fund to have no more than 99 investors, known as limited partners, with stable income of at least $200,000, or net worth other than a home of more than $1 million. The rationale for these restrictions is that wealthy people guard their money's assets more carefully, so hedge funds remain largely unregulated. Many of the 4,000 hedge funds are based overseas to avoid regulation.

Hedge funds also differ from traditional mutual funds in that they usually require investors to give up the use of assets over a longer period of time. This requirement is intended to create a permissive environment for managers to develop long-term strategies. Hedge funds often charge investors hefty fees. Generally speaking, hedge funds charge an annual fee of 2% on their assets and 20% on profits.

Hedge fund names are misleading because "hedge" often indicates a risk-averse investment strategy. The case of Long-Term Capital Management's bankruptcy shows that despite their name, these funds can and take a lot of risk. Many hedge funds pursue a "market neutral" strategy in which they buy a certain security, such as a bond, that appears cheap and sell an equal amount of a similar security that appears overvalued. If interest rates overall rise or fall, the fund's risk is hedged because a fall in the value of one security is matched by an increase in the value of another. However, the fund needs to speculate on whether the spread between the two securities moves in the direction predicted by the fund manager. If a Fund loses its bet, it could suffer significant losses, particularly if the Fund uses leverage to operate its positions, borrowing large amounts of money so that its capital is significantly small relative to the size of its portfolio. When Long-Term Capital Management was bailed out, its leverage ratio was 50:1, meaning its assets were 50 times its capital, and even before it got into trouble, it was still 20:1.

The near-collapse of Long-Term Capital Management led many U.S. politicians to call for greater regulation of these funds, and the Securities and Exchange Commission set new rules requiring hedge funds to register with it. However, since many funds operate overseas, such as the Cayman Islands, outside the jurisdiction of the United States, supervision is difficult. What U.S. regulators can do is ensure that banks and investment banks have clear guidance on the size of loans they can provide to these funds, and require these institutions to obtain sufficient confidence disclosures from hedge funds about their risk positions, but this would also Simply reducing part of the risk will not solve the root cause.