Alernatives

Relative to traditional investments, alternative investments are least likely to be characterized by: high levels of transparency. limited historical return data. significant restrictions on redemptions.

A is correct. Alternative investments are characterized as typically having low levels of transparency.

The first stage of financing at which a venture capital fund most likely invests is the: (2020 Q13) seed stage. mezzanine stage. angel investing stage.

A is correct. 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.

Alternative investment funds are typically managed: actively. to generate positive beta return. assuming that markets are efficient.

A is correct. There are many approaches to managing alternative investment funds, but typically these funds are actively managed.

A significant challenge to investing in timber is most likely its: high correlation with other asset classes. dependence on an international competitive context. return volatility compounded by financial market exposure.

B is correct. A primary risk of timber is the international competitive landscape. Timber is a globally sold and consumed commodity subject to world trade interruptions. So the international context can be considered one of its major risk factors.

An investor chooses to invest in a brownfield, rather than a greenfield, infrastructure project. The investor is most likely motivated by: growth opportunities. predictable cash flows. higher expected returns.

B is correct. 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. 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: (2020 Q26) 11.58%. 12.54%. 12.80%.

B is correct. The net investor return is 12.54%, calculated as follows: 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%.

Until the committed capital is fully drawn down and invested, the management fee for a private equity fund is based on: (2022 Q33) invested capital. committed capital. assets under management.

B is correct. Until the committed capital is fully drawn down and invested, the management fee for a private equity fund is based on committed capital, not invested capital.

Capital provided for companies moving toward operation but before commercial manufacturing and sales have occurred best describes which stage in venture capital investing? Later stage Seed stage Early stage

C is correct. Early-stage financing is capital provided for companies moving toward operation but before commercial manufacturing and sales have occurred. A is incorrect. Later-stage financing is provided after commercial manufacturing and sales have begun but before any initial public offering. B is incorrect. Seed-stage financing is capital provided for a business idea.

Capricorn Fund of Funds invests GBP100 million in each of Alpha Hedge Fund and ABC Hedge Fund. Capricorn Fund of Funds 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, Capricorn's investment in Alpha is valued at GBP80 million and Capricorn's investment in ABC is valued at GBP140 million. The annual return to an investor in Capricorn Fund of Funds, net of fees assessed at the fund-of-funds level, is closest to: (2020 Q27) 7.9%. 8.0%. 8.1%.

A is correct because the net investor return is 7.9%, calculated as follows: First, note that "1 and 10" refers to a 1% management fee and a 10% incentive fee. End-of-year capital = GBP140 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%.

Which of the following most likely belongs in an alternative asset category? A limited partnership that takes long and short positions in publicly traded equity. Equity in an emerging market company that is traded over-the-counter. Securitized commercial real estate debt.

A is correct. A limited partnership that takes long and short positions in publicly traded equity is one type of hedge fund, a category of alternative assets . B is incorrect because traded equity, even equity that is traded over the counter, is a part of the traditional equity asset category. C is incorrect because securitized real estate debt (i.e., CMBS and RMBS) are part of the publicly traded debt universe, which is not an alternative asset.

The investment method that typically requires the greatest amount of or most thorough due diligence from an investor is: fund investing. co-investing. direct investing.

C is correct. Due diligence in direct investing will usually be more thorough and more rigid from an investor's perspective because of the absence of a fund manager that would otherwise conduct a large portion of the necessary due diligence.

What is the most significant drawback of a repeat sales index to measure returns to real estate? (2020 Q14) Sample selection bias Understatement of volatility Reliance on subjective appraisals

A is correct. A repeat sales index uses the changes in price of repeat sales 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.

The distribution method by which profits generated by a fund are allocated between LPs and the GP is called: a waterfall. an 80/20 split. a fair division. Solution

A is correct. Although profits are typically split 80/20 between LPs and the GP, the distribution method of profits is not called an "80/20 split." "Fair division" is not a real term that exists in the industry.

