C3

what are the major due diligence checkpoins in selecting active managers of alternative investments?

1) assess the market opportunity offered ( are there market inefficiencies that the manager specializes in?) 2)assess the investment process 3)assess the organization (stable and well run? staff turnover?) 4)assess the people by meeting them, characters 5) assess the terms and structure(amount and time period) 6)assess the service providers (lawyers, brokers, ancillary staff) the outside firms that support the managers business 7)review documents such as prospectus and private placement memorandum and the audits

what are the distinguishing features for hedge funds?

1) intentionally structured to avoid regulation to be less transparent in reporting their investment strategies 2) use strategies not seen in conventional investments

what are the commonly known benchmark for private equity? how is it calculated? how is it biased?

Cambridge Associates and Thomson Venture Economics Constructed for the buyout and venture capital values is calculated from events like IPOs and mergers, new financing as they are not usually available repricing occurs infrequently private equity investors also construct custom benchmarks

what is merger arbitrage (deal arbitrage)?

a style of hedge funds - focuses on returns from mergers, spin-offs, takeovers etc buy acquiree and sell acquirer

how emerging markets style can be made?

a style of hedge funds - only permit long positions and no derivatives to hedge the investments

what is global macro?

a style of hedge funds - take positions in major financial and non-financial markets through derivatives and currencies. they focus on an entire group of area instead of individual securities or classes of securities

what is fixed income arbitrage?

a style of hedge funds - taking long and short positions in fixed income instruments based on expected changes in the yield curve or credit spreads

what is private equity in distressed securities investing strategies?

a type of distressed securities investing strategies - an active approach where the investor acquires positions to obtain controls and ownership so they can influence

what is long-only value investing strategy?

a type of distressed securities investing strategies - try to find opportunities where the prospects will improve or before others do.

what are advantages and disadvantages of investing in direct equity real estate?

advantages - many related expenses are tax deductible - ability to use more leverage - more direct control than equity - diversify geographically - lower volatility of returns than stock disadvantages - lack of divisibility (too much% in PF) - high information costs, high commissions, high operating and maintenance costs, hands-on management requirements - special geographical risks, neighborhood deterioration, political risks, changing tax codes etc

how alternative investments can be categorized into three categories?

alternative investment can provide....... 1)exposure to asset classes that stocks and bonds cannot provide 2)exposure to special investment strategies (hedge and venture capital funds) 3)special strategies and unique asse classes (funds that invest in private equity and distressed securities)

fallen angel?

an issue of debt dropped from investment grade

what is systematic trading strategies?

apply sets of rules such as short, intermediate, and/or long -term trends, contrarian

what are the benefits and drawbacks to adding alternative investments to a portfolio?

benefits - diversification, return enhancement drawbacks - amount of capital required, lack of liquidity

what are the similarities between commodity swap and interest rate swaps?

both are agreements between two parties to exchange cash flows based on whether a certain market variable is above or below a fixed benchmark value.(swap rare)

compare buyout funds and venture capital funds

buyout funds have higher level of leverage earlier and steadier cash flows less error in the measurement of returns less frequent losses less upside potential

compared to other alternative investments, what is the feature of commodity investment? what about risk feature?

commodity investments are usually more liquid risk feature include low correlation with stocks and bonds and business cycle sensitivity, most have a positive correlation with inflation - good diversification to an investor's portfolio

what are the differences between commodity swap and interest rate swap?

commodity swaps are more risk considerations due to more inputs commodity swaps have a seasonality factor as supply and demands shift due to a seasonality

which one is more exposure, more convenient, more carry cots between indirect and direct commodity investments?

direct more exposure, more costs, less convenient than indirect commodity investments

what is discretionary trading strategy?

discretion of the CTA, same as any active manager

distressed securities? how is it calculated? how is it biased?

distressed securities funds are considered a hedge fund SUBGROUP. sub-index for distressed securities same characteristics as long-only hedge fund benchmarks biases - self reporting, backfill or inclusion bias, popularity bias, survivorship biases.

