01 alternative investments for portfolio management

Question #17 of 101 Question ID: 466379In distressed securities investing, the type of risk that is from the human element associated with decisions determined in acourt of law is called

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Test ID: 7428164

Alternative Investments for Portfolio Management

With respect to adding managed futures investing to a stock and bond portfolio:

a trend-following strategy will offer more diversification than a contrarian

strategy

a trend-following strategy will offer diversification equal to that of a contrarian strategy

a trend-following strategy will offer lower diversification than a contrarian strategy

Explanation

For managed futures funds, a trend-following strategy will offer lower diversification than a contrarian strategy This should beobvious since the trends would be those of the cash markets for which the investor is trying to obtain diversification Themarket for the underlying securities will also play a role

With respect to venture capital (VC) funds and buyout funds, measuring returns accurately is:

more difficult with VC funds than with buyout funds

less difficult with VC funds than with buyout funds

equally difficult with VC funds as it is with buyout funds

Explanation

The difference is a natural consequence of the buyout funds purchasing entities in later stages of development

With respect to managed futures and real estate, legal issues and valuation methods are special due diligence issues

associated with:

real estate only

managed futures only

real estate and managed futures

Explanation

Active, direct investment in real estate requires all the due diligence checkpoints For the investment process due diligencecheckpoint, valuation methods deserve special attention Under documents, there may be special zoning and legal issues

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Question #4 of 101 Question ID: 466309

When added to a portfolio of stocks and bonds, based upon historical performance, we can expect distressed securities tocontribute:

enhanced return but not diversification

diversification but not enhanced return

both enhanced return and diversification

Explanation

They can provide high returns because many investors cannot hold distressed debt securities, and few analysts cover themarket Based on comparisons of the average and Sharpe ratio, the HFR Distressed Securities Index outperformed bothstocks and bonds both absolutely and on a risk-adjusted basis The returns are often event-driven so the return is

uncorrelated to the overall stock market and can provide diversification

In the special issues that alternative investments raise for investment advisors of private wealth clients, with respect to taxissues and suitability:

both are explicitly special issues to consider

suitability is a special issue to consider but tax issues are not

tax issues are a special issue to consider but suitability is not

Explanation

Special issues that advisors for private-wealth clients should address are tax issues, determining suitability, communicatingwith the client, decision risk, and determining if they have a large position in a closely-held company

In making investments in private equity, diversification is:

not possible to any investor

possible by holding a number of positions, but usually only for investors with portfolios

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Compared to common stockholders, investors who use convertible preferred stock to make venture capital investments willreceive the promised dividend:

only if common stockholders receive a dividend or a disbursement through

liquidation

before common stockholders receive a dividend but not if there is a liquidation

before common stockholders receive a dividend or a disbursement through

liquidation

Explanation

Preferred stockholders must be paid a specified amount, say twice the initial investment, before common stockholders canreceive cash in the form of dividends or distributions through liquidation

For hedge funds, the basic incentive fee for managers may not be adequate because:

they are usually too low, e.g., 2% or less

a manager usually earns a minimum incentive fee regardless of the performance of

the fund

a hedge fund manager may have several goals other than earning a high return, e.g.,

lowering downside risk

Explanation

The rationale for incentive fees is obvious: encourage the manager to earn higher profits There is some controversy

concerning fees because a manager may have or should have other goals than simply earning a gross return For example,the manager may/should be providing limited downside risk and diversification The basic incentive fee does not reward thisservice

Hedge fund managers with good track records:

often demand higher incentive fees

usually lower their fees to increase the assets under management

generally continue to have good track records

Explanation

Managers with good track records often demand higher incentive fees The concern for investors is whether the manager with

a good historical record can continue to perform well enough to justify the higher fees

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the extra layer of fees only.

no reason; fund of funds earn returns that are equal to those of individual hedge

of fees and cash drag (resulting from a desire to have higher liquidity)

Which of the following is least likely to be a due diligence checkpoint in the selection process of active managers of alternativeinvestments?

Market opportunity the manager seeks to exploit

The service providers like lawyers and ancillary staff working for the manager's firm

The geographic location of the office with respect to the geographic locations in which

the manager invests

Explanation

The due diligence checkpoint list does not mention the geographic location of the offices

Which stage of financing generally supports further expansion of production and sales?

The second stage

The third stage

The first stage

Explanation

The second stage of financing supports further expansion of production and sales The third stage of financing typically cansupport additional major expansion First stage funding is used to begin manufacturing and sales

With respect to commodities and managed futures, which have investable indices?