With regard to commodities, it is most likely true that: exposure is most commonly achieved via commodity derivatives. their returns are based on an income stream such as interest or dividends. they are physical products so most investors prefer to trade the actual commodity.

A is correct. Commodity exposure is most commonly accessed via commodity derivatives. B is incorrect because commodities returns are based on changes in price rather than income streams. C is incorrect because holding commodities (i.e., the physical products) incurs costs for transportation and storage. Thus, most commodity investors do not trade actual physical commodities, but rather trade commodity derivatives.

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: hard hurdle rate. management fee. high-water mark provision.

A is correct. 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. B is incorrect because there is no fixed management fee (one that does not depend on performance). C is incorrect because there is no requirement that the fund's value exceed its previous maximum.

Risks in infrastructure investing are most likely greatest when the project involves: construction of infrastructure assets. investment in existing infrastructure assets. investing in assets that will be leased back to a government.

A is correct. 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.

Compared with traditional investments, alternative investments are more likely to have: greater use of leverage. long-only positions in liquid assets. more transparent and reliable risk and return data.

A is correct. 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.

Both event-driven and macro hedge fund strategies use: long-short positions. a top-down approach. long-term market cycles.

A is correct. 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 a catalyst event typically involving a corporate action, such as an acquisition or a restructuring. Macro strategies seek to profit from expected movements in evolving economic variables.

Which of the following hedge fund strategies emphasizes a top-down approach? Macro Equity hedge Event-driven

A is correct. 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. C is incorrect because event-driven strategies typically seek to profit from potential changes in the corporate structure of individual companies. This strategy is considered "bottom up" where the analysis starts at the company level, as opposed to a "top down" approach which starts with macroeconomic analysis.

A hedge fund that implements trades based on a top-down analysis of expected movements in economic variables most likely uses a(n): macro strategy. relative value strategy. event-driven strategy.

A is correct. Macro strategies emphasize a top-down approach, and trades are made based on expected movements of economic variables. B is incorrect. Relative value strategies focus on pricing discrepancies between related securities. C is incorrect. Event-driven strategies focus on short-term events that are expected to affect individual companies. The approach is thus "bottom up.

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 is correct. 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). B is incorrect because many alternative investments have exhibited high downside risks. C is incorrect because many alternative investments have exhibited strong risk-adjusted returns and low correlations with traditional asset classes.

Hedge fund losses are most likely to be magnified by a: margin call. lockup period. redemption notice period.

A is correct. 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.

Hedge funds are similar to private equity funds in that both: are typically structured as partnerships. assess management fees based on assets under management. do not earn an incentive fee until the initial investment is repaid.

A is correct. Private equity funds and hedge funds are typically structured as partnerships where investors are limited partners and the fund is the general partner. 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? Real estate limited partnership Real estate investment trust Collateralized mortgage obligation

A is correct. Real estate limited partnerships are a form of private real estate investment. B is incorrect. Real estate investment trusts are a form of public real estate investment. C is incorrect. Collateralized mortgage obligations are a form of public real estate investment.

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: 14.15%. 12.33%. 11.87%.