show calculation of the swap price given 1 and 2-year forward rates, 4% and 5%, forward oil prices $100 and $120, using the prices of zero coupon bonds with a face value of $1000

first calculate 1000/1.04=a a/1.05=b [(a x 100) + (b x 1210)]/[(a+b)]

what will affect value of a commodity swap? and how do you remove them?

forward prices, interest rates, market prices? counterparties need to hedge the interest rate risk using such as IRS

financially settled swap?

less credit risk compared to a prepaid swap

what forms usually private equity funds take?

limited partnerships or limited liability companies (LLCs) these will limited the loss to investors to the initial investment and avoid corporate double taxation limited partnerships sponsor is called general partner and LLC sponsor is called managing director

what are the types of distressed securities investing strategies?

long-only value investing distressed debt arbitrage private equity

what are the conventions to consider in hedge fund performance evaluation?

longer lockup periods tends to outperform shorter lockup periods young funds tend to outperform older funds smaller funds tend to outperform larger funds

what are the common features of alternative investments?

low liquidity diversification due diligence costs(high costs because of their complex characteristics and low transparency) difficult to value access to information (alternative markets are informationally less efficient than stock markets)

what issues need to be addressed in formulating a private equity investment strategy?

low liquidity diversification through a number of positions so Large funds are required diversification strategy - know the unique aspects of a proposed private equity investment that will relate to the overall portfolio plans for meeting capital calls - committed funds have to be ready whenever needed to meet calls.

what is market liquidity risk in distressed securities investing?

low liquidity and there can be cyclical supply and demand

risk is between equities and bonds what alternative investment is it?

managed futures

what is market risk in distressed securities investing?

market risk due to macroeconomic change is usually less important than market liquidity risk and event risk

what are the six categories of alternative investments?

real estate, private equity, commodities, hedge funds, managed futures and distressed securities

what are the five divided scheme of hedge funds strategies?

relative value event driven equity hedge global asset allocators short selling

what is event risk in distressed securities investing?

return on one investment within this class typically depends on an event for its company. these are uncorrelated to the economy, it can provide diversification benefits

what are things to note about returns, leverage and risk in hedge funds performance evaluations?

returns - to smooth out variability investors often compute a rolling return such as 12month moving average. leverage - they trat an asset as if it were fully paid for(look through the leverage) risk - using standard deviation is MISLEADING. they are skewed with significant leptokurtosis (fat tails)

what is J factor risk in distressed securities investing?

risk refers to the role that courts and judges can play in the return relating to unpredictable human element

what hedge fund styles fall in the event-driven?

short-term focus on an event merger arbitrage, and distressed securities

what are the roles of Managed Futures in the portfolio?

significant diversification - potentially improving Sharpe ratio

what hedge fund styles fall in Global asset allocators?

sonomama, Global macro strategies take long and short positions in a variety of both financial and non-financial assets

what hedge fund styles fall in hedged equity?

sonomama, hedged equity strategies take long and short equity positions with varying overall net long or short positions and can include LEVERAGE

What is Venture capital limited partnership like?

the manager (General partner) invests the investors' (limited partners') moeney

hedge funds? how is it calculated? how is it biased?

there are many hedge fund benchmarks as they vary a great deal in composition and even frequency of reporting they are susceptible to many biases including self-reporting backfill inclusion, survivorship and popularity biases. many of them produce an upward biases.

what are the likely results of adding Hedge Funds to equity only or bonds portfolio?

they provide good diversification, higher sharpe ratio hedge funds are generally higher risk-adjusted returns than stock stocks and bonds

what is hedge equity strategies (equity long-short)?

this is the largest hedge fund classification - take long and short positions and unlike equity market neutral, hedge equity strategies do NOT focus on balancing the positions to eliminate systematic risk, and can range from net long to net short.

what are the limitations of usage of Sharpe ratio with hedge fund performance calculation?

