Alternative Investments
A private equity firm sells a portfolio company to a buyer that is active in the same industry as the portfolio company. This transaction is best described as a(n): A. trade sale. B. secondary sale. C. initial public offering.
A
Concentrated portfolio strategies are attractive because of their: A. potential to generate alpha. B. ability to track market indices. C. low risk.
A
Q. Alternative investment funds are typically managed: A. actively. B. to generate positive beta return. C. assuming that markets are efficient.
A
Q. An investor allocates $10 million at the beginning of the year to a hedge fund charging a management fee of 2% and an incentive fee of 20% with a 6% (hard) hurdle rate. At year-end the value of the investment is $11.8 million. The incentive fee is calculated net of the management fee and the management fee is based on the year-end value. The net-of-fees return the investor earned is closest to: A. 13.71%. B. 13.24%. C .13.93%.
A
Q. An investor seeking an indirect debt investment in real estate will: A. purchase a mortgage-backed security. B. purchase a commercial property. C. originate a residential mortgage
A
Q. Compared with other investment asset classes, an investment in real estate is least likely to be characterized by: A. homogeneity. B. fixed location. C. basic indivisibility.
A
Q. A hedge fund begins the year with $120 million and earns a 25% return for the year. The fund charges a 1.5% management fee on end-of-year fund value and a 15% incentive fee on the return, net of the management fees, that is in excess of a 6% fixed hurdle rate. The fund's investors' return for the year, net of fees, is closest to: A. 20.56%. B. 21.25%. C. 19.66%.
A The $120 million grows by 25% to $150 million [= $120 million × (1 + 0.25)]. The management fee is $2.25 million (= $150 million × 0.015), leaving $147.75 million, net of the management fee, or an increase of $27.75 million over the beginning value of $120 million. The 6% hurdle rate requires an increase of $7.2 million (= $120 million × 0.06), so the fund has earned $20.55 million (= $27.75 million − $7.2 million) over the hurdle rate, net of the management fee.
An investor who has positions in multiple long-short equity hedge funds and is concerned about whether these positions are sufficiently diversified will mostly likely be concerned about the lack of: A. transparency in reported positions. B. frequent independent valuations. C. liquidity in the underlying assets.
A . Long-short hedge funds invest in liquid, publicly traded equity (taking long and short positions); therefore, the underlying positions can be reversed easily and there is no need for independent valuations because current market prices are available. The investor will have difficulty in determining if the different funds are holding diverse or concentrated positions (both within each fund and between funds) because hedge funds generally do not reveal their holdings.
A manager is compensated with a management fee based on committed capital plus an incentive fee based on fund performance. This scenario best describes the fee structure of a: A. private equity fund. B. hedge fund. C. mutual fund.
A A private equity manager is compensated through a management fee based on committed capital plus an incentive fee.
Q. What is the most significant drawback of a repeat sales index to measure returns to real estate? A. Sample selection bias B. Understatement of volatility C. Reliance on subjective appraisals
A A repeat sales index uses the changes in price of repeat-sale properties to construct the index. Sample selection bias is a significant drawback because the properties that sell in each period vary and may not be representative of the overall market the index is meant to cover. The properties that transact are not a random sample and may be biased toward properties that changed in value. Understated volatility and reliance on subjective appraisals by experts are drawbacks of an appraisal index.
Q. Capricorn Fund of Funds invests GBP 100 million in each of Alpha Hedge Fund and ABC Hedge Fund. Capricorn FOF has a "1 and 10" fee structure. Management fees and incentive fees are calculated independently at the end of each year. After one year, net of their respective management and incentive fees, the investment in Alpha is valued at GBP80 million and the investment in ABC is valued at GBP140 million. The annual return to an investor in Capricorn, net of fees assessed at the fund of funds level, is closest to: A. 7.9%. B. 8.0%. C. 8.1%.
A First, note that "1 and 10" refers to a 1% management fee, and a 10% incentive fee. End of year capital = GBP 140 million + GBP80 million = GBP220 million Management fee = GBP220 million × 1% = GBP2.2 million Incentive fee = (GBP220 − GBP200) million × 10% = GBP2 million Total fees to Capricorn = (GBP2.2 + GBP2) million = GBP4.2 million Investor net return: (GBP220 − GBP200 − GBP4.2) / GBP200 = 7.9%
Q. An argument for investing in commodities is that they: A. may provide a hedge against inflation. B. are correlated negatively with stocks and bonds. C. have low volatility.
