CFA L2 Alternative Investments Flashcards

Question

Collateral return/Collateral yield

Answer 1

When a futures portfolio is fully collateralized, the investor must post cash or acceptable securities w/ a value equal to the notional value of the futures contract. If U.S. Treasury bills are deposited as collateral, the return is the holding period return on the T-Bills.

Answer 2

The change in spot prices (which can be proxied by futures prices on near-month contracts). Price return = (current price - previous price) ÷ previous price

Answer 3

Since commodity derivative contracts expire, an investor who wants to maintain a position over time must close out the expiring futures position and reestablish a new position with a settlement date further in the future. This process is referred to as **rolling over** the position and leads to gains or losses which are termed the roll return. Roll return = (price of expiring futures contract - price of new futures contract) ÷ price of expiring futures contract ## Footnote * The roll return can be positive if the futures price curve is in backwardation or negative if the futures price curve is in contango. * To hold the value of a long position constant, an investor must buy more contracts if the new longer-dated futures are trading at a lower price (market in backwardation) and buy fewer contracts if the new longer-dated futures are trading at a higher price (market in contango).

Answer 4

Used to hedge commodities risk. The swap buyer (the long) will receive periodic payments based on the change in the futures price of a commodity plus the return on the collateral, and will pay a series of fixed payments. Each period, the long will receive the total return on holding the commodity times a notional principal amount, net of the payment promised to the short. If the total return is negative, the long makes the promised fixed payment percentage plus the negative return percentage on the commodity over the period, times the notional amount.

Answer 5

(1) (0.0145 - 0.0025) * $10MM = $120,000 - Investor A will receive $120,000 (2) (-0.0214 - 0.0025) * $10MM = -$239,000 - Investor A will pay -$239,000

Answer 6

A party may make a single payment at the initiation of the swap and then receive periodic payments of any percentage by which the commodity price exceeds some fixed or benchmark value, times the notional value of the swap. In months where the commodity price does not exceed the fixed value, no payments are made.

Answer 7

The variable payments are based on the difference between the prices of two commodities. This is often done when one commodity has liquid future contracts available and the other doesn't. Because the price changes of the two commodities are less than perfectly correlated, the difference between them (the basis) changes over time. By combining a hedge using the liquid futures with a basis swap, the swap buyer can hedge the price risk he faces from the input that does not have a liquid futures market.

Answer 8

The underlying factor is the volatility of the commodity's price. If the volatility of the commodity's price is higher than the expected level of volatility specified in the swap, the volatility buyer receives a payment. When actual volatility is lower than the specified level, the volatility seller receives a payment.

Answer 9

* Which commodities are included * The weighting of the commodities in the index * The method of rolling contracts over as they near expiration * The method of rebalancing portfolio weights ## Footnote * With regard to roll methodology, a passive strategy may be to simply roll the expiring futures contracts into the near-month contract each month. A more active strategy would be to maximize roll return by selecting the further-out contracts with the greatest backwardation or smallest contango.

Answer 10

Components included in the index and weighting characteristics

Answer 11

Public real estate: Ownership usually involves a direct investment such as purchasing property or lending money to a purchaser. Direct investments can be solely owned or indirectly owned through partnerships where the GP provides property management services and LPs are investors Private real estate: Does not involve direct investment, but rather ownership of securities: REITs, REOCs, and MBSs. ## Footnote * Private RE investments are usually larger than public investments because real estate is indivisible and illiquid. * Public RE are usually more liquid and allow investors more diversity.

Answer 12

* Heterogenity: No two properties are exactly the same (this is esp. true w/ commercial properties) * High unit value: Because RE is indivisible, the unit value is significantly higher than stocks and bonds, which makes it difficult to construct a diversified portfolio. * Active mgmt: Private RE requires active mgmt * High transaction costs: appraisals, brokers, etc. * Depreciation and desirability * Cost & availability of debt capital * Lack of liquidity * Difficulty in determining price: Because of the high costs to acquire and develop RE, property values are impacted by the level of interest rates and availability of debt capital. Real estate values are usually lower when interest rates are high and debt capital is scarce.

Answer 13

1. Supply and demand risks * Business conditions * Demographics * Excess supply: If there is a market downturn, there could be a lack of CFs from a lack of rental income, and therefore excess supply. 2. Risks relating to valuation * Cost and availability of capital: RE must compete with other investments for capital. Demand for RE is reduced when debt capital is scarce and interest rates are high. Conversely, demand is higher when debt capital is easily obtained and interest rates are low. Thus, RE prices can be affected by capital market forces without changes in demand from tenants. * availability of info * Iliquidity * Interest rates 3. Operational risks * Mgmt expertise * Lease terms * Leverage * ESG considerations * Obsolescence * Market disruptions * Other risk factors

Answer 14

The use of debt (leverage) to finance a RE purchase. ## Footnote * Lower the better. Higher values mean higher risk.