time dependency - annualized Sharpe ratio is biased upward as they use shorter time period. assumes normality - standard deviation is not appropriate for skewed return distributions assume liquidity - illiquid holdings have upward biased Sharpe ratio as downward biased standard deviation etc assume uncorrelated returns - standard deviation will be artificially lower when returns correlated across time (returns rising in trend) Sharpe ratio assumes RETURNS ARE NOT SERIALLY CORRELATED stand alone measure - it does not automatically consider diversification effects research shows Sharpe ratio is not accurate for predicting winners Managers can manipulate their returns artificially high

what are the likely results of adding Managed Futures to equity only or bonds portfolio?

usually considered a category of hedge funds higher return but lower sharpe ration than bonds same returns but a better sharpe ration than equity managed futures provide near zero correlation between the index and the 50/50 stock/bond fund.

what are orphan equities investing?

(long only value investing with distressed securities investing strategies) purchase of the equities of firms emerging from reorganization.

vulture funds?

(private equity with distressed securities investing strategies) specialize in purchasing undervalued distressed securities

what are angel investors?

(venture capital) accredited investors and the first outside investors after the family and frieds of the company founders

what is the common compensation structure of a hedge fund to manager?

AUM fee of 1-2% and incentive fee of 20% of profits

what ia a lock-up period?

a lock up period is a common provision in hedge funds to limit withdrawals by requiring a minimum investment period.

what are the commonly known benchmark for commodity markets? how is it calculated? how is it biased?

Dow Jones UBS Commodity Index and the SP Commodity Index they represent returns associated with passive long positions in futures they cannot use a market cap weighting they have to be investable they have ot be either basing weights on world production of the underlying commodities or basing weights on the perceived relative worldwide importance of the commodity can be either arithmetic or geometric averaging biases - indices vary widely with respect to purpose, composition and method of weighting

what are the likely results of adding Commodities to equity only or bonds portfolio?

Great diversification benefit to a portfolio of stocks and bonds Some are even negative correlations Except for some agricultural subgroups, they have a very strong positive correlation with inflation Higher Sharpe ratio, lower standard deviation usually lower return than stock

what are the shared features with hedge funds for Managed Futures? and what is the difference?

Like hedge funds, managed futures structure limited partnership, performance base fees, absolute return etc managed futures differ as they only trade in derivatives markets and indices(more macro) and more regulated, while HF trade in spot and use futures for hedging and look for individual asset price anomalies (more micro)

CPO and CTA?

Managed futures - CPO is commodity pool advisor limited partnership CTA - CPO hires CTA commodity trading advisers to manage individual funds or groups of funds in the pool They are both registered with the CFTC(commodity futures trading commission) and NFA(national futures association)

how is it categorized in Buyout Funds?

Middle-market buyout funds Mega-cap buyout funds depending on the size of the TARGET

what are the commonly known benchmark for managed futures? how is it calculated? how is it biased?

Mount Lucas Management Index - replicate the return to a mechanical trend following strategy CTA Indices - peer group managed futures funds - dollar-weighted or equal weighted returns from databases biases - requires special weighting scheme

what are the commonly known benchmark for indirect Real estate investments how is it calculated?

NAREIT - National Association of Real Estate Investment Trusts Index cap-weighted and includes all REITs on the NSE or AMEX

what are the commonly known benchmark for direct Real estate investments how is it calculated and how often updated? how is it biased?

NCREIF - National Council of Real Estate Investment Fiduciaries Property Index value weighted index of commercially owned properties based both on geographic location and type (apartment or industrial etc) by annually appraisal (quarterly updated) volatility of the index is DOWNWARD BIASED

what are the likely results of adding Private Equity to equity only or bonds portfolio?

Private Equity is less diversifier but more a long-term return enchancer they are very illiquid, require long term commitment, high level of risk usually higher correlation with equity markets - so moderate diversification compare to other alternative investments some misleading lower correlations with equity markets are due to stale(infrequently updating) prices

REITs or direct real estate which one increase Sharpe ratio and return more?