A Given that commodity prices are positively correlated with inflation, commodity investing may provide higher returns when inflation is rising. In this way, commodity investing can provide inflation protection.
A hedge fund limited partnership agreement describes the general partner's total fees for each year as follows: The general partner will measure the fair value of the fund's assets at the beginning of the year (net of fees from the previous year) and the fair value of the fund's assets at the end of the year. The general partner will receive 15% of any increase in fair value in excess of the 1-year US Treasury yield at the beginning of the year. This fee structure most likely includes a: A. hard hurdle rate. B. management fee. C. high-water mark provision.
A In order for the general partner to earn its incentive fee, the return on the fund must exceed the Treasury yield (which is a hurdle rate), and the incentive fee is based only on the return in excess of the hurdle rate, so it is a hard hurdle rate. The general partner doesn't earn any fee regardless of performance, so there is no management fee. There is no mention of the fund's value needing to exceed its historical maximum value, so there is no high-water mark.
Q. Risks in infrastructure investing are most likely greatest when the project involves: A. construction of infrastructure assets. B. investment in existing infrastructure assets. C. investing in assets that will be leased back to a government.
A Infrastructure projects involving construction have more risk than investments in existing assets with a demonstrated cash flow or investments in assets that are expected to generate regular cash flows because the assets will be leased back to a government.
Q. Compared with traditional investments, alternative investments are more likely to have: A. greater use of leverage. B. long-only positions in liquid assets. C. more transparent and reliable risk and return data.
A Investing in alternative investments is often pursued through such special vehicles as hedge funds and private equity funds, which have flexibility to use leverage. Alternative investments include investments in such assets as real estate, which is an illiquid asset, and investments in such special vehicles as private equity and hedge funds, which may make investments in illiquid assets and take short positions. Obtaining information on strategies used and identifying reliable measures of risk and return are challenges of investing in alternatives.
Q. Which of the following is most likely to be available when conducting hedge fund due diligence? A. The benchmark used by the fund B. Information on systems risk management C. Details of investment strategies and processes
A It should be possible to identify the benchmark against which the fund gauges its performance in the hedge fund due diligence process. It should also be possible to establish the range of markets in which the fund invests as well as the fund's general strategy. Hedge funds consider their strategies, systems, and processes to be proprietary and are unwilling to provide much information to potential investors.
Q. Both event-driven and macro hedge fund strategies use: A. long-short positions. B. a top-down approach. C. long-term market cycles.
A Long-short positions are used by both types of hedge funds to potentially profit from anticipated market or security moves. Event-driven strategies use a bottom-up approach and seek to profit from short-term events typically involving a corporate action, such as an acquisition or a restructuring. Macro strategies seek to profit from expected movements in evolving economic variables.
Q. Which of the following hedge fund strategies emphasizes a top-down approach? A. Macro B. Equity hedge C. Event-driven
A Macro hedge funds emphasize a "top down" approach to identify economic trends and trade on expected movements in economic variables. B is incorrect because equity hedge funds use a "bottom up" approach and employ strategies, such as market neutral, which uses quantitative (technical) and/or fundamental analysis to identify under- and overvalued equity securities at the company level.
Q. Hedge fund losses are most likely to be magnified by a: A. margin call. B. lockup period. C. redemption notice period.
A Margin calls can magnify losses. To meet the margin call, the hedge fund manager may be forced to liquidate a losing position in a security, which, depending on the position size, could exert further price pressure on the security, resulting in further losses. Restrictions on redemptions, such as lockup and notice periods, may allow the manager to close positions in a more orderly manner and minimize forced-sale liquidations of losing positions.
The real estate index most likely to suffer from sample selection bias is a(n): A. repeat sales index. B. REIT index. C. appraisal index.
A Only properties that sell in each period and are included in the index and vary over time which may not be representative of the whole market.
Q. Which attribute would a private equity firm most likely desire when deciding if a company is particularly attractive as a leveraged buyout target? A. Sustainable cash flow B. Efficient management C. Market value exceeds intrinsic value
A Private equity firms look for companies that have strong cash flows and a significant amount of physical assets. These physical assets can be used as security and borrowed against.
