47: Alts

Question 1

In a 2-and-20 hedge fund fee structure, the “2” refers to a hedge fund’s

Answer 1

2= management fee
20= incentive fee

Question 2

Profits are distributed as each fund investment is sold and subsequently shared according to the partnership agreement

Profits distributed as fund exits each investment

Answer 2

deal-by-deal (American) waterfall structure for incentive fees

Question 3

Refers to the way in which payments are allocated to GP and LPs as profits and losses are realized on deals

Answer 3

Waterfall

Question 4

The limited partners receive all distributions until they have received 100% of their initial investment plus the hurdle rate

The GP does not earn an incentive fee until the LP have received their initial investment back

Answer 4

Whole-of-fund waterfall (European waterfall)

Question 5

For hedge funds, management fees are calculated as:

Answer 5

a percentage of assets under management (AUM); net asset value of fund

Typically structured as a partnership

Question 6

The typical trade used by a merger arbitrage fund is:

Answer 6

Short position of the acquirer
Long position in the firm being acquired;

Short the stock of the acquirer and buy the stock of the firm being acquired

Merger arbitrage, a type of Event driven hedge funds strategy;

Question 7

Long based hedge fund strategy that involves long or short positions in common equity, preferred equity, or debt of a specific corporation

Answer 7

Event-driven hedge fund strategy:
* merger arbitrage
* distressed/restructuring
* special situations strategies

Question 8

strategy involves seeking to profit from long and short positions in publicly traded equities and derivatives with equities as their underlying assets

Answer 8

Equity hedge;
not based on events such as restructuring or acquisition

Question 9

a hedge fund charges an incentive fee on all profits, but only if the fund’s rate of return exceeds a stated benchmark.

Answer 9

Soft hurdle

Question 10

hedge fund charges an incentive fee only on the portion of returns that exceed a stated benchmark

Answer 10

hard hurdle

Question 11

A fund’s value must exceed its highest previous value (net of fees) before the fund may charge an incentive fee:

Answer 11

high water mark

Prevents GP from collecting incentive fees twice on investment gains

Prevents a GP from receiving incentive fees on incresas in investment value that do not increase its value above its previous high value

Question 12

Convertible arbitrage is a strategy that involves buying a security and selling short a related security with the goal of profiting when a perceived pricing discrepancy between the two is resolved

Answer 12

Relative value hedge fund strategy

Also includes: asset backed fixed income, general fixed income, volatility, multi-strategy

Question 13

The goal of adding hedge funds to a traditional portfolio is:

Answer 13

• increase expected return
• decrease variance; because returns on these investments are less than perfectly correlated with returns on traditional investments

Question 14

Attempt to profit from short positions in equities they believe to be overvalued

Answer 14

Equity hedge fund strategies, with a short bias

Question 15

strategy attempts to identify undervalued equities

Answer 15

Fundamental value- Equity hedge fund strategy

Question 16

Investing in companies that are experiencing high growth and rapid earnings; and for which the fund managers anticipate significant capital appreciation

Answer 16

Fundamental growth- Equity hedge fund strategy

Question 17

time after initial investment over which limited partners either:
* cannot request redemptions
* or incur significant fees or redemptions (soft)

Answer 17

Lockup period

Question 18

The period following a redemption request, within which the fund must fulfill the request;
amount of time a fund has to fulfill a redemption request made after the lockup period has passed

Answer 18

Notice period

Question 19

This stage of venture capital financing provides capital during the period prior to an initial public offering

Answer 19

mezzanine stage

Question 20

This formative stage of venture capital investing, the capital is furnished for product development, marketing, and market research:

Answer 20

Seed stage

Question 21

This formative stage of venture capital investing is when investment funds are used for:
* business plans
* assessing market potential
* product development
* marketing effort

Answer 21

Seed stage

Question 22

This formative stage of venture capital financing refers to investments made to fund initial commercial production and sales

Answer 22

Early stage

Question 23

The capital supplied, in this formative stage, is used to fund initial production & sales

Answer 23

Early stage

Question 24

With deal by deal strucutre, requires the manager to return any periodic incentive fees to investors that would result in investors receiving less than 80% of the profits generated by portfolio investments as a whole

LPS may recover incentive fees if subsequent losses result in prior incentive fees exceeding agreed percentage of overall profits

Answer 24

clawback provision

Question 25

in the formative stage, this funding is for the formation of the business

Answer 25

angel investing

Question 26

When the company issues debt to fund a dividend distribution to equity holders (the fund) A private equity firm that wants to receive money from a portfolio company **without giving up control** of the portfolio company is most likely to engage in:

Answer 26

Recapitalization

Question 27

Private equity firm sells the portfolio company to a competitor or another strategic buyer

Answer 27

Trade sale; private equity firm is exiting an investment

Question 28

Value of having the physical commodity for use over the period of the futures contract

Answer 28

convenience yield

Question 29

If there is little or no convenience yield, the futures market for that commodity is:

Answer 29

in contango Futures price > spot price ## Footnote Convenience yield < Storage costs

Question 30

If the convenience yield is high, the futures market for that commodity is:

Answer 30

in backwardation Futures price < spot price ## Footnote Convenience yield > Storage costs

Question 31

Returns are smoother than those based on actual sales and have the **lowest standard deviation of returns**

Answer 31

appraisal index | Returns are based on property values ## Footnote Because estimating values tends to introduce smoothing into returns data, appraisal index returns are likely to have lower standard deviations than index returns based on repeat sales or trading prices of REIT shares.