A is correct. The net-of-fees return to the fund in Year 3 is closest to 14.15%, calculated as follows: Year 1: Portfolio gain = Year-end value - Beginning value = $112 million − $98 million = $14 million Management fee = Year-end value × Management fee % = $112 million × 2% = $2.24 million Incentive fee = Portfolio gain × Incentive fee % = $14 million × 20% = $2.8 million Total fees = Management fee + Incentive fee = $2.24 million + $2.8 million = $5.04 million Ending Capital Position = Year-end value - Total fees = $112 million − $5.04 million = $106.96 million High water mark = Ending capital position = $106.96 million Year 2: No incentive fee is earned as the fund declines in value; the high water mark established in Year 1 is not exceeded. Management fee = Year-end value × Management fee % = $100 million × 2% = $2 million Ending Capital Position = Year-end value - Management fee = $100 million − $2 million = $98 million High water mark = Highest ending capital position = $106.96 million Year 3: Net-of-fee returns are affected by the Year 1 high water mark and the Year 2 net capital position (i.e. Year 3 beginning capital position). Management fee = Year-end value × Management fee % = $116 million × 2% = $2.32 million Incentive fee = (Year-end value - High water mark) × Incentive fee % = ($116 million - $106.96 million) × 20% = $1.81 million. Total fees = Management fee + Incentive fee = $2.32 million + $1.81 million = $4.13 million Net-of-fees return = (Year-end value - Total fees - Beginning capital position)/Beginning capital position = ($116 million - $4.13 million - $98 million)/$98 million = 14.15%.

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: (2020 Q10) timberland. collectibles. commodities.

A is correct. 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.

Which of the following relates to a benefit when owning real estate directly? Taxes Capital requirements Portfolio concentration

A is correct. When owning real estate directly, there is a benefit related to taxes. The owner can use property non-cash depreciation expenses to reduce taxable income and lower the current income tax bill. In fact, accelerated depreciation and interest expense can reduce taxable income below zero in the early years of asset ownership, and losses can be carried forward to offset future income. Thus, a property investment can be cash-flow positive while generating accounting losses and deferring tax payments. If the tax losses do not reverse during the life of the asset, depreciation-recapture taxes can be triggered when the property is sold. B is incorrect because the large capital requirement is a major disadvantage of investing directly in real estate. C is incorrect because a disadvantage for smaller investors who own real estate directly is that they bear the risk of portfolio concentration.

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: 12.29%. 10.89%. 11.06%.

B is correct. 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% A is incorrect because only the management fee is included in the return calculation. Return = ($541,500,000 - $475,000,000 - $8,122,500)/$475,000,000 = 0.1229 or 12.29% C is incorrect. The incentive fee is incorrect. It is incorrectly calculated as follows: Incentive fee = ($541,500,000 - $475,000,000 - $8,122,500) × 0.10 = $5,837,750 Total fees = $13,960,250 = $8,122,500 + $5,837,750 Return = ($541,500,000 - $475,000,000 - $13,960,250)/$475,000,000 = 0.1106 or 11.06%

Initial investment capital$100 millionReturn at the end of one year12%Management fee based on assets under management1%Incentive fee based on the return net of the management fee10% Assume management fees are calculated using end-of-period valuation. The investor's net return given this fee structure is closest to: 10.88%. 9.79%. 9.68%.

B is correct. Management fee: 1% of $112 million = $1.12 million Incentive fee: 10% of ($12 million - $ 1.12 million) = $1.088 million Fund value after fees: $112 million - $1.12 million - $1.088 million = $109.792 million Investor return: ($109.792 million/$100 million) - 1 = 9.79% C is incorrect. It ignores the fact that the incentive fee is calculated net of management fees. Management fee: 1% of $112 million = $1.12 million. Incentive fee: 10% of $12 million = $1.2 million. Fund value after fees: $112 million - $1.12 million - $1.2 million = $109.68 million Investor return: ($109.68 million / $100 million) - 1 = 9.68% B is incorrect. It neglects the incentive fee. Management fee: 1% of $112 million = $1.12 million Fund value after fees: $112 million - $1.12 million = $110.88 million Investor return: ($110.88 million/$100 million) - 1 = 10.88%

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 likely to protect the investor from the general partner receiving excess fees? (2020 Q32) A high hurdle rate A clawback provision A lower capital commitment

B is correct. 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 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.

he potential benefits of allocating a portion of a portfolio to alternative investments include: ease of manager selection. improvement in the portfolio's risk-return relationship. accessible and reliable measures of risk and return.

B is correct. 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 and selecting portfolio managers for the alternative investments.