Q. Hedge funds are similar to private equity funds in that both: A. are typically structured as partnerships. B. assess management fees based on assets under management. C. do not earn an incentive fee until the initial investment is repaid.
A Private equity funds and hedge funds are typically structured as partnerships where investors are limited partners (LP) and the fund is the general partner (GP). The management fee for private equity funds is based on committed capital whereas for hedge funds the management fees are based on assets under management. For most private equity funds, the general partner does not earn an incentive fee until the limited partners have received their initial investment back.
Which of the following is most likely a private real estate investment vehicle? A. Real estate limited partnership B. Real estate investment trust C. Collateralized mortgage obligation
A Real estate limited partnerships are a form of private real estate investment.
Q. A measure that is most likely well suited to analyzing the performance of alternative investments that may exhibit negative skewness in returns is the: A. Sortino ratio. B. Sharpe ratio. C. safety-first measure.
A The Sharpe ratio and the safety-first measure use standard deviation as the measure of risk, which ignores the negative skewness in returns. The Sortino ratio uses the downside deviation as the measure of risk, which will reflect negative skewness if present.
Q. Which of the following statements concerning the historical record of alternative investments is most likely correct? A. The exclusion of returns of funds that have been liquidated leads to an upward bias in index performance. B. The use of appraised values instead of market prices leads to an upward bias in volatility. c. The inclusion of previous return data for funds that enter the index leads to a downward bias in index performance.
A The exclusion of returns of funds that have been liquidated is called survivorship bias. It is most likely that only poor performers are eliminated and thus reported returns are artificially inflated.
Investors look at many key due diligence factors when investing in hedge funds. Which of the following factors is most likely the biggest challenge to fully assess? A. Investment strategy and process B. Size and longevity C. Track record
A The investment strategy and process of a hedge fund is likely to be challenging to fully assess because hedge funds often limit disclosure in order to maintain their competitive advantage and to not give away information that is considered proprietary.
Q. At the first of the year, an investor decides to invest $1.5 million in a hedge fund with an incentive fee of 15% and a hard hurdle rate of 4%. At the end of the year, the fund has a return of 23.3%. The incentive fee payment that the general partner of the fund earned based on this client's investment at the end of the year is closest to? A. $43,425 B. $52,425 C. $38,445
A The investor's return met the 4% hurdle rate, so the incentive fee charged would be ($1,849,500 − $1,500,000 − $60,000) × 15% = $43,425.
The management fee of a private equity fund that has not yet invested all of its committed capital is most likely based on: A. committed capital. B. remaining capital. C. invested capital.
A The management fee of private equity funds is based on committed capital until the committed capital is fully drawn down and invested. This approach is in contrast to hedge funds, for which the management fee is based on invested capital.
Q. A hedge fund with $98 million of initial capital charges a management fee of 2% and an incentive fee of 20%. The management fee is based on assets under management at year end and the incentive fee is calculated independently from the management fee. The fee structure has a high-water mark provision. The fund value is $112 million at the end of Year 1, $100 million at the end of Year, and $116 million at the end of Year 3. The net-of-fees return earned by the fund in Year 3 is closest to: A. 14.15%. B. 12.33%. C. 11.87%.
A The net-of-fees return to the fund in Year 3 is closest to 14.15%
Q. The first stage of financing at which a venture capital fund most likely invests is the: A. seed stage. B. mezzanine stage. C. angel investing stage.
A The seed stage supports market research and product development and is generally the first stage at which venture capital funds invest. The seed stage follows the angel investing stage. In the angel investing stage, funds are typically provided by individuals (often friends or family), rather than a venture capital fund, to assess an idea's potential and to transform the idea into a plan. Mezzanine-stage financing is provided by venture capital funds to prepare the portfolio company for its IPO.
When the futures price of a commodity exceeds the spot price, the commodity market is most likely in: A. contango. B. backwardation. C. carry.
A When a commodity market is in contango, futures prices are higher than spot prices. When spot prices are higher than the futures price, the market is said to be in backwardation.
Q. Based on the historical record, adding alternative investments to a traditional investment portfolio consisting of publicly traded debt and equity will most likely decrease the portfolio's: A. liquidity. B. downside risk. C .risk-adjusted return.