Question 32

Funds that invest in specific commodity sectors such as oil and gas or precious metals are best described as

Answer 32

specialized commodity funds

Question 33

Can provide a hedge against inflation:

Answer 33

Commodities & Natural Resources

Question 34

Including a previous year's performance when adding a new fund, in an index

Answer 34

Backfill bias

Question 35

Survivorship bias and backfill bias cause an upward bias on:

Answer 35

Index Returns

Question 36

Infrequent valuation of portfolio companies cause a downward bias on:

Answer 36

correlations & standard deviation (risk)

Question 37

The Sharpe ratio is a less-than-ideal performance measure for alternative investments because:

Answer 37

Returns on alternatives are not normally distributed (Sharpe ratio assumes normal distribution)

Question 38

The IRR calculation involves the assumption of two rates:

Answer 38

Rate for outgoing cash flows: WACC: required rate of return on investment Rate for incoming cash flows: reinvestment rate

Question 39

The need to use a model for valuation arises when there is not reliable market values available on an asset because:

Answer 39

asset is so illiquid

Question 40

Focus on the left side of the return distribution curve, where losses occur

Answer 40

Downside risk measures models used to measure: Sortino & VaR | Macro stategy fund

Question 41

Mostly involves leveraged buyouts of **established, profitable, and cash generating companies**

Answer 41

Private equity | Typically structured as a partnership ## Footnote Returns are described in terms of the J-curve effect

Question 42

The management fee is typically based on **committed capital**, not invested capital:

Answer 42

private equity funds ## Footnote vs hedge funds who's feed are based on AUM

Question 43

Invests in other hedge funds, and incurs an additional layer of management & incentive fees:

Answer 43

Fund of Funds ## Footnote Provides lower returns compared to directing investing in a hedge fund

Question 44

Institutional investors typically begin investing in alternative investments via: ## Footnote Pool assets with other investors

Answer 44

Fund investing | Limited partnership agreement ## Footnote lower minimuim investment amounts less investor involvement pay management & incentive fees benefit from the expertise of the fund manager (general partner)

Question 45

A private equity firm that provides equity capital to a publicly traded company to finance the company's restructuring, but does not take the company private:

Answer 45

Private Investment in Public Equity

Question 46

# Examples of: Social infrastructure: Utility infrastructure: Communications infrastructure:

Answer 46

Health care Waste treatment plants Broadcasting towers

Question 47

A hedge fund strategy that takes positions in shares of firms undergoing restructuring or acquisition is said to be pursuing:

Answer 47

Event driven strategy

Question 48

Private equity funds use which water fall structure?

Answer 48

Whole of fund (European) ## Footnote The GP does not earn an incentive fee until the LP have received their initial investment back

Question 49

Making a direct investment in an asset that an investor also owns an interest in indirectly through a fund (invests through a fund): ## Footnote Pool assets with other investors, but also invest directly alongside fund manager:

Answer 49

Co-investing ## Footnote Reduced fees Greater investor control Requires greater involvement and expertise

Question 50

Investing through a limited partnership:

Answer 50

Investing in a group of assets (real estate or private companies) | Provides greater diversification compared to direct investing

Question 51

Gives investors more control over the selection of assets Lower management fees ## Footnote Investor purchases and manages the asset itself

Answer 51

Direct Investing ## Footnote Control over decisions Requires expertise Less diversification Avoids management fees charged in a limited partnership structure

Question 52

Rate of return that must be exceeded **before** incentive fees are paid to the **general partner:**

Answer 52

Hurdle rate

Question 53

Catch-up provisions favor:

Answer 53

General Partner ## Footnote The limited partners get the first % hurdle rate gross return and the general partners get all returns above that rate to a maximum specified

Question 54

The use of **derivatives** is typically a feature of:

Answer 54

hedge funds

Question 55

Provides an investor with indirect equity exposure to real estate:

Answer 55

Real estate investment trusts (REITs)

Question 56

**Infrastructure asset** with growth opportunities and returns that are expected to be **lower:**

Answer 56

Brownfield Assets | Lower risk compared to Greenfield assets

Question 57

The Fund structure for fund investing includes:

Answer 57

General partners: fund managers Limited partners: investors

Question 58

Portfolio managers invest in one of two ways to achieve returns:

Answer 58

Alts are generally **actively managed**; however a portfolio manager may use passive management to provide exposure to certain alts asset classes **Passively**: focus on index or asset coverage (real estate, commodities, infrasture)

Question 59

Private equity strategy that includes: * management buyouts * management buy ins

Answer 59

Leveraged buyouts * Management buyouts; Existing managers buyout the company * Management buy-ins; replace exisiting managers with new managers

Question 60

Real estate investment that is characterized by illiquidity:

Answer 60

Commerical property

Question 61

Returns are only generated from price changes:

Answer 61

Commodities | (different from all other alternative investments)

Question 62

Due to biases, hedge fund returns & risk are:

Answer 62

Returns: overstated Risk: understated