The return on a commodity index is likely to be different from returns on the underlying commodities because: data are subject to survivorship bias. indices are constructed using futures contracts. assets are not marked to market.

B is correct. 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. A is incorrect. There are no survivorship bias concerns with commodity index returns (that is a concern with hedge fund and private equity returns). C is incorrect. Commodity index returns reflect market values, but private equity returns may not.

In comparison to other alternative investment approaches, co-investing is most likely: more expensive. subject to adverse selection bias. the most flexible approach for the investor.

B is correct. Co-investing may be subject to adverse selection bias. For example, the fund manager may make less attractive investment opportunities available to the co-investor while allocating its own capital to more appealing deals. A is incorrect because co-investing is likely not more expensive than fund investing since co-investors can co-invest an additional amount alongside the fund directly in a fund investment without paying management fees on the capital that has been directly invested. C is incorrect because direct investing, not co-investing, provides the greatest amount of flexibility for the investor.

If a commodity's forward curve is downward sloping and there is little or no convenience yield, the market is said to be in: backwardation. contango. equilibrium.

B is correct. Contango is a condition in the futures markets in which the spot price is lower than the futures price, the forward curve is upward sloping, and there is little or no convenience yield. Backwardation is the opposite condition in the futures markets, where the spot price exceeds the futures price, the forward curve is downward sloping, and the convenience yield is high. Equilibrium is an economic term where supply is equal to demand.

Relative to co-investing, direct investing due diligence is most likely: harder to control. more independent. equally thorough.

B is correct. Direct investing due diligence may be more independent than that of co-investing because the direct investing team is typically introduced to opportunities by third parties rather than fund managers, as is customary in co-investing. A is incorrect because the direct investing team has more control over the due diligence process compared with co-investing. C is incorrect because due diligence for direct investing requires the investor to conduct a thorough investigation into the important aspects of a target asset or business, whereas in co-investing, fund managers typically provide investors with access to a data room so they can view the due diligence completed by the fund managers.

Angel investing capital is typically provided in which stage of financing? (2020 Q24) Later stage Formative stage Mezzanine stage

B is correct. 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.

An alternative investments fund that uses leverage and takes long and short positions in securities is most likely a: leveraged buyout fund. hedge fund. venture capital fund.

B is correct. Hedge funds invest in securities and may take long and short positions. They may also use leverage. A is incorrect. Leveraged buyout funds make equity investments in established companies C is incorrect. Venture capital funds provide capital to start-up firms with high growth potential.

The privatization of an existing hospital is best described as: a greenfield investment. a brownfield investment. an economic infrastructure investment.

B is correct. 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.

Private capital is: accurately described by the generic term "private equity." a source of diversification benefits from both debt and equity. predisposed to invest in both the debt and equity of a client's firm.

B is correct. Investments in private capital funds can add diversity to a portfolio composed of publicly traded stocks and bonds because they have less-than-perfect correlation with those investments. There is also the potential to offer further diversification within the private capital asset class. For example, private equity investments may also offer vintage diversification since capital is not deployed at a single point in time but is invested over several years. Private debt provides investors with the opportunity to diversify the fixed-income portion of their portfolios since private debt investments offer more options than bonds and other public forms of traditional fixed income.

Which approach is most commonly used by equity hedge strategies? Top down Bottom up Market timing

B is correct. Most equity hedge strategies use a bottom-up strategy.

Illiquidity is most likely a major concern when investing in: real estate investment trusts. private equity. commodities. Solution

B is correct. Once a commitment in a private equity fund has been made, the investor has very limited liquidity options. C is incorrect. The majority of commodity investments are implemented through derivatives, so liquidity is not a major concern. A is incorrect. Real estate investment trusts are publicly listed, so liquidity is not a major concern.

A private equity fund desiring to realize an immediate and complete cash exit from a portfolio company is most likely to pursue: (2020 Q18) an IPO. a trade sale. a recapitalization.

B is correct. 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.

