Alternative Investments

Question 1

What is a hard-catalyst event driven strategy?

Answer 1

Trades are made after event announcement.

Question 2

What is a soft-catalyst event driven strategy?

Answer 2

Trades are made before event announcement.

Question 3

What is the conversion price of a convertible bond and when is it undervalued?

Answer 3

Price x 10 / conversion ratio

Undervalued when the conversion price is less than the share price.

Question 4

What three market factors make a convertible bond arbitrage trade more favourable?

Answer 4

Periods of high CB issuance, moderate volatility, high market liquidity to maintain delta hedge.

Question 5

What strategies provide positive right tail skewness in market stress?

Answer 5

Global macro and managed futures.

Question 6

In managed futures, what is a time-series momentum strategy, and what is a key risk?

Answer 6

Go long assets that are rising in price and short assets falling in price. Can be more volatile in trending markets as all positions could be the same direction.

Question 7

In managed futures, what is a cross-sectional momentum strategy, and the key benefit over TMS?

Answer 7

Go long assets that are rising in price the most and short assets falling in price the most. Generally results in zero-market risk exposure.

Question 8

What three factors make a life settlements policy more attractive?

Answer 8

Lower surrender value, lower ongoing premiums, and probability of the insured buying sooner that predicted.

Question 9

What are three benefits to multi-fund strategies?

Answer 9

Reallocate capital into different strategies more quickly to take advantage of market conditions. Fees are netted out resulting in higher net returns. Higher transparency into manager decision making.

Question 10

What are two limitations to multi-fund strategies?

Answer 10

Higher manager specific operating risks and more variance in returns due to a higher use of leverage.

Question 11

What is two benefits to FoF strategies?

Answer 11

FoFs can have more diverse mix of strategies, give smaller investors access to hedge funds, and lower manager specific risk.

Question 12

What is two limitations to FoF strategies?

Answer 12

Reduced transparency into portfolio decisions made at the manager level. Double layer of fees and no netting.

Question 13

What is a pro and con of a traditional approach to defining asset classes?

Answer 13

Easy to communicate and implement. Over-estimates portfolio diversification and muddles primary drivers of risk.

Question 14

What are two analytical challenges with adding alternatives to a portfolio?

Answer 14

Stale data underestimates risk and correlations with other assets, more pronounced non-normal return distributions (higher leverage and non-symmetrical fee structures).

Question 15

What is a pro and a con of MVO as an asset allocation approach with alternatives?

Answer 15

Easy to understand and implement. Unsuitable for smoothed data and non-normal distributions.

Question 16

What is a pro and a con of mean-CVaR as an asset allocation approach with alternatives?

Answer 16

Highlights tail risk rather than symmetrical risk like MVO. Requires much more data than MVO.

Question 17

What is a pro and a con of a risk factor approach as an asset allocation approach with alternatives?

Answer 17

Can identify common risk factors across all investments, fixes the traditional approach limitation of overestimating portfolio diversification and muddling risk drivers. Risk exposures can change over time.

Question 18

What instruments can you use to take bets on volatility?

Answer 18

Exchange traded and OTC options but will need to delta hedge to isolate volatility. VIX futures and options and OTC volatility swaps are a pure volatility position.

Question 19

What are three limitations to a convertible arbitrage trade?

Answer 19

Shorted security is called back at an inopportune time, changes in credit risk can cause a mismatch in hedged positions, time decay of the long option position over time can reduce returns.

Question 20

What are the 7 high leverage strategies?

Answer 20

EMN, merger arbitrage, fixed income and convertible bond arbitrage, managed futures, global macro, volatility strategies.

Question 21

Name two functional roles that alts play in a portfolio?

Answer 21

Risk diversification: traditional portfolios are often heavily exposed to equity risk.
Income generation: real estate can produce steady cash flows.
Safety: some asset classes do well when traditional asset classes fall e.g., gold.