Answer 15

* Current income: Investors can collect rental incomes * Capital appreciation: Investors usually expect property values to increase over time. * Inflation hedge: During inflation, investors expect RE values to rise. * Diversification: Can provide diversification outside of stocks and bonds * Tax benefits: in the United States, the depreciable life of real estate is usually shorter than the actual life. As a result, depreciation expense is higher and taxable income is lower, resulting in lower income taxes. In addition, REITs do not pay taxes in some countries, which allows investors to escape double taxation

Answer 16

A conservative RE investment strategy that limits investments to high quality and low leverage (<30% LTV), and avoids speculative risks in favor of steady returns.

Answer 17

office, industrial/warehouse, retail, and multifamily. ## Footnote * Hospitality properties (hotels and motels) are riskier because leases are not involved and performance is highly correlated with the business cycle.

Answer 18

Gross lease: The owner is responsible for the operating expenses Net lease: The leasee is responsible for the operating expenses. Rent under a net lease is lower than under a gross lease.

Answer 19

Requires the tenants to pay their share of common area maintenance, repairs, property taxes, and building insurance.

Answer 20

- Office: Demand is dependent on job growth - Industrial: Demand is dependent on the overall economy. - Retail: Demand is dependent on consumer spending, and therefore the overall economy. - Multifamily residential: Demand dependent on population growth, esp. in the age demographic that typically rents apartments.

Answer 21

Additional rent charged to a retail tenant once sales reach a certain level.

Answer 22

The opposite of a percentage lease- it's the rent paid by a retail tenant w/o regard to sales.

Answer 23

Any residential property w/ more than one housing unit.

Answer 24

- Review market to assess local demographics and economy - Lease review and rental history - Confirm operating expenses (do this by reviewing bills) - Review CF statements - Obtain an environmental report to identify possibility of contamination - Perform an inspection to identify structural issues - Examine maintenance/service agreements to identify any recurring problems - Inspect the property's title for any deficiencies. - Have the property surveyed to confirm the boundaries and identify easements. - Verify compliance w/ zoning laws, building codes, and environmental regs - Verify payment of taxes, insurance, special assessments, and other expenditures

Answer 25

Track the performance of the RE asset class, including appraisal-based indices and transaction-based indices.

Answer 26

Indices based on appraisal values. A popular index in the U.S. is the NCREIF Property Index (NPI). Members of NCREIF, mainly investment managers and pension fund sponsors, submit appraisal data quarterly. After quarterly returns, the index is value weighted based on the returns of the separate properties. Appraisal-based indices tend to lag actual transactions because actual transactions occur before appraisals are performed. Thus, changes in prices may not be reflected in the index until the next quarter or even later depending on when the appraisal happens. Appraisal lags also tend to smooth the index. Appraisal lag also results in lower correlation w/ other asset classes. Appraisal lag can be adjusted by unsmoothing the index or by using a transaction-based index. The index return is equivalent to a single period IRR. Return is measured as current yield + capital gains yield. Return = (NOI - CAPEX + (ending market value - beginning market value)) ÷ beginning market value ## Footnote * The reason we use NOI instead of NI is that the value of RE should be independent of interest expense. * NCREIF is a value-weighted index that is based on appraisal data.

Answer 27

Can be constructed using a repeat-sales index and a hedonic index. Repeat-sales index relies on multiple sales of the same property, whereas a hedonic index requires only one sale. A regression model controls for differences in property characteristics. ## Footnote * Hedonic Index construction does not require multiple sales of the same property.

Answer 28

- REITs - REOCs - MBSs

Answer 29

REITs are tax-advantaged firms that are mostly exempt from corporate income tax. Equity REITs are actively managed and seek profit by growing CFs, improving existing properties, and purchasing additional properties. - REITs often specialize in a particular type of property. ## Footnote * Because REITs are not able to retain earnings as other companies do, REITs make frequent secondary equity offerings, in order to finance growth and property acquisitions.

Answer 30

Primarily invest in mortgages, mortgage securities, or loans secured by RE.

Answer 31

An equity security that's a non-tax-advantaged firm that owns RE. A business usually forms as a REOC if it's ineligible to be a REIT. REITs are usually expected to payout 90% of their income to shareholders, but this is not the case w/ REOCs; instead, the money can be reinvested. REOCs can also invest in a wider range of property types. ## Footnote * REOCs are subject to double taxation (not tax-advantaged) * Directing privately in RE and REITs are both tax-advantaged while REOCs are not.

Answer 32

Publicly traded ABSs that receive CFs from an underlying pool of residential mortgages (RMBSs) or commercial mortgages (CMBSs).