Compared with direct investment in infrastructure, publicly traded infrastructure securities are characterized by: higher concentration risk. more transparent governance. greater control over the infrastructure assets.

B is correct. 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 among 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.

Q. From the perspective of the investor, the most active approach to investing in alternative investments is: co-investing. fund investing. direct investing.

C is correct. From the perspective of the investor, direct investing is the most active approach to investing because of the absence of fund managers and the services and expertise they generally provide. A is incorrect because co-investing includes fund investing, which requires less due diligence compared with direct investing. B is incorrect because fund investing in alternative assets demands less participation from the investor compared with the direct and co-investing approaches because an investor depends on the fund manager to identify, select, and manage the fund's investments.

. Which of the following statements is true for REITs? According to GAAP, equity REITs are exempt from reporting earnings per share. Though equity REIT correlations with other asset classes are typically moderate, they are highest during steep market downturns. The REIT corporation pays taxes on income, and the REIT shareholder pays taxes on the REIT's dividend distribution of after-tax earnings.

B is correct. Real estate investments, including REITs, provide important portfolio benefits due to moderate correlation with other asset classes. However, there are periods when equity REIT correlations with other securities are high, and their correlations are highest during steep market downturns. A is incorrect because equity REITs, like other public companies, must report earnings per share based on net income as defined by GAAP or IFRS. C is incorrect because REITs can avoid this double taxation. A REIT can avoid corporate income taxation by distributing dividends equal to 90%-100% of its taxable net rental income. This ability to avoid double taxation is the main appeal of the REIT structure.

A real estate investor looking for equity exposure in the public market is most likely to invest in: real estate limited partnerships. shares of real estate investment trusts. collateralized mortgage obligations.

B is correct. Shares in real estate investment trusts are publicly traded and represent an equity investment in real estate. A is incorrect. Real estate limited partnerships are an example of a private real estate investment. C is incorrect. A collateralized mortgage obligation is an example of debt-based exposure to real estate.

The Sharpe ratio is a less-than-ideal performance measure for alternative investments because: it uses a semi-deviation measure of volatility. returns of alternative assets are not normally distributed. alternative assets exhibit low correlation with traditional asset classes.

B is correct. The Sharpe ratio assumes normally distributed returns. However, alternative assets tend to have non-normal return distributions with significant skewness (fat tails in one direction or the other) and kurtosis (sharper peak than a normal distribution has, with fatter tails). Therefore, the Sharpe ratio may not be a good risk-adjusted performance measure to rely on for alternative investments. A is incorrect because the Sharpe ratio does not use a semi-deviation measure of volatility; it uses standard deviation. The Sortino ratio uses a semi-deviation measure of volatility. Further, the use of semi-deviation instead of standard deviation actually makes the Sortino ratio a more attractive measure of alternative asset performance than the Sharpe ratio. C is incorrect because correlation does not enter into the calculation of the Sharpe ratio. However, it is true that alternative assets can have low correlations with other asset classes. In contrast to the Sharpe ratio, the Treynor ratio incorporates the beta of the alternative asset relative to a benchmark, which is conceptually similar to correlation.

Which of the following is true regarding private equity performance calculations? The money multiple calculation relies on the amount and timing of cash flows. The IRR calculation involves the assumption of two rates. Because private equity funds have low volatility, accounting conventions allow them to use a lagged mark-to-market process.

B is correct. The determination of an IRR involves certain assumptions about a financing rate to use for outgoing cash flows (typically a weighted average cost of capital) and a reinvestment rate assumption to make on incoming cash flows (which must be assumed and may or may not actually be earned). A is incorrect because the money multiple calculation completely ignores the timing of cash flows. C is incorrect because it is somewhat of a reversal of cause and effect: Private equity (PE) funds can appear to have low volatility because of the lag in their mark-to-market process. It's not that PE investments don't actually rise and fall behind the scenes with economic influences, but accounting conventions may simply leave longer-lived investments marked at their initial cost for some time or with only modest adjustments to such carrying value until known impairments or realization events begin to transpire. Also, because PE funds are not easily marked to market, their returns can appear somewhat smoothed, making them appear more resilient and less correlated with other assets than they really are. The slowness to re-mark them can unfortunately be confused by investors as an overall lack of volatility.

