Chapter 5 Other Managed Products EXAM
All of the following are typical trading practices of hedge funds EXCEPT A) Concentration in tangible investments B) High degree of leverage C) Short securities positions D) Undisclosed investments made with fund capital
A Concentration in tangible investments Explanation: Although hedge funds may invest funds in tangible investments like real estate, they typically employ a wide variety of strategies and hold very diverse assets. They are not typically concentrated in real estate. They invest aggressively using high degrees of leverage and often lack transparency which is why they are inappropriate for typical investors.
A private equity firm is most likely to invest in which of the following companies? I. Underperforming private companies II. Large and successful public companies III. Public companies that want to go private A) I and III only B) I, II, and III C) II and III only D) I and II only
A I and III only Explanation: Private equity firms typically look for investment opportunities in underperforming private companies that they can take public, or in public firms they can take private.
A business structure that offers limited liability and pass through benefits but is publicly traded is a A) Master Limited Partnership B) C-Corp C) Limited Liability Corporation D) Subchapter S Corporation
A Master Limited Partnership Explanation: A master limited partnership (MLP) is a pass-through taxation entity, but has ownership divided into shares that can be publicly traded.
A comparison of a mutual fund and a hedge fund will show that A) Mutual funds may invest in various types of securities, including both debt and equities, while hedge funds can invest in a broad array of securities, as well as other alternative products, such as real estate and commodities. B) Hedge funds are typically suitable for a broad range of investors, while mutual funds are only appropriate for more sophisticated investors C) Mutual funds tend to be illiquid investments, while hedge funds are often very liquid. D) Both mutual funds and hedge funds can trade on margin in their respective portfolios, and both can use leverage and derivatives to finance their activities.
A Mutual funds may invest in various types of securities, including both debt and equities, while hedge funds can invest in a broad array of securities, as well as other alternative products, such as real estate and commodities. Explanation: Mutual funds will use more traditional securities products, as their federal regulations will limit the types of investments they can employ to achieve their stated investment objectives. Hedge funds, owing to lighter federal regulation, can use far more expansive styles and products to achieve their investment goals.
An entity engages in oil and gas drilling. Rather than paying income tax at the entity level, it flows through the tax consequences to its investors. It is a A) Master trust B) Direct participation program C) Shell company D) Syndicate
B Direct participation program Explanation: A direct participation program (DPP) is characterized by the flow-through of tax consequences to investors. It may participate in oil & gas, real estate, agriculture and other types of activities.
Which of the following investment opportunities offer a flow through of losses to investors? I. Closed end funds II. Direct participation programs III. Hedge funds IV. ETFs A) II and IV B) II and III C) I and IV D) I and III
B II and III Explanation: Both direct participation programs and hedge funds offer a flow through of losses that can be used to offset passive income. Limited partnerships are a common form of a direct participation program that provide this tax feature.
The secondary market for ETFs is generally A) The same as ETNs B) More liquid than ETNs C) Limited to high net worth investors only, making them inaccessible to most retail investors D) Less liquid than ETNs
B More liquid than ETNs Explanation: While both ETFs and ETNs offer secondary market trading, the market for ETNs tends to be more limited than that for ETFs.
To limit downside exposure and generate income, structured products often rely on which of the following? A) International investment opportunities B) Options strategies C) Value investing D) High participation rates
B Options strategies Explanation: Downside protection and income is generated for structured products through the use of derivative investments and options strategies.
Passive losses generated by a limited partnership may be used to reduce which of the following? A) Both ordinary income and passive income B) Passive income only C) Capital gains from the sale of appreciated investments only D) Ordinary income only
B Passive income only Explanation: Passive losses may be used to offset earnings from other passive sources only.
All of the following are true of both mutual funds and REITS EXCEPT A) Both have a Board of Directors to establish their strategic direction B) Secondary market trading offers liquidity to investors C) A prospectus must be made available to potential purchasers D) Investors own a proportionate share of diverse assets that is professionally managed on their behalf
B Secondary market trading offers liquidity to investors Explanation: Mutual fund shares do not trade on the secondary market. They are redeemed by the fund. There are both publicly traded, and private, but non-traded REITS.
All of the following statements describing REITs are true EXCEPT A) Shares trade in the secondary market at a discount or premium to their net asset value B) They generally invest in residential real estate only C) They offer ownership in a pool of assets much like a mutual fund D) Public REITs are first offered to the market through an IPO
B They generally invest in residential real estate only Explanation: REITS generally invest their assets in commercial real estate, but also hold residential real estate mortgages. The ownership interest held by an investor reflects a share in all properties held by the fund much like ownership of mutual fund shares. REIT shares trade in the secondary market at a premium or discount to their NAV. REITs raise capital through an initial public offering.
A hedge fund in which the fund manager is given complete authority to decide on the assets in which to invest is a A) Absolute authorization fund B) Blank check fund C) Blind pool fund D) Full discretion fund
C Blind pool fund Explanation: In a blind pool hedge fund, there is not disclosure of the investments that will be made.
The type of REIT which generates revenue for investors primarily through rents collected and sale of properties is a(n) A) Balanced REIT B) Hybrid REIT C) Equity REIT D) Mortgage REIT
C Equity REIT Explanation: Equity REITS generate revenues primarily from collecting rents on property they own and also from the sales of properties they have held.