A Many categories of alternative assets have low liquidity because of the fund structures used (e.g., limited partnerships for hedge funds and private equity) or high transactions costs for underlying assets (e.g., real estate). Alternative assets have generally had high downside risks. However, low correlations with traditional asset classes suggest strong diversifying potential, and high returns result in relatively strong Sharpe ratios (high risk-adjusted returns).
The following information applies to Rotunda Advisors, a hedge fund: - $288 million in assets under management (AUM) as of prior year-end - 2% management fee (based on year-end AUM) - 20% incentive fee calculated: - net of management fee - using a 5% soft hurdle rate - using a high-water mark (high-water mark is $357 million) - Current year fund return is 25% Q. The total fee earned by Rotunda in the current year is closest to: A. $7.20 million. B. $20.16 million. C. $21.60 million.
A Rotunda earns a management fee of $7.20 million but does not earn an incentive fee because the year-end fund value net of management fee does not exceed the high-water mark of $357 million. Rotunda fees: End-of-year AUM = Prior year-end AUM × (1 + Fund return) = $288 million × 1.25 = $360 million $360 million × 2% = $7.20 million management fee $360 million - $7.2 million = $352.8 million AUM net of management fee The year-end AUM net of fees does not exceed the $357 million high-water mark. Therefore, no incentive fee is earned.
In commodity futures market pricing, when the convenience yield is higher than the cost of carry, the roll yield is positive for: A. long futures. B. short futures. C. both long and short futures.
A The futures market is in backwardation when the convenience yield is higher than the cost of carry. The futures price then generally rolls up (moves up along the forward curve) to the spot price curve as the expiry date of the futures contract approaches, which results in a positive roll yield for the long positions.
Alternative investments that rely on estimates rather than observable market prices for valuation purposes are most likely to report: A. returns that are understated. B. volatility of returns that is understated. C. correlations of returns with the returns of traditional assets that are overstated.
B
If the level of broad inflation indexes is largely determined by commodity prices, the average real yield on direct commodity investments is most likely: A. less than zero. B. equal to zero. C. greater than zero.
B
In the context of venture capital financing, seed-stage financing most likely supports: A. initial commercial production and sales. B. product development and/or marketing efforts. C. transformation of an idea into a business plan.
B
In valuing underlying hedge fund positions, the most conservative approach is most likely one that uses: A. the average of the bid and ask prices. B. bid prices for longs and ask prices for shorts. C. the most recent market prices.
B
Q. A least likely reason for investors to include commodity derivatives in their investment portfolios is: A. commodity-related stocks' positive correlation with the overall equity market. B. it eliminates the need to understand the physical supply chain and general supply-demand dynamics of a commodity. C. the tendency for commodity prices to be positively correlated with inflation.
B
Q. Private equity funds are most likely to use: A. merger arbitrage strategies. B. leveraged buyouts. C. market-neutral strategies.
B
Q. The majority of private equity activity involves: A. derivative positions. B. leveraged buyouts. C. investing in mortgaged-backed securities.
B
Q. Until the committed capital is fully drawn down and invested, the management fee for a private equity fund is based on: A. invested capital. B. committed capital. C. assets under management.
B
Q. Which of the following least likely describes an advantage of investing in hedge funds through a fund of funds? A fund of funds may provide investors with: A. access to due diligence expertise. B. lower fees because of economies of scale. C. access to managers who can negotiate better redemption terms.
B
Relative to traditional investments, alternative investments are best characterized as having: A. higher correlations with other asset classes. B. unique legal and tax considerations. C. greater liquidity.
B
Which of the following investments most likely provides an investor with indirect equity exposure to real estate? A. Real estate limited partnerships B. Real estate investment trusts C. Commercial mortgage-backed securities
B
Which of the following infrastructure investments would most likely be easiest to value? A: A. master limited partnership holding greenfield investments. B. master limited partnership holding brownfield investments. C. private equity fund holding brownfield investments.
B A master limited partnership (MLP) is publicly traded, whereas a private equity fund is not. Therefore the MLP will have market pricing information to help with valuation. A brownfield investment is an existing asset that likely has operational and financial history to aid in valuation; a greenfield investment is in new construction.