Private equity funds are most likely to use: merger arbitrage strategies. leveraged buyouts. market-neutral strategies.

B is correct. The majority of private equity activity involves leveraged buyouts. Merger arbitrage and market neutral are strategies used by hedge funds.

The majority of real estate property may be classified as either: debt or equity. commercial or residential. direct ownership or indirect ownership.

B is correct. The majority of real estate property may be classified as either commercial or residential.

A characteristic of farmland strongly distinguishing it from timberland is its: commodity price-driven returns. inherent rigidity of production for output. value as an offset to other human activities.

B is correct. Unlike timberland products, farm products must be harvested when ripe, so there is little flexibility in the production process. In contrast, timber (trees) can be grown and easily "stored" by simply not harvesting. This feature offers the flexibility of harvesting more trees when timber prices are up and delaying harvests when prices are down. A is incorrect because just as a primary return driver for timberland is change in commodity price (of lumber from cut wood) in either the spot or futures price, farmland's returns are driven by agricultural commodity prices, with commodity futures contracts potentially combined with farmland holdings to generate an overall hedged return. C is incorrect because for both farmland and timberland owned or leased for the benefit of the bounty each generates in the form of crops and more broadly timber, since these resources consume carbon as part of the plant life cycle, the considered value comes not just from the harvest but also from the offset to other human activities.

An equity hedge fund following a fundamental growth strategy uses fundamental analysis to identify companies that are most likely to: (2022 Q16) be undervalued. be either undervalued or overvalued. experience high growth and capital appreciation.

C is correct. 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 fundamental analysis to identify under- and overvalued companies.

A collateralized loan obligation specialist is most likely to: sell its debt at a single interest rate. cater to niche borrowers in specific situations. rely on diverse risk profiles to complete deals.

C is correct. A CLO manager will extend several loans to corporations (usually to firms involved in LBOs, corporate acquisitions, or other similar types of transactions), pool these loans, and then divide that pool into various tranches of debt and equity that range in seniority and security. The CLO manager will then sell each tranche to different investors according to their risk profiles; the most senior portion of the CLO will be the least risky, and the most junior portion of the CLO (i.e., equity) will be the riskiest. A is incorrect because with the different CLO tranches having distinct risks varying with their seniority and security, they will be priced over a range of interest rates. In contrast, unitranche debt combines different tranches of secured and unsecured debt into a single loan with a single, blended interest rate. B is incorrect because debt extended to niche borrowers in specific situations is more commonly offered through specialty loans. For example, in litigation finance, a specialist funding company provides debt to a client to finance the borrower's legal fees and expenses in exchange for a portion of any case winnings.

Which of the following forms of infrastructure investment is the most liquid? An unlisted infrastructure mutual fund A direct investment in a greenfield project An exchange-traded MLP

C is correct. A publicly traded infrastructure security, such as an exchange-traded MLP, provides the benefit of liquidity. (A master limited partnership (MLPs) is a business venture that exists in the form of a publicly traded limited partnership. They combine the tax benefits of a private partnership—profits are taxed only when investors receive distributions—with the liquidity of a publicly traded company. KEY TAKEAWAYS A master limited partnership (MLP) is a company organized as a publicly traded partnership. MLPs combine a private partnership's tax advantages with a stock's liquidity. MLPs have two types of partners; general partners, who manage the MLP and oversee its operations, and limited partners, who are investors in the MLP. Investors receive tax-sheltered distributions from the MLP. MLPs are considered low-risk, long-term investments, providing a slow but steady income stream. MLPs are limited to the natural resources and real estate sectors.)