Both commodities and managed futures

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Commodities but not managed futures.

Neither commodities nor managed futures

Explanation

Indices for both asset classes use trading rules and assets to which investors have access

Direct investment in commodities has become easier for all investors because of the:

the increase in the number of commodity indices

increased number of hedge funds in these markets

increase in hedging activities of managers in firms that produce and/or deal in

commodities

Explanation

There has been an increase in the number of indices making it easier for smaller investors to invest in commodities and takederivative positions in commodities

Compared to indirect investments in commodities, direct investments offer:

more exposure to commodity returns but higher carrying costs

less exposure to commodity returns and higher carrying costs

less exposure to commodity returns but lower carrying costs

Explanation

Often indirect investments via investing in a company producing the commodity provide lower exposure because the

managers hedge the very exposure the investor seeks Direct investments in commodities incur costs of storage called

carrying costs

William Jones, CFA, has a client who wants to invest in a hedge fund Jones might recommend a fund of funds instead of asingle fund for all of the following reasons EXCEPT a fund of funds:

would be more liquid

would have a lower correlation with equity markets

may serve as a better indicator of aggregate performance of hedge funds

Explanation

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In distressed securities investing, the type of risk that is from the human element associated with decisions determined in acourt of law is called:

Which of the following most likely represents the compensation to a sponsor of a private equity fund?

A management fee of 10% and an incentive fee of 10%

Explanation

As a manager, the sponsor gets a management fee and incentive fee The management fee is usually around 1.5%-2.5%, and

is based upon the committed cash and not just the cash already invested The percent may decline over time based upon theassumption that the sponsor's work declines over time The incentive fee is the share of the profits, usually around 20%, that ispaid to the manager after the fund has returned the outside investors' capital

In distressed securities investing, a private equity fund that seeks to partner with the company in which the fund invests wouldmost likely be called:

an orphan equity fund

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For use in evaluating hedge funds, which of the following is NOT a shortcoming of the Sharpe ratio?

It has had little success in predicting winners

It uses an arbitrary reference return

It is a stand-alone measure that ignores the diversification contributions of a hedge

fund to an overall portfolio

Explanation

The Sharpe ratio is a very standardized measure, and none of the inputs are arbitrary Both remaining choices are recognizedshortcomings of the Sharpe ratio

Style drift and survivorship bias are often mentioned in the analysis of hedge fund performance Which of the following

statements is most accurate? Fund of funds can serve as better indicators of aggregate hedge fund performance than hedgefund indices because they tend to have a lower level of:

both survivorship bias and style drift

survivorship bias only

style drift only

Explanation

A fund of funds may serve as a better indicator of aggregate performance of hedge funds (i.e., a better benchmark) becausethey suffer from less survivorship bias If a fund of funds includes a fund that dissolves, the fund of funds includes the effect ofthat failure in the return of the fund of funds; however, an index may simply drop the failed fund A fund of funds can sufferfrom style drift This can produce problems in that the investor may not know what he/she is getting Over time, managers maytilt their respective portfolios in different directions It is not uncommon that two fund of funds who claim to be of the same style

to have returns with a very low correlation

With respect to buyers of venture capital, which group represents the first group to invest in the company after the initialentrepreneurs and their friends and family?

Angel investors

Strategic partners

Venture capitalists

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Which of the following is least likely to be included in private equity subgroups?

In distressed securities investing, event risk is:

a source of both return and diversification

a source of diversification only

a source of return only

Formative-stage companies only

Neither formative-stage companies nor expansion-stage companies

Both formative-stage companies and expansion-stage companies

Explanation

Issuers of venture capital include formative-stage companies that are either new or young and expansion-stage companiesthat need funds to expand their revenues or prepare for an IPO

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If a hedge fund goal is the elimination of systematic risk, a problem for the fund in motivating the manager is that:

the standard incentive fee only applies to raw earnings and would not reward

the elimination of systematic risk

the standard incentive fee only applies to assets under management and would not

reward the elimination of systematic risk

it is impossible to gauge the degree to which systematic risk has been eliminated

Explanation

There is some controversy concerning fees because a manager may have or should have other goals than simply earning agross return For example, the manager may/should be providing limited downside risk and diversification The basic incentivefee does not reward this service

In the special issues that alternative investments raise for investment advisors of private wealth clients, "decision risk" isassociated with:

making hiring and firing decisions and general employee turnover of the

investment firm

changing a strategy at the time the portfolio has incurred a large loss

assessing the investment opportunity

Explanation

Decision risk is the risk of irrationally changing a strategy

Commodities can be categorized into storable and nonstorable Which category, if any, should an analyst recommend as ahedge against inflation?