REITs increases slightly better Sharpe ration than direct real estate REITs increases more portfolio return typically

what is fund of funds?

a style of hedge funds - a hedge fund that invests in many hedge funds - good diversification but more fees paid. MORE correlated with equities than with individual hedge fund strategies

what is equity market neutral?

a style of hedge funds - attempt to exploit price discrepancies through combinations of long and short positions - eliminating systematic risk while capitalizing on mispricing

what is convertible arbitrage?

a style of hedge funds - buying undervalued convertible bonds, preferred stock or warrants while shorting the underlying stock to create a hedge. investors gain from increases of the convertible, the short rebate(interest on short-sale proceeds) and further decline in the stock price.

how distressed securities style can be made?

a style of hedge funds - can be made in both debt and equity. shorting can be difficult or imposible, can earn a high return because many investors do not want to deal with the legal complications.

show calculation of the swap price given 1 and 2-year forward rates, 4% and 5%(1yr fwd 1yr from today), forward oil prices $100 and $120, using the current and forward rates

[ (100/1.04)+(120/(1.04)(1.05)) ] / [ (1/1.04) + 1/( (1.04)(1.05) ) ]

what is the most liquid alternative investments?

commodities, then publicly traded commodity futures funds(managed futures) some hedge funds structure distressed securities are liquid too

what are the indirect real estate investments?

companies that develop and manage real estate real estate investment trusts (REITs) commingled real estate funds (CREFs) which are pooled investments in real estate that are professionally managed - more flexible than REITs as they are privately held separately managed accounts by managers like those that manage the CREFs Infrastructure funds which provide private investment in public projects like schools and hospitals for a promised cash flow in the future

what are the buyers risks associated with a prepaid swap?

counterparty risk market risk from price change financial risk that interest rate increases leading to an increase in the opportunity cost of the prepaid price

what is backwardation's full explanation

couterparties who are long the commodity dominate the market and willing to accept a reduced price in the fure to guarantee selling their crops or something at a known price. contange is the other way around.

what are direct investment in PE and indirect investment in PE _

direct - direct purchases from the firm (preferred shares etc) indirect - through private equity funds (Venture capital and buyouts)

Commodities - what are indirect and direct investments like?

direct - either through the purchases of the physical commodity or futures indirect - own firms that mine or associated with a commodity business

Name stages of venture capital and describe characteristics of each stage

early stage (3) - seed (small capital by the entrepreneur to get the idea off the ground) - start-up (still pre-revenue stage bringing the entrepreneur's idea to commercialization) - first stage (additional funds are required) latter stage - occurs after revenue as started, sales expanding exit stage - time when the venture capitalist realizes the value of the investment via merger, sale or IPO

what are the risks associate with investing in distressed securities?

event risk market liquidity risk market risk J factor risk

what hedge fund styles fall in the Relative value strategies?

exploit price discrepancies on the relative mispricing, so the equity market neutral, the convertible arbitrage, and the fixed-income arbitrage strategies

describe characteristics of fund of funds

good entry level investment, better diversification, more liquidity to investors but higher management fees better benchmark than typical hedge fund index because there is less survivorship and backfill bias FOF often suffer from style drift - individual hedge fund managers tilt their portfolios in different directions. MORE correlations with equity markets than those of individual hedge funds

in which alternative investments Distressed securities typically included?

hedge fund class (more liquid) or private equity class (more illiquid)

what are the issues involved and critique about hedge fund performance evaluations?

hedge funds are absolute return vehicles so no benchmark exists. - so how do you determine the alpha with no benchmark?? to create comparable portfolios 1) create single and multi factor models 2) use an optimization technique to create a tracking portfolio

what are the likely results of adding Distressed Securities to equity only or bonds portfolio?

higher average return BUT a large negative skew so Sharpe rations are misleading returns are event-driven, so they are uncorrelated with the overall stock market

how direct or indirect alternative investments differ?

in a direct - you own the asset (low liquidity, high transaction costs low transparency, low mobility generally) in an indirect - you own shares of a fund(limited partnership etc) that owns the shares

semivariance in hedge fund performance evaluation?

in a downside deviation calculation where the threshold return is a recent average return, you can call it semivartance

how can assess the seasonality of commodity prices?