Q. An investor chooses to invest in a brownfield rather than a greenfield infrastructure project. The investor is most likely motivated by: A. growth opportunities. B. predictable cash flows. C. higher expected returns.
B A brownfield investment is an investment in an existing infrastructure asset, which is more likely to have a history of steady cash flows compared with that of a greenfield investment. Growth opportunities and returns are expected to be lower for brownfield investments, which are less risky than greenfield investments.
Q. An investor in a private equity fund is concerned that the general partner can receive incentive fees in excess of the agreed-on incentive fees by making distributions over time based on profits earned rather than making distributions only at exit from investments of the fund. Which of the following is most likey to protect the investor from the general partner receiving excess fees? A. A high hurdle rate B. A clawback provision C. A lower capital commitment
B A clawback provision requires the general partner in a private equity fund to return any funds distributed (to the general partner) as incentive fees until the limited partners have received back their initial investments and the contracted portion of the total profits. A high hurdle rate will result in distributions occurring only after the fund achieves a specified return. A high hurdle rate decreases the likelihood of, but does not prevent, excess distributions. Management fees, not incentive fees, are based on committed capital.
Q. The potential benefits of allocating a portion of a portfolio to alternative investments include: A. ease of manager selection. B. improvement in the portfolio's risk-return relationship. C. accessible and reliable measures of risk and return.
B Adding alternative investments to a portfolio may provide diversification benefits because of these investments' less than perfect correlation with other assets in the portfolio. As a result, allocating a portion of one's funds to alternatives could potentially result in an improved risk-return relationship. Challenges to allocating a portion of a portfolio to alternative investments include obtaining reliable measures of risk and return as well as selecting portfolio managers for the alternative investments.
Q. The return on a commodity index is likely to be different from returns on the underlying commodities because: A. data are subject to survivorship bias. B. indices are constructed using futures contracts. C. assets are not marked to market.
B Because commodity indices are constructed using commodity futures and not the underlying commodities, there can be differences between commodity index returns and the returns of the underlying commodities.
For a hedge fund investor, a benefit of investing in a fund of funds is least likely the: A. higher level of due diligence expertise. B. multilayered fee structure. C. ability to negotiate better redemption terms.
B Funds of funds have a multilayered fee structure that will reduce the returns to the investor.
A disadvantage of a fund of hedge funds as compared to a large multi-strategy fund is: A. due diligence expertise. B. higher management fees. C. diversified exposure to various hedge fund strategies.
B Funds of hedge funds will add an extra layer of fees because each hedge fund in which such fund of hedge funds invests will charge a management fee plus an incentive fee. Such a layer of fees comes on top of the fees that the fund of hedge funds charges investors., including management fees, to the costs for investors.
Q. An investor is seeking an investment that can take long and short positions, may use multi-strategies, and historically exhibits low correlation with a traditional investment portfolio. The investor's goals will be best satisfied with an investment in: A. real estate. B. a hedge fund. C. a private equity fund.
B Hedge funds may use a variety of strategies (event-driven, relative value, macro and equity hedge), generally have a low correlation with traditional investments, and may take long and short positions.
Q. High-water marks are typically used when calculating the incentive fee on hedge funds. They are most likely used by clients to: A. avoid prime brokerage fees. B. avoid paying twice for the same performance. C. claw back the management fees.
B High-water marks help clients avoid paying twice for the same performance. When a hedge fund's value drops, the manager will not receive an incentive fee until the value of the fund returns to its previous level.
Q. The privatization of an existing hospital is best described as: A. a greenfield investment. B. a brownfield investment. C. an economic infrastructure investment.
B Investing in an existing infrastructure asset with the intent to privatize, lease, or sell and lease back the asset is referred to as a brownfield investment. An economic infrastructure asset supports economic activity and includes such assets as transportation and utility assets. Hospitals are social infrastructure assets, which are focused on human activities.
High Plains Capital is a hedge fund with a portfolio valued at $475,000,000 at the beginning of the year. One year later, the value of assets under management is $541,500,000. The hedge fund charges a 1.5% management fee based on the end-of-year portfolio value as well as a 10% incentive fee. If the incentive fee and management fee are calculated independently, the effective return for a hedge fund investor is closest to: A. 12.29%. B. 10.89%. C. 11.06%.