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When compared to a portfolio of publicly traded stocks, private equity is:

correlated with stocks but adds moderate diversification because of its

idiosyncratic risk component

correlated with stocks and has a low idiosyncratic risk component so it adds virtually

In the life of a private equity fund, capital calls represent the:

request for more capital by the fund sponsor from the investors after the

commitment period

request for more capital by the fund sponsor from the investors during the

commitment period

request for more capital by the fund sponsor from the investors at the beginning of the

fund prior to the commitment period

Explanation

The timeline includes the sponsor getting commitments from the investors at the start of the fund and then giving "capital calls"over the first five years (typically) called the commitment period to bring in the promised cash

Direct equity real estate investing has all of the following advantages over indirect real estate investing EXCEPT:

lower information costs

tax deductible expenses

the ability to manage geographic diversification

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preferences, Jones should recommend:

the Hera Fund only

Which of the following is an example of an issuer of venture capital?

Special due diligence issues such as valuation, credit analysis, and financial structure are most likely associated with

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Within the alternative asset class of real estate, analysts can classify investments as:

either direct or indirect and as either start-up or middle market

either start-up or middle market but not as direct or indirect

either direct or indirect but not as either start-up or middle market

Explanation

Real estate investments are generally categorized as direct (i.e., the purchase of land and buildings) or indirect that includesREITs and CREFs The sub-categories of start-up and middle market apply to private equity and not real estate

With respect to hedge fund indices, back-fill bias refers to:

a hedge fund manager filling in historical values of his/her hedge fund's

performance when the fund has been selected to be included in an index

the increased inflow of investments to a given fund in an index right after the style of

the index has performed well

modifying the historical series of the index by replacing the historical returns of

recently dropped funds with the historical returns of new funds added to the index

Explanation

Biases often exist in hedge fund indices because of the self-reporting of fund returns This can apply to returns as they areearned or when filling in gaps in the historical data The inclination is to over report Backfill or inclusion bias is the name of thepotential bias when a hedge fund joins an index and the manager adds historical data to complete the series

A commodity pool operator (CPO) is deciding whether or not to hire a particular commodity trading advisor (CTA) The CTAhas a good track record of performance and often exhibits negative correlation with equities thus enhancing overall

performance in down markets Which of the following statements regarding whether or not the CPO should hire the CTA ismost accurate? The CPO should:

hire the CTA only if its beta and correlation have been considered in

determining its risk relative to the pool of operators

not hire the CTA if their beta relative to other CTAs managing the pool of futures

contracts is too low, as this indicates that the CTA's past returns are low relative to the

pool of operators

not hire the CTA if their past performance is highly correlated with the pool of

operators, as this indicates their volatility relative to the pool is high

Explanation

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individual equity security or portfolio to the overall equity market, the CTA beta measures the risk of the individual CTA relative

to a fund of CTAs

Diversification is one of the major issues that must be addressed when formulating a private equity investment strategy To beconsidered diversified, investors must be able to invest in 5 to 10 different investments In order to do this investors musttypically have portfolios of at least:

In contrast to venture capital funds, buyout funds usually have:

less frequent losses and more upside potential

less frequent losses and less upside potential

more frequent losses and more upside potential

ranks ahead of debt investors

has dividends that can increase

benefits in the event of a company buyout

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Unsystematic – the commodity trading advisor tracks specific commodity

futures contracts and uses trading rules to signal when to buy and sell the

contract

Discretionary – the commodity trading advisor uses their own discretion to buy futures

contracts they feel are over or undervalued

Systematic – the commodity trading advisor trades according to market trends and

may even use a contrarian strategy which trades against the market trend

Explanation

Commodity trading advisor (CTA) strategies can be described as systematic or discretionary (not unsystematic) CTAs thatspecialize in systematic trading strategies typically apply sets of rules to trade according to short, intermediate, and/or long-term trends They may also trade counter to trends in a contrarian (against the trend) strategy

A discretionary trading strategy is based on the discretion of the CTA, in the same way that any active manager seeksvalue

Managed futures can also be classified according to the markets in which they trade They apply systematic or discretionarytrading strategies in financial markets, currency markets, or diversified markets In financial markets, they trade in financial(i.e., interest rate) and currency futures, options, and forward contracts Those that specialize in currency markets tradeexclusively in currency derivatives A fund that trades in diversified markets trades in all the financial derivatives marketsdescribed as well as commodity derivatives