Fill in the blanks with the correct words: An American waterfall distributes performance fees on a(n) _____ basis and is more advantageous to the _____. deal-by-deal; LPs aggregate fund; LPs deal-by-deal; GP

C is correct. American waterfalls, also known as deal-by-deal waterfalls, pay performance fees after every deal is completed and are more advantageous to the GP because they get paid sooner (compared with European, or whole-of-fund, waterfalls).

An alternative investment fund's hurdle rate is a: rate unrelated to a catch-up clause. tool to protect clients from paying twice for the same performance. minimum rate of return the GP must exceed in order to earn a performance fee.

C is correct. An alternative investment fund's hurdle rate is a minimum rate of return the GP must exceed in order to earn a performance fee. A is incorrect because if a catch-up clause is included in the partnership agreement, the catch-up clause permits distributions in relation to the hurdle rate. B is incorrect because it is a high-water mark (not a hurdle rate) that protects clients from paying twice for the same performance.

Which of the following statements about commodity investing is invalid? Few commodity investors trade actual physical commodities. Commodity producers and consumers both hedge and speculate. Commodity indexes are based on the price of physical commodities.

C is correct. Commodity indexes typically use the price of futures contracts on the commodities included in them rather than the prices of the physical commodities themselves in order to be transparent, investable, and replicable. A is incorrect because trading in physical commodities is primarily limited to a smaller group of entities that are part of the physical supply chain. Thus, most commodity investors do not trade actual physical commodities but, rather, trade commodity derivatives. B is incorrect because although supply chain participants use futures to hedge their forward purchases and sales of the physical commodities, those commodity producers and consumers nonetheless both hedge and speculate on commodity prices.

An analyst wanting to assess the downside risk of an alternative investment is least likely to use the investment's: (2020 Q34) Sortino ratio. value at risk (VaR). standard deviation of returns.

C is correct. 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 distributions 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 VaR measure are measures of downside risk.

An investor may prefer a single hedge fund to a fund of funds if she seeks: (2022 Q8) due diligence expertise. better redemption terms. a less complex fee structure.

C is correct. Hedge funds of funds have multi-layered fee structures, whereas 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 an individual investor in a single hedge fund could.

hich is not true of mark-to-model valuations? Return volatility may be understated. Returns may be smooth and overstated. A calibrated model will produce a reliable liquidation value.

C is correct. It is not true that a calibrated model will produce a reliable liquidation value in a mark-to-model valuation. The need to use a model for valuation arises when an asset is so illiquid that there are not reliable market values available. A model may reflect only an imperfect theoretical valuation, not a true liquidation value, should liquidation become necessary. The illiquid nature of alternative assets means that estimates, rather than observable transaction prices, may have been used for valuation purposes. A and B are not correct because they are both true statements.

The most likely impact of adding commodities to a portfolio of equities and bonds is to: increase risk. provide higher current income. reduce exposure to inflation. Solution

C is correct. Over the long term, commodity prices are closely related to inflation, so including commodities in a portfolio of equities and bonds will reduce its exposure to inflation. A is incorrect because commodities have low correlations with traditional securities and therefore reduce overall risk. B is incorrect because commodity investments tend to produce no current income.

As the loan-to-value ratio increases for a real estate investment, risk most likely increases for: (2020 Q19) debt investors only. equity investors only. both debt and equity investors.

C is correct. The higher the loan-to-value ratio, the higher leverage is for a real estate investment, which increases the risk to both debt and equity investors.

A hedge fund has the following fee structure: Annual management fee based on year-end AUM2%Incentive fee20%Hurdle rate before incentive fee collection starts4%Current high-water mark$610 million Q. The fund has a value of $583.1 million at the beginning of the year. After one year, it has a value of $642 million before fees. The net percentage return to an investor for this year is closest to: (2020 Q29) 6.72%. 6.80%. 7.64%.

