Reading 2.1: What is an Alternative Investment?

Question 1

absolute return standard

Answer 1

An absolute return standard means that returns are to be evaluated relative to zero, a fixed rate, or relative to the riskless rate, and therefore independently of performance in equity markets, debt markets, or any other markets.

Question 2

active management

Answer 2

Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.

Question 3

absolute return products

Answer 3

Absolute return products are investment products viewed as having little or no return correlation with traditional assets, and have investment performance that is often analyzed on an absolute basis rather than relative to the performance of traditional investments.

Question 4

active return

Answer 4

Active return is the difference between the return of a portfolio and its benchmark that is due to active management.

Question 5

active risk

Answer 5

Active risk is that risk that causes a portfolio’s return to deviate from the return of a benchmark due to active management.

Question 6

alternative investments

Answer 6

Alternativeinvestments are sometimes viewed as including any investment that is not simply a long position in traditional investments.

Question 7

benchmark

Answer 7

A benchmark is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.

Question 8

benchmark return

Answer 8

A benchmark return is the return of the benchmark index or benchmark portfolio.

Question 9

commodities

Answer 9

Commodities are homogeneous goods available in large quantities, such as energy products, agricultural products, metals, and building materials.

Question 10

compensation structure

Answer 10

Compensation structure refers to the ways that organizational issues, especially compensation schemes, influence particular investments.

Question 11

distressed debt

Answer 11

Distressed debt refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection.

Question 12

diversifier

Answer 12

A diversifier is an investment with a primary purpose of contributing diversification benefits to its owner.

Question 13

efficiency

Answer 13

Efficiency refers to the tendency of market prices to reflect all available information.

Question 14

farmland

Answer 14

Farmland consists of land cultivated for row crops (e.g., vegetables and grains) and permanent crops (e.g., orchards and vineyards).

Question 15

financial asset

Answer 15

A financial asset is not a real asset; it is a claim on cash flows, such as a share of stock or a bond.

Question 16

hedge fund

Answer 16

A hedge fund is a privately organized investment vehicle that uses its less regulated nature to generate investment opportunities that are substantially distinct from those offered by traditional investment vehicles, which are subject to regulations such as those restricting their use of derivatives and leverage.

Question 17

illiquidity

Answer 17

Illiquidity means that the investment trades infrequently or with low volume (i.e., thinly).

Question 18

incomplete markets

Answer 18

Incomplete markets refer to markets with insufficient distinct investment opportunities.

Question 19

inefficiency

Answer 19

Inefficiency refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.

Question 20

information asymmetries

Answer 20

Information asymmetries refer to the extent to which market participants possess different data and knowledge.

Question 21

infrastructure investments

Answer 21

Infrastructure investments are claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government).

Question 22

innovation

Answer 22

Innovation is the application of creativity.

Question 23

institutional factors

Answer 23

Institutional factors refer to the financial markets (and their policies, such as restrictions on short selling, leverage, and trading) and financial institutions related to a particular investment, such as whether the investment is publicly traded.

Question 24

institutional-quality investment

Answer 24

An institutional-quality investment is the type of investment that financial institutions such as pension funds or endowments might include in their holdings because they are expected to deliver reasonable returns at an acceptable level of risk.

Question 25

investment

Answer 25

An investment is a deferred consumption. Any net outlay of cash made with the prospect of receiving future benefits might be considered an investment.

Question 26

land

Answer 26

Land comprises a variety of forms, including undeveloped land, timberland, and farmland.

Question 27

lumpy assets

Answer 27

Lumpy assets are assets that can be bought and sold only in specific quantities, such as a large real estate project.

Question 28

mezzanine debt

Answer 28

Mezzanine debt derives its name from its position in the capital structure of a firm: between the ceilings of senior secured debt and the floor of equity.

Question 29

moral hazard

Answer 29

Moral hazard is risk that the behavior of one or more parties will change after entering into a contract.

Question 30

operationally focused real assets

Answer 30

Operationally focused real assets include real estate, land, infrastructure, and intellectual property.

Question 31

passive investing

Answer 31

Passive investing tends to focus on buying and holding securities in an effort to match the risk and return of a target, such as a highly diversified index.

Question 32

private equity

Answer 32

The term private equity is used in the CAIA curriculum to include both equity and debt positions that, among other things, are not publicly traded.

Question 33

pure arbitrage

Answer 33

Pure arbitrage is the attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets.

Question 34

real assets

Answer 34

Real assets are investments in which the underlying assets involve direct ownership of nonfinancial assets rather than ownership through financial assets, such as the securities of manufacturing or service enterprises.

Question 35

real estate

Answer 35

Real estate focuses on land and improvements that are permanently affixed, like buildings.

Question 36

regulatory factors

Answer 36

Regulatory factors in the context of investing refer to the role of government, including both regulation and taxation, in influencing the nature of an investment.

Question 37

relative return standard

Answer 37

A relative return standard means that returns are to be evaluated relative to a benchmark.

Question 38

return diversifier

Answer 38

If the primary objective of including the product is the reduction in the portfolio’s risk that it is believed to offer through its lack of correlation with the portfolio’s other assets, then that product is often referred to as a return diversifier.

Question 39

return enhancer

Answer 39

If the primary objective of including an investment product in a portfolio is the superior average returns that it is believed to offer, then that product is often referred to as a return enhancer.

Question 40

structured products

Answer 40

Structured products are instruments created to exhibit particular return, risk, taxation, or other attributes.

Question 41

structuring

Answer 41

Structuring refers to the partitioning of claims to cash flows through leverage and securitization.

Question 42

timberland

Answer 42

Timberland includes both the land and the timber of forests of tree species typically used in the forest products industry.

Question 43

trading strategies

Answer 43

Trading strategies refer to the role of an investment vehicle’s investment managers in developing and implementing trading strategies that alter the nature of an investment.

Question 44

traditional investments

Answer 44

Traditional investments include publicly traded equities, fixed-income securities, and cash.

Question 45

Alternative Investments by Inclusion

Answer 45

[1] Hedge funds (+ managed futures)
[2] Private Equity/Debt
[3] Structured Products (+ credit derivatives)
[4] Real Assets (natural resources, commodities, real estate, infrastructure and intellectual property)