THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 337

CHAPTER 12 Nonbank Financial Institutions 305 Money Market Mutual Funds An important addition to the family of mutual funds resulting from the financial innovation process described in earlier chapters is the money market mutual fund Recall that this type of mutual fund invests in short-term debt (money market) instruments of very high quality, such as treasury bills, commercial paper, and bank certificates of deposit There is some fluctuation in the market value of these securities, but because their maturity is typically less than six months, the change in the market value is small enough that these funds allow their shares to be redeemed at a fixed value Changes in the market value of the securities are figured into the interest paid out by the fund In the United States, many money market mutual funds allow their shareholders to redeem shares by writing cheques on the funds account at a commercial bank In this way, shares in money market mutual funds effectively function as chequable deposits that earn market interest rates on short-term debt securities For this reason, in the United States the share of money market mutual funds in total financial intermediary assets has increased to nearly 6% and currently money market mutual funds account for around one-quarter of the asset value of all mutual funds Hedge Funds Hedge funds are a special type of investment fund, with estimated assets of more than $1 trillion Hedge funds have received considerable attention recently due to the shock to the financial system resulting from the near collapse of Long-Term Capital Management, once one of the most important hedge funds (see the FYI box, The Long-Term Capital Management Debacle) Well-known hedge funds in the United States include Moore Capital Management and the Quantum group of funds associated with George Soros Investors in hedge funds, who are limited partners, give their money to managing (general) partners to invest on their behalf Several features distinguish hedge funds from mutual funds Hedge funds have a minimum investment requirement between $100 000 and $20 million, with the typical minimum investment being $1 million Long-Term Capital Management required a $10 million minimum investment In the United States, federal law limits hedge funds to have no more than 99 investors (limited partners) who must have steady annual incomes of $200 000 or more or a net worth of $1 million, excluding their homes These restrictions are aimed at allowing hedge funds to be largely unregulated, on the theory that the rich can look out for themselves Many of the 4000 U.S hedge funds are located offshore to escape regulatory restrictions Hedge funds also differ from traditional mutual funds in that they usually require that investors commit their money for long periods of time, often several years The purpose of this requirement is to give managers breathing room to pursue long-run strategies Hedge funds also typically charge large fees to investors The typical fund charges a 2% annual fee on the assets it manages plus 20% of profits The term hedge fund is highly misleading because the word hedge typically is used to indicate strategies to avoid risk As the near failure of Long-Term Capital illustrates, despite their name, these funds can and take big risks Many hedge funds engage in what are called market-neutral strategies where they buy a security, such as a bond, that seems cheap and sell an equivalent amount of a similar security that appears to be overvalued If interest rates as a whole go up or down, the fund is hedged because the decline in value of one security is matched by the rise in value of the other However, the fund is speculating on whether the spread between the prices on the two securities moves in the direction predicted by the fund managers If the fund bets wrong, it can lose a lot of