C is correct. The management fee for the year is $642 × 0.02 = $12.84 million. Because the ending gross value of the fund of $642 million exceeds the high-water mark of $610 million, the hedge fund can collect an incentive fee on gains above this high-water mark but net of the hurdle rate of return. The incentive fee calculation becomes {$642 − [$610 × (1 + 0.04)]} × 0.20 = $1.52 million. The net return to the investor for the year is [($642 − $12.84 − $1.52)/$583.1] − 1 ≈ 0.07638 ≈ 7.64%.

The following information is available about a hedge fund:Initial fund assets$100 millionFund assets at the end of the period (before fees)$110 millionManagement fee based on assets under management2%Incentive fee based on the return20%Soft hurdle rate8% No deposits to the fund or withdrawals from the fund occurred during the year. Management fees are calculated using end-of-period valuation. Management fees and incentive fees are calculated independently. The net-of-fees return of the investor is closest to: 7.8%. 7.4%. 5.8%.

C is correct. The soft hurdle rate is surpassed because the return of the fund is 10%. For that reason, the full fee, based on the full performance, is due. Management fee: 2% of $110 million = $2.2 million Incentive fee: 20% of $10 million = $2 million Total fees: $4.2 million Therefore, the fund assets at the end of the period after fees are $105.8 million. The return for the investor is 5.8%. A is incorrect. It completely neglects the incentive fee. This is only appropriate if the hurdle rate is not cleared. Management fee: 2% of $110 million = $2.2 million. Therefore, the fund assets at the end of the period after fees are $107.8 million. The return for the investor is 7.8%. B is incorrect. It reduces the base of the incentive fee by the hurdle rate. This is only correct in the case of a hard hurdle rate, but not in the case of a soft hurdle rate. Management fee: 2% of $110 million = $2.2 million. Incorrect subtraction of $8 million (because of the hurdle rate) from the performance of $10 million leaves $2 million. Incentive fee 20% of $2 million = $0.4 million Total fees: $2.6 million Therefore, the fund assets at the end of the period after fees are $107.4 million. The return for the investor is 7.4%.

Which of the following statements is true regarding mortgage-backed securities? Insurance companies prefer the first-loss tranche. When interest rates rise, prepayments will likely accelerate. When interest rates fall, the low-risk senior tranche will amortize more quickly.

C is correct. When interest rates decline, borrowers are likely to refinance their loans at a faster pace than before, resulting in faster amortization of each MBS tranche, including the senior tranche, which is the lowest-risk tranche. A is incorrect because risk-averse investors, primarily insurance companies, prefer the lowest-risk tranches, which are the first to receive interest and principal. The junior-most tranche is referred to as the first-loss tranche. It is the highest-risk tranche and is the last to receive interest and principal distributions. B is incorrect because when interest rates rise, prepayments will likely slow down, lengthening the duration of most MBS tranches. Prepayments will likely increase when interest rates decline, because borrowers are likely to refinance their loans at a faster pace.

Define funds of hedge funds, and identify their primary purpose.

Funds of hedge funds are funds that hold a portfolio of hedge funds. Their primary purpose is to add value in manager selection and due diligence and create a diversified portfolio of hedge funds accessible to smaller investors.

The following information applies to Rotunda Advisers, a hedge fund: $288 million in 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 gross return is 25%. Q. The total fee earned by Rotunda in the current year is closest to: (2020 Q28) $7.20 million. $20.16 million. $21.60 million.

vA is correct. Although the gross return of Rotunda results in a $360 million gross NAV, the deduction of the $7.2 million incentive fee brings NAV to $352.8 million, which is below the prior high-water mark. 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 prior high-water mark of $357 million. Since Rotunda is still also below the prior-year high-water mark, the hurdle rate of return is also basically irrelevant in this fee calculation. The specifics of this calculation are as follows: 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 do not exceed the $357 million high-water mark. Therefore, no incentive fee is earned.