Answer 33

Most REITs are set up as corporations or trusts. To be exempt from taxation, REITs must distribute 90%-100% (depending on the country) of their taxable income as dividends. REITs must invest make a 75% minimum investment in RE and derive at least 75% of their income from rental or mortgage interest to keep their title.

Answer 34

This is a U.S. rule. REITS must have more than 100 owners, and no fewer than five owners can own more than 50% of the REIT shares.

Answer 35

- More liquidity than direct RE investments. - Transparency: info about current and historical prices and volume in readily available. - Exemption from taxation - Predictable earnings - Access to properties that would be too expensive for direct investment - Active professional mgmt (investor doesn't have to worry about property mgmt) - Diversification

Answer 36

- Limited potential for income growth: Since most of a REITs earnings are paid out, there isn't much reinvestment. - Lack of flexibility: REITs are invested in their investment choices - Lower diversification benefit relative to direct investment in RE

Answer 37

1. Net asset value (NAV): value of REIT assets to pvt market buyer 2. Price-to-funds from operations (P/FFO) 3. Price-to-adjusted FFO (P/AFFO) 4. DCF ## Footnote * P/FFO is the most common multiple used to analyze REITs * In discounted cash flow REIT models, investors generally use intermediate-term cash flow projections and a terminal value based on historical cash flow multiples.

Answer 38

The per share amt by which assets exceed liabilities using MV. This is what's used to measure the fundamental value of a REIT. If the market price of a REIT varies from NAVPS, the premium (or discount) reflects an investor's view of the management capabilities, leverage, and governance. REITs with high leverage and trading at a discount to NAVPS may find it difficult to refinance their maturing debt. ## Footnote * BVPS is based on accounting values where most assets are carried at historical cost. This is often a poor representation of economic value. * REITs have historically traded at a large premium/discount to NAV.

Answer 39

[[ ((NOI - noncash rents + FY adjustment for acquisitions + forecast growth in NOI) ÷ cap rate) + other assets ] - liabilities ] ÷ shares outstanding ## Footnote * This is how to estimate the value of RE in the absence of a reliable appraisal

Answer 40

Cap rate is the rate of return generated from a RE property. Cap rate = capitalized NOI ÷ Transaction price of a comparable piece of RE - NOI is the amt of income remaining after subtracting vacancy losses, collection loss, and operating expenses (maintenance, repairs, etc.) - We use cash NOI that deducts non-cash rent from NOI

Answer 41

A popular measure of continuing operating income of a REIT or REOC. FFO = accounting NI + D&A + impairments/write-downs - gains on sale + losses on sale

Answer 42

An extension of FFO that is considered to be a more useful representation of ***current economic income*** because AFFO considers the capital expenditures that are required to sustain the property's economic income. FFO - noncash rent adjustment - recurring maintenance CAPEX - leasing commissions

Answer 43

The amt by which the avg contractual rent over a lease period exceeds the rent actually paid. A lease calling for increasing rental rates over the lease term will have significant non-cash rent early in the lease term.

Answer 44

True, relative valuation using NAVPS is essentially comparing NAVPS to the market price of a REIT (or REOC) share. Absolute valuation is usually in the form of a DDM.

Answer 45

- The multiples P/FFO and P/AFFO are globally accepted. - Multiples allow comparisons - FFO estimates are widely available from reputable sources - Multiples are evaluated in conjunction with other factors such as growth rates to allow for reconciliation of differences in multiples between different REITs. - Because leverage is not explicitly accounted for in FFO and AFFO, analysts need to adjust for leverage differences in relative value analysis.

Answer 46

- Multiples do not capture the value of non-income-producing RE - FFO does not capture the impact of recurring CAPEX maintenance (AFFO does, however) - One time gains/losses can make comparisons between companies difficult

Answer 47

- Direct exposure to the RE class - Returns dictated by property performance - Tax benefits (accelerated depreciation, timing option for capital gains) - Inflation hedge - Illiquidity premium - Control and ability to pursue diverse strategies - Lower correlation w/ other asset classes

Answer 48

- Illiquidity - High fees and expenses - High minimum investment - Low transparency - Fewer regulatory protections for investors - Appraisals lag actual market values - Higher returns derived from the use of leverage, but increases risk

Answer 49

- Tracks RE asset class fundamentals over the long-term - High liquidity - Professional mgmt - Inflation hedge - Tax efficiency (for REITs) - Access to a diversified pool of assets - Access to special sectors - Low minimum investment - Low entry/exit costs - Regulatory protection for investors - High transparency - Limited liability

Answer 50

- Higher volatility - Higher correlation w/ stocks - Dividends are taxed at higher rates - Poor governance/agency conflict - Equity markets penalize high leverage - Market prices often differ from NAV - REIT structure limits possible activities - Compliance costs may be prohibitive for smaller companies