B Management fee = $541,500,000 × 0.015 = $8,122,500 Incentive fee = ($541,500,000 - $475,000,000) × 0.10 = $6,650,000 Total fees = $14,772,500 Return = ($541,500,000 - $475,000,000 - $14,772,500)/$475,000,000 = 0.1089 or 10.89%
Q. A private equity fund desiring to realize an immediate and complete cash exit from a portfolio company is most likely to pursue a(n): A. IPO. B. trade sale. C. recapitalization.
B Private equity funds can realize an immediate cash exit in a trade sale. Using this strategy, the portfolio company is typically sold to a strategic buyer.
Q. Compared with direct investment in infrastructure, publicly traded infrastructure securities are characterized by: A. higher concentration risk. B. more-transparent governance. C. greater control over the infrastructure assets.
B Publicly traded infrastructure securities, which include shares of companies, exchange-traded funds, and listed funds that invest in infrastructure, provide the benefits of transparent governance, liquidity, reasonable fees, market prices, and the ability to diversify across underlying assets. Direct investment in infrastructure involves a large capital investment in any single project, resulting in high concentration risks. Direct investment in infrastructure provides control over the assets and the opportunity to capture the assets' full value.
Which of the following is least likely to reduce the likelihood of being defrauded by a dishonest money manager? A. Third-party custody of assets under management B. Strong and consistent reported investment performance C. Independent verification of investment results
B To prevent fraud, involvement of third parties in the reporting and asset management process is helpful. A strong and consistent reported investment performance that lacks outside verification may actually be a warning sign.
Do management fees most likely get paid to the manager of a hedge fund, regardless of the fund's performance? A. No, only when the fund's net asset value exceeds the previous high-water mark B. No, only when the fund's gross return is positive C. Yes
C
Q. As the loan-to-value ratio increases for a real estate investment, risk most likely increases for: A. debt investors only. B. equity investors only. C. both debt and equity investors.
C
Q. Compared with traditional investments, over longer periods, alternative investments are least likely to have: A. better diversifying power. B. higher expected returns. C. more efficiently priced assets.
C Alternative investment strategies are more likely to include securities that trade in less liquid markets than securities that trade in relatively more liquid markets in which traditional, long-only investments
Q. Compared with long-only investments in stocks and bonds, alternative investments are most likely characterized by less: A. flexibility to use derivatives. B. manager specialization. C. transparency.
C Alternative investments are typically expected to have a lower level of regulation and less transparency than traditional long-only investments.
Categories of alternative investments would least likely be described by which of the following? A. Fine wine and other tangibles B. Schools and other long-lived real assets C. Cash and other liquid investments
C Cash and other short-term liquid investments would not generally be considered alternative investments. Alternative investments fall outside of the definition of long-only publicly traded investments in stocks, bonds, and cash (often referred to as traditional investments). In other words, these investments are alternatives to long-only positions in stocks, bonds, and cash.
A characteristic that makes a target company attractive for a leveraged buyout transaction most likely is: A. efficient management. B. high leverage. C. strong cash flow.
C Companies generating strong and sustainable cash flow are attractive for leveraged buyout transactions because these transactions are typically financed with significant debt where cash flow is necessary to make interest payments on the increased debt load.
Q. An analyst wanting to assess the downside risk of an alternative investment is least likely to use the investment's: A. Sortino ratio. B. value at risk (VaR). C. standard deviation of returns
C Downside risk measures focus on the left side of the return distribution curve where losses occur. The standard deviation of returns assumes that returns are normally distributed. Many alternative investments do not exhibit close-to-normal distribution of returns, which is a crucial assumption for the validity of a standard deviation as a comprehensive risk measure. Assuming normal probability distributions when calculating these measures will lead to an underestimation of downside risk for a negatively skewed distribution. Both the Sortino ratio and the value-at-risk measure are both measures of downside risk.
Q. Capital provided for companies moving toward operation but before commercial manufacturing and sales have occurred best describes which stage in venture capital investing? A. Later stage B. Seed stage C. Early stage
C Early-stage financing is capital provided for companies moving toward operation but before commercial manufacturing and sales have occurred. A is incorrect because later-stage financing is provided after commercial manufacturing and sales have begun but before any initial public offering. B is incorrect because seed-stage financing is capital provided for a business idea.