All of the following statements regarding the trading strategies of hedge funds are true EXCEPT A) Tangible assets are frequently used as investment alternatives within hedge funds B) Both short and long positions are heavily used to attempt to produce high returns for investors C) Hedge funds are limited in the amount of leverage they can employ in accomplishing their investment objectives D) Lock up periods allow hedge fund managers to invest in illiquid investments without concern for customer withdrawal requests
C Hedge funds are limited in the amount of leverage they can employ in accomplishing their investment objectives Explanation: The amount of leverage or other trading strategies employed are often left to the discretion of the hedge fund manager.
The frequent trading of securities within hedge funds may subject investors to A) Increased return of capital distributions B) Increased dividend distributions C) Increased short-term capital gains D) Increased long-term capital gains
C Increased short-term capital gains Explanation: Frequent trading by hedge fund managers can subject investors to increased short-term capital gains which can be costly because of the higher tax rate that applies to these distributions.
Investors in REITs can expect all of the following EXCEPT A) Participation in real estate investments B) Liquidity C) Redemption at NAV D) Dividend distributions
C Redemption at NAV Explanation: REITs trade in the secondary market at a premium or discount to their NAV. Investors sell their shares to other investors to through exchange transactions; REITs do not redeem their shares.
All of the following statements about structured products are true EXCEPT A) They can offer retail investors exposure to hard to access asset classes B) They often are based on derivative or option strategies for producing income and providing downside protection C) They offer a high degree of liquidity D) They must be sold with an offering document for investor disclosure
C They offer a high degree of liquidity Explanation: Structured products typically do not trade after they are issued. There is generally a significant discount when they are sold before their maturity.
For which type of customer is a hedge fund generally most appropriate? A) A sophisticated high net worth investor with a high-risk tolerance, but a short term need for liquidity B) A retail customer that is looking for a non-correlated investment to diversify his retirement savings C) A retail investor that has saved a substantial nest egg and is seeking aggressive growth through alternative investments with a share of his savings D) A sophisticated high net worth investor that has high risk tolerance and substantial investment experience
D A sophisticated high net worth investor that has high risk tolerance and substantial investment experience Explanation: Hedge funds are not designed for the typical retail investors. They employ highly aggressive trading strategies and have limited liquidity.
All of the following are investment benefits of real estate investment trust (REITs) EXCEPT: A) Avoidance of double taxation on dividends B) Attractive dividends C) Diversification among real estate properties, through a single investment D) Ability to pass through losses for investment tax deductions
D Ability to pass through losses for investment tax deductions Explanation: REITs offer diversification, attractive dividends and avoidance of double taxation on dividends. However, REITs can not pass through tax losses to investors.
To avoid double taxation on dividends paid to shareholders, REITs must invest what portion of their total assets in real estate? A) Substantially all B) At least 51% C) At least 90% D) At least 75%
D At least 75% Explanation: REITs can avoid double taxation on profits passed through as dividends to shareholders by concentrating their investments in real estate. At least 75% of total assets must be in real estate, and at least 75% of gross income must be derived from real estate. Also, they must pass through at least 90% of their gains to shareholders.
In a limited partnership a limited partner is permitted to engage in all of the following activities EXCEPT A) Inspecting the books and records of the partnership B) Initiating a lawsuit against the GP C) Voting on significant changes to the partnership such as a new GP or refinancing of partnership property D) Borrowing money from the partnership
D Borrowing money from the partnership Explanation: Neither a limited nor a general partner are permitted to borrow money from the partnership.
The pricing characteristics of REIT shares are most like those of shares of a A) Growth mutual fund B) Direct participation program C) Money market fund D) Closed end fund
D Closed end fund Explanation: REIT shares trade in the secondary market at a discount or premium to their NAV like closed end fund shares. Mutual fund shares like growth funds or money market funds are redeemed by the fund at their NAVs. DPPs do not generally trade; there is an extremely limited secondary market for investors who wish to sell their interests.
A recommendation for a purchase of an interest in a non-traded public REIT would be most appropriate for an investor who A) Has a short-term time horizon and does not need liquidity B) Has a long-term time horizon and needs liquidity C) Has a short-term time horizon and needs liquidity D) Has a long-term time horizon and does not need liquidity
D Has a long-term time horizon and does not need liquidity Explanation: A non-traded REIT, although offered to the public, is not generally liquid. It is most suitable for someone who has a long-term investment time horizon because funds are usually tied up for a lengthy period.
Which two of the following describe the typical investment in a private equity firm? I. Can range from a small to large investment minimum II. Typically a large minimum investment III. Generally committed for a long period of time IV. Generally committed for a relatively short timeframe A) I and III B) I and IV C) II and IV D) II and III
D II and III Explanation: Most private equity is raised through large investments from institutional investors and accredited investors that are committed for a long period of time typically about 10 years.
When evaluating the investment potential of a limited partnership, an investor should be most concerned with the A) Amount of loss the partnership can pass through B) Amount of recourse debt the investor needs to assume C) Potential benefits of the partnership as a tax shelter D) Overall economic viability of the partnership
D Overall economic viability of the partnership Explanation: The most important factor in choosing a direct participation or limited partnership investment is its economic potential, not its tax benefits or loss pass throughs.
