CFA- Alternative Investments

With regard to commodities:

- Commodity exposure is most commonly accessed via commodity derivatives. -Commodity exposure is most commonly accessed via commodity derivatives. - 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.

Investors will most likely have difficulty managing diversification across hedge funds if the funds: seek to keep their strategies private.

. The lack of transparency in positions and strategies makes it difficult for investors to effectively manage diversification across funds.

If the level of broad inflation indexes is largely determined by commodity prices, the average real yield on direct commodity investments is most likely: equal to zero.

As the price increases of commodities are mirrored in higher price indexes, the nominal return is equal to inflation and thus the real return is zero.

Categories of alternative investments would LEAST likely be described by "Cash and other liquid investments"

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.

One hedge fund strategy that involves simultaneously holding short and long positions in common stock is most likely: quantitative directional.

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.

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

Shares in real estate investment trusts are publicly traded and represent an equity investment in real estate.

Alternative investments that rely on estimates rather than observable market prices for valuation purposes are most likely to report: volatility of returns that is understated.

The use of estimates tends to smooth the return series. As a consequence, the volatility of returns will be understated. there is a tendency for returns to be overestimated or at least smoothed. correlations of returns with the returns of traditional assets tend to be understated as a consequence of smoothing the return series.

The value at risk of an alternative investment is best described as the: minimum amount of loss expected over a given time period at a given probability level.

Value at risk is defined as the minimum amount of loss expected over a given time period at a given probability level.

When the futures price of a commodity exceeds the spot price, the commodity market is most likely in: contango.

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.

Relative to traditional investments, alternative investments are most likely to be characterized by higher: fees.

liquidity tends to be comparably low in alternative investments. transparency tends to be comparably low in alternative investments.

Compared with other investment asset classes, an investment in real estate is least likely to be characterized by: homogeneity.

no two properties are identical, homogeneity is not a feature of an investment in real estate.

An investor seeking an indirect debt investment in real estate will:

purchase a mortgage-backed security.

. Commodity futures prices are most likely in backwardation when:

the convenience yield is high. 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.

A private equity limited partner

- There are likely to be long time lags between investments in and exits from portfolio companies. - capital calls are likely in the partnership's early years in order to fund investments in new portfolio companies. - in most private equity firms the general partner earns management fees based on committed capital, not invested capital.

The reasons for investors to include commodity derivatives in their investment portfolios are:

- commodity prices tend to be positively correlated with inflation. - the prices of commodity derivatives are, to a significant extent, a function of the underlying commodity prices, it is important to understand the physical supply chain and general supply-demand dynamics of a commodity. - commodity-related stocks tend to exhibit a high degree of correlation with the overall equity market. High correlation means low diversification benefits, which reduces the appeal of including this type of investment in a portfolio so investors may be drawn to commodity derivatives that have a lower correlation with the overall equity market.

A characteristic that makes a target company attractive for a leveraged buyout transaction most likely is:

-Strong cash flow: 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. -Inefficiency managed: in a leveraged buyout transaction, private equity firms seek to generate attractive returns on equity by creating value in the companies they buy. They achieve this goal by identifying companies that are inefficiently managed and that have the potential to perform well if managed better. - Low leverage: private equity firms target companies with low leverage in a leveraged buyout transaction, making it easier to use debt to finance the transaction.

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: private equity fund.

A private equity manager is compensated through a management fee based on committed capital plus an incentive fee.

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

Early-stage financing is capital provided for companies moving toward operation but before commercial manufacturing and sales have occurred.

A disadvantage of a fund of hedge funds as compared to a large multi-strategy fund is: higher management fees.

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.

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

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

High-water marks are typically used when calculating the incentive fee on hedge funds. They are most likely used by clients to: avoid paying twice for the same performance.

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.

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: transparency in reported positions.

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.

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: liquidity.

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). - many alternative investments have exhibited high downside risks. - many alternative investments have exhibited strong risk-adjusted returns and low correlations with traditional asset classes.

Illiquidity is most likely a major concern when investing in: private equity.

Once a commitment in a private equity fund has been made, the investor has very limited liquidity options.

If the price of a commodity futures contract is below the spot price, it is most likely that the: convenience yield exceeds storage costs.

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.

The statement concerning the historical record of alternative investments is likely correct: "The exclusion of returns of funds that have been liquidated leads to an upward bias in index performance."

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. the use of appraised values instead of market prices leads to a downward bias in volatility. the inclusion of previous return data for funds that enter the index is called backfill bias. It leads to an upward bias in index performance.

In commodity futures market pricing, when the convenience yield is higher than the cost of carry, the roll yield is positive for: long futures.

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.

With regard to venture capital, which of the following statements is most likely true regarding venture capital: Investors require a higher return than investors in publicly traded equity.

The historical standard deviations of annual return for venture capital are higher than that of common stocks. Investors should therefore require a higher return in exchange for accepting this higher risk, along with the illiquidity of venture capital investing. the venture capital strategy typically invests in start-up or early stage companies, not later stage companies. venture capital investments require long time horizons.

The majority of private equity activity involves: leveraged buyouts.

The majority of private equity fund activity involves leveraged buyouts of established profitable and cash generative companies. although a private equity fund may use derivatives, this use is not a defining characteristic of private equity investing. Derivative strategies are most likely used in hedge fund and commodity investment strategies. private equity funds generally invest in non-publicly traded companies or public companies with the intent to take them private, not mortgage-backed securities which are a form of publicly traded real estate debt.

The market approach to valuing portfolio companies in private equity firms is most likely based on: multiples.

The market approach to valuing portfolio companies uses multiples of different measures that are compared with similar companies.