Q. An equity hedge fund following a fundamental growth strategy uses fundamental analysis to identify companies that are most likely to: A. be undervalued. B. be either undervalued or overvalued. C. experience high growth and capital appreciation.
C Fundamental growth strategies take long positions in companies identified, using fundamental analysis, to have high growth and capital appreciation. Fundamental value strategies use fundamental analysis to identify undervalued companies. Market-neutral strategies use quantitative and/or fundamental analysis to identify under- and overvalued companies.
Q. Commodity futures prices are most likely in backwardation when: A. interest rates are high. B. storage costs are high. C. the convenience yield is high.
C In backwardation, futures prices are lower than spot prices, that is, the commodity forward curve is downward sloping. This scenario occurs when the convenience yield is high. Futures price ≈ Spot price (1 + r) + Storage costs − Convenience yield.
Q. An effective risk management process used by alternative investment funds most likely includes: A. in-house valuations. B. internal custody of assets. C. segregation of risk and investment process duties.
C Investment risk should be monitored by a chief risk officer who is separated from the investment process. Risk factors monitored include leverage, sector, and individual position limits as well as counterparty risks. Independent (as opposed to in-house) valuation of underlying positions should be performed and reviewed on a regular basis. Third-party custody of assets can help reduce the chance of fraud.
Q. Which of the following hedge fund strategies is most likely categorized as an event-driven strategy? A. Fixed-income convertible arbitrage B. Quantitative directional C. Merger arbitrage
C Merger arbitrage is an event-driven strategy that involves buying the stock of the company being acquired and selling the stock of the acquiring company when the merger and acquisition (M&A) transaction is announced.
Q. One hedge fund strategy that involves simultaneously holding short and long positions in common stock is most likely: A. volatility. B. distressed/restructuring. C. quantitative directional.
C Quantitative directional is an equity strategy that uses technical analysis to identify over- and underpriced securities, buy the underpriced ones, and short the overpriced ones.
If the price of a commodity futures contract is below the spot price, it is most likely that the: A. cost of carry exceeds the convenience yield. B. roll yield is negative. C. convenience yield exceeds storage costs.
C The convenience yield must exceed the cost of carry to arrive at a futures price below the spot price because the futures price is approximately equal to the spot price [(1 + r) + Storage cost - Convenience yield] and the cost of carry is defined as interest cost plus storage cost. Given that interest cost is always positive, the convenience yield must also exceed storage costs to arrive at a futures price below the spot price.
A private equity limited partner would least likely experience which of the following? A. Capital calls in the partnership's early years to fund investments. B. A management fee based on committed capital, not invested capital. C. Short time lags between investments in and exits from portfolio companies.
C There are likely to be long time lags between investments in and exits from portfolio companies.
A commodity market is in contango when futures prices are: A. lower than the spot price. B. the same as the spot price. C. higher than the spot price.
C When a commodity market is in contango, futures prices are higher than the spot price. A is incorrect. This is the definition of backwardation. B is incorrect. This is neither contango nor backwardation
Illiquidity is most likely a major concern when investing in: A. real estate investment trusts. B. private equity. C. commodities.
B
Q. Relative to traditional investments, alternative investments are least likely to be characterized by: A. high levels of transparency. B. limited historical return data. C. significant restrictions on redemptions.
A
Q. Relative to traditional investments, alternative investments are most likely to be characterized by higher: A. fees. B. liquidity. C. transparency.
A
Which of the following most likely belongs in an alternative asset category? A. A limited partnership that takes long and short positions in publicly traded equity. B. Equity in an emerging market company that is traded over-the-counter. C. Securitized commercial real estate debt.
A
With regard to commodities, it is most likely true that: A. exposure is most commonly achieved via commodity derivatives. B. their returns are based on an income stream such as interest or dividends. C. they are physical products so most investors prefer to trade the actual commodity.
A
Q. An investor seeks a current income stream as a component of total return, and desires an investment that historically has low correlation with other asset classes. The investment most likely to achieve the investor's goals is: A. timberland. B. collectibles. C. commodities
A Timberland offers an income stream based on the sale of timber products as a component of total return and has historically generated returns not highly correlated with other asset classes.
Investors in alternative assets who seek liquidity are most likely to invest in: A. hedge funds. B. real estate investment trusts. C. private equity.
