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Waz new in investing?

In Financial competency, Financial planning on 02/07/2011 at 8:46 am

End of the world funds otherwise known as tail risk or black swan funds.

Although the names tail risk funds and black swan funds are often used interchangeably, they are distinct. Tail risk events are situations that, while conceivable, are highly unlikely based on mathematical modeling. By contrast, a black swan — a concept popularized by Nassim N. Taleb’s 2007 book “The Black Swan” — is an event that models fail to predict.

This piece explains the latest fad to hit the US and which will very soon come the wayof private banking clients here.

So how do such Armageddon funds work? Take a situation like the collapse of China’s economy, an event considered highly unlikely. While most American investors do not own Chinese stocks, real estate or currency, the fear is that a shock to China would spread to the rest of the world. As the stock markets fell, a tail risk or black swan fund would profit because it owned the options to sell shares in the Standard & Poor’s 500-stock index at far higher levels. The more the index dropped, the more valuable those options would become.

 

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