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With respect to weighting schemes for hedge fund indices, the weighting schemes:

can be either equally weighted or based upon assets under management

are always based upon assets under management

are always equally weighted

Explanation

Weighting schemes are usually either equally weighted or based upon assets under management

With respect to the role of alternative assets in a portfolio, it can be best described as exposure to:

unique asset classes only

unique asset classes and/or special investment strategies

special investment strategies

Explanation

We can categorize alternative investments into three categories corresponding to the role they play in the portfolio

1 Exposure to asset classes that stocks and bonds cannot provide

2 Exposure to special investment strategies such as those used by hedge funds

3 Investments that use both special strategies and unique asset classes (e.g., funds that invest in private equity and

distressed securities)

Direct equity real estate investing has the following disadvantages over indirect real estate investing EXCEPT:

less control over the investment's performance

An investor in private equity needs to prepare for capital calls, which:

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equal the funds promised at the initiation of the fund and usually occur during

the first five years of the fund

is additional money requested by the sponsor as mezzanine financing after the

not include measuring the ownership in the client's corporate bond portfolio

but would include measuring the client's ownership in closely held companies

include measuring the ownership in the client's corporate bond portfolio and the

client's ownership in closely held companies

not include measuring the ownership in the client's corporate bond portfolio and not

include measuring the client's ownership in closely held companies

Explanation

Special issues that advisors for private-wealth clients should address are tax issues, determining suitability, communicatingwith the client, decision risk, and determining if they have a large position in a closely-held company Measuring the ownership

in corporate bonds is not a "special issue."

When evaluating hedge funds, special issues that complicate the process would include the fact(s) that:

benchmarks are absolute return in nature and do not address other goals such

as the elimination of systematic risk

many hedge funds are absolute return vehicles for which no benchmark exists, and

they can use long/short strategies while most benchmarks are long only in nature

benchmarks are designed to be both long and short in nature, but most hedge funds

are long only

Explanation

These are two problems in defining and creating benchmarks One method for addressing problems in defining and creatingbenchmarks is the use of single and multi-factor models Thus, factor models do not pose a complication but offer a solution

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Either one since both have approximately the same liquidity

An investment with a hedge fund structure over a private equity structure

An investment with a private equity structure over a hedge fund structure

Explanation

Distressed securities can be divided by the two indicated structures Hedge fund structured investments are usually moreliquid than investments in distressed equity using the private equity structure

Which of the following statements regarding the performance of managed futures is most accurate?

Privately managed futures have not performed as well as publicly traded funds

Publicly traded managed futures have performed well on both a stand-alone and

portfolio basis

Managed futures have exhibited a positive correlation to equities and bonds during up

markets and a negative correlation during falling markets

Explanation

The primary benefit to managed futures is the significant diversification potential (i.e., improved Sharpe ratios) For example,some research has even shown that managed futures have exhibited positive correlation to equities and bonds during upmarkets and negative correlations during falling markets, although the performance seems to be related to specific strategiesand time periods In particular, private funds seem to add value whereas publicly traded funds have performed poorly bothstand-alone and in portfolios

Which of the following most likely represents the timeline of a private equity fund?

The commitment period of 7-10 years, the life of the fund reaching 12-15 years,

an option to extend the fund 5 more years

The commitment period of 2 years, the life of the fund reaching 5 years, an option to

extend the fund 3 more years

The commitment period of 5 years, the life of the fund reaching 7-10 years, an option

to extend the fund 5 more years

Explanation

The commitment period usually occurs during the first five years when the sponsor gives the capital calls The expected life ofthese funds is 7-10 years, and there is often an option to extend the life up to 5 more years

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A hedge fund that focuses on earning returns from mergers, spin-offs, and takeovers would be most accurately placed inwhich style category?

Compared to direct investing in commodities, indirect investing is usually considered to be:

just as convenient, which is very convenient

With respect to the operations of a hedge fund, a high water mark is designed to:

prevent a manager from allowing the fund to become so large that it cannot be

managed efficiently and/or use its selected style effectively

prevent a manager from being paid twice for the same gains of the fund

put a cap on the assets-under-management fee

Explanation

The high-water mark provision is designed to prevent payment to a manager twice for the same gains If a fund goes from

$100 to $120 in value and the manager earns an incentive fee for the $20 gain, and then the fund's value goes down to $110and back to $120, the manager will not earn a fee for the gain from $110 back to $120 $120 was a "high water mark."

In contrast to venture capital funds, buyout funds usually have a:

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