include both a varying quantity and a price component in the swap agreement

what is high water marks (HWMs)?

investor and subscription date specific the previous high value of the fund set to require manager to perform above it, only if they met, incentive fees can be paid.

downside deviation ?

it measures only the dispersion of returns below some specified threshold return.. downside deviation= √[(∑min(return - threshold)^2 / (n-1))] where threshold return is usually zero or risk-free rate

what is popularity bias?

popularity bias arises in value-weighted index when one funds increases in value then attracts more and more capital, which results in further inflow of investment misleading effect on the index.

what is the prepaid swap and its drawback?

prepaid swap - pays an amount at the inception of the contract to receive a specified amount of oil in the future therefore significant credit risks involved (counterparty defaults)

hedge funds or private equity which one is more tax efficient generally?

private equity is more tax efficient generally remember - insurance company and banks are taxable investors while pension, foundation,endowments are tax-exempt

what is distressed debt arbitrage strategy?

purchasing of a companys distressed debt while short selling the companys equity. returns can be obtained in two ways 1 if the firms condition declines, the equity decline more as debt has seniority 2 if company improves due to priority of paying intrest over dividends, returns to bondholders should be greater than those equity holders.

what are the likely results of adding Real Estate to equity only or bonds portfolio?

real estate investments can increase Sharpe ration due to lower correlation with the existing assets as real estates have a large idiosyncratic risk component

explain three return components for a commodity futres contract

spot return - price return caused by underlying commodity spot price collateral return - collateral tield that is the risk-free rate, given no-arbitrage assumption if an investor is long a contract and invests the value of the futures contract in Tbills, he will be able to pay for the required purchase at the futures maturity. such a fully hedge position should earn the risk-free rate roll return - roll yield is the change in the futures price not explained by the change in the spot price usually due to backwardation. backwardation exists with a downward sloping term (futures prices are lower) positive rol return

what is the key features for infrastructure funds?

stable, long-term real returs, more regulated, reliable cash flows, low correlation with equity - providing diversification, low risk but lower returns

how is the risk and returns like for start up, middle market private companies and private investment in public entities? what about liquidity and asymmetric information?

start-up and middle are more risky and higher returns but on average due to their high initial failure rate, their returns are lower than investments in established companies via buyout funds they also suffer from asymmetric information in terms of liquidity, all of these three are low liquidity

how do you categorize private equity?

start-up or formative stage (have not sold products or just started selling products), more risky and higher returns middle-market private companies (getting large revenues, preparing for IPO) private investment in public entities (PIPEs) - purchasing to privatize public company, purchasing an established private company, or purchasing a division of an established company

what are the factors that determine whether a commodity is a good inflation hedge?

storability - storable commodity is a good hedge against unexpected inflation. metals, energy, while foods are negatively affected by unexpected inflation economic activity - whether commodity is linked to economic activity.(metals energy are linked and good hedge, while foods are little affected so little hedge only)

Name Managed futures(CTAs) strategies

systematic trading strategies discretionary trading strategy

what are the special issues in alternative investments that investment advises of private wealth clients should address?

taxes - can be unique to the individual suitability - should be very careful for private investors due to short-term horizon communication - client may not be knowledgeable enough to effectively communicate her needs decision risk - risk of changing a strategy irrationally - because individuals tend to make emotional decisions concentrate positions - wealthy individuals tend to hold large positons in closed held companies - they need be properly allocated and diversified

what is dividend recapitalization?

the buyout fund issues debt through an acquired firm and pays a special dividend to itself and other equity investors. ownership structure does not change while increasing leverage reducing the firm's equity

what are the main points in Valuing Swaps?

value at any time of sap is the PV of the settlement cash flows that can be locked in by taking offset positions in forward contract value at inception of both types of swap has to be zero values will change as interest rates change values of commodity swaps change as commodity prices change values of IRS and commodity swaps both change over time even with no market rates and prices change

how do buyout funds generate value?

via IPO or private placement or through dividend recapitalizations