B
An alternative investments fund that uses leverage and takes long and short positions in securities is most likely a: A. leveraged buyout fund. B. hedge fund. C. venture capital fund.
B
If an investor uses derivatives to make a long investment in commodities, the return earned on margin is best described as: A. convenience yield. B. collateral yield. C. price return.
B
Q. Hedge funds are least likely to have restrictions concerning: A. the withdrawal of invested funds. B. the use of derivatives. C. the number of investors in the fund.
B
Q. Angel investing capital is typically provided in which stage of financing? A. Later-stage. B. Formative-stage. C. Mezzanine-stage.
B Formative-stage financing occurs when the company is still in the process of being formed and encompasses several financing steps. Angel investing capital is typically raised in this early stage of financing.
Q. A hedge fund invests primarily in distressed debt. Quoted market prices are available for the underlying holdings but they trade infrequently. Which of the following will the hedge fund most likely use in calculating net asset value for trading purposes? A. Average quotes B. Average quotes adjusted for liquidity C. Bid prices for short positions and ask prices for long positions
B Many practitioners believe that liquidity discounts are necessary to reflect fair value. This has resulted in some funds having two NAVs - for trading and reporting. The fund may use average quotes for reporting purposes but apply liquidity discounts for trading purposes.
Q. If a commodity's forward curve is in contango, the component of a commodities futures return most likely to reflect this is: A. spot prices. B. the roll yield. C. the collateral yield.
B Roll yield refers to the difference between the spot price of a commodity and the price specified by its futures contract (or the difference between two futures contracts with different expiration dates). When futures prices are higher than the spot price, the commodity forward curve is upward sloping, and the prices are referred to as being in contango. Contango occurs when there is little or no convenience yield.
Q. United Capital is a hedge fund with $250 million of initial capital. United charges a 2% management fee based on assets under management at year end, and a 20% incentive fee based on returns in excess of an 8% hurdle rate. In its first year, United appreciates 16%. Assume management fees are calculated using end-of-period valuation. The investor's net return assuming the performance fee is calculated net of the management fee is closest to: A. 11.58%. B. 12.54%. C. 12.80%.
B The net investor return is 12.54%, calculated as: End of year capital = $250 million × 1.16 = $290 million Management fee = $290 million × 2% = $5.8 million Hurdle amount = 8% of $250 million = $20 million; Incentive fee = ($290 − $250 − $20 − $5.8) million × 20% = $2.84 million Total fees to United Capital = ($5.8 + $2.84) million = $8.64 million Investor net return: ($290 − $250 − $8.64) / $250 = 12.54%
Which of the following is most likely a private equity strategy? A. Merger arbitrage B. Venture capital C. Quantitative directional
B Venture capital is a private equity strategy in which private equity companies invest and get actively involved in the management of portfolio companies.
Q. Investors will most likely have difficulty managing diversification across hedge funds if the funds: A. make decisions via investment committees. B. fail to appoint chief risk officers. C. seek to keep their strategies private.
C
Q. The real estate valuation method that uses a discounted cash flow model is best characterized as: A. a comparable sales approach. B. a cost approach. C. an income approach.
C
Q. Which of the following forms of infrastructure investments is the most liquid? A. An unlisted infrastructure mutual fund B. A direct investment in a greenfield project C. An exchange-traded master limited partnership (MLP)
C
Q. Which of the following is least likely to be considered an alternative investment? A. Real estate B. Commodities C. Long-only equity funds
C
With regard to venture capital, which of the following statements is most likely true regarding venture capital? A. Investments typically are in later stage and more established companies. B. Investors tend to have short time horizons. C. Investors require a higher return than investors in publicly traded equity.
C
Q. An investor may prefer a single hedge fund to a fund of funds if he seeks: A. due diligence expertise. B. better redemption terms. C. a less complex fee structure.
C Hedge funds of funds have multi-layered fee structures, while the fee structure for a single hedge fund is less complex. Funds of funds presumably have some expertise in conducting due diligence on hedge funds and may be able to negotiate more favorable redemption terms than could an individual investor in a single hedge fund.
The market approach to valuing portfolio companies in private equity firms is most likely based on: A. present value. B. the value of assets minus the value of liabilities. C. multiples.
C The market approach to valuing portfolio companies uses multiples of different measures that are compared with similar companies.