Answer 51

(FFO ÷ shares outstanding) * P/FFO

Answer 52

[ (FFO - noncash rents - recurring maintenance CAPEX) ÷ shares outstanding ] * P/AFFO

Answer 53

* Lower regulatory and legal restraints * Flexibility to use short selling and derivatives * A larger investment universe * Agressive investment exposures * Comparatively free use of leverage * Liquidity constraints for investors * Lack of transparency * Higher cost structure

Answer 54

1. Equity related: Strategies surrounding investment in stocks. Can be long or short driven. 2. Event driven: These strategies relate to corporate actions, such as M&A, bankruptcies, etc. The main risk w/ this strategy is *event risk* , the possibility that something won't happen. 3. Relative value: Strategies that seek to profit from the price differentials between related securities (arbitrage). 4. Opportunistic: These strategies employ a top-down approach, often span multiple asset classes, and vary with market conditions. The two opportunistic strategies that will be considered here are *global macro and managed futures*. 5. Specialist: Strategies that require market experise. 6. Multi-manager: These strategies use other hedge fund strategies as building blocks, combining different strategies together and rebalancing exposures over time. The two types of multi-manager hedge funds we will consider are multi-strategy funds and funds-of-funds.

Answer 55

These strategies focus primarily on stock markets, and their risk primarily stems from stocks. Subtypes of the equity-related category include: long/short equity, dedicated short bias, and equity market neutral.

Answer 56

Strategies that involve longing and shorting stocks. When managers combine long and short strategies, the portfolio will have a beta, which equals that equals the weighted sum of the positive and negative betas of the various long and short positions. L/S funds typically have 40%-60% net long exposure, which is done since the markets generally trend upwards over time. L/S funds often take a sector-specific approach. ## Footnote * L/S strategies often have similar returns to long only firms but with less risk. * These strategies often involve investing in index funds.

Answer 57

The excess return over a certain benchmark

Answer 58

A type of equity strategy. Hedge funds that seek out securities that are overpriced in order to sell them short. A major challenge for this strategy is that market prices generally trend upwards over time. Dedicated short sellers only invest in shorts, whereas short-biased managers may use some long positions but with an overall net short exposure (often 60%-120%) exposure. ## Footnote * These strategies produce a negative correlation w/ traditional securities. * Historically, the returns on these strategies have been lower than other strategies. * Higher risk given the higher beta than L/S * These strategies do not use significant amounts of leverage.

Answer 59

When a fund manager not only takes a short position in a stock, but also presents research that contends that the stock is overpriced.

Answer 60

Strategies that seek to attain a near-zero net exposure to the stock market. This is done by taking long and short positions to obtain a beta that equals zero. The goal of this strategy is to reduce exposure to market movements and offer low volatility. Since EMN hedges beta, leverage is often used to achieve acceptable levels of return. ## Footnote * This strategy seeks zero net exposure. * These strategies use relatively high levels of leverage.

Answer 61

Discretionary managers: Fund managers that rely on intuition Quant managers: Fund managers that rely on a fixed set of rules to identify trade opportunities.

Answer 62

1/3 EMN subtypes. W/ this strategy, 2 stocks w/ similar charactersitics but that are respectively overvalued and undervalued are identified. A long position will be taken in one and a short position in the other. The cointegrated trading prices are monitored, and unusual divergence is exploited.

Answer 63

1/3 EMN subtypes. This strategy involves going long and short shares of a subsidiary and its parent company. Generally, the posititions taken correspond to the % of the subsidiary owned by the parent.

Answer 64

1/3 EMN subtypes. This strategy involves going long and short mispriced share classes of the same firm (ex: voting and non-voting shares).

Answer 65

A type of event-driven strategy where an investment is made before an event has been announced.

Answer 66

A type of event-driven strategy where an investment is made after an event has been announced. Seeks to take advantage of security prices that have not fully adjusted.

Answer 67

An event-driven strategy that attempts to earn a return from the uncertainty that exists in the market during the time between an acquisition being announced and when the acquisition is completed. The PM will predict that the aquistion will have negative effects on the stock or positive and their strategy will be made accordingly. PMs will often apply 300%-500% leverage in pursuit of low-double digit returns. ## Footnote * Compared to typical hedge fund strategies, merger arbitrage tends to be more liquid * There is significant left tail risk w/ this strategy * These strategies tend to have high sharpe ratios * A reason why the merger may not work is that regulators can block M&A activity for a variety of reasons.

Answer 68

A PM takes a position in a company w/ the expectation of a successful deal. The PM will long the stock of the target firm and short the stock of the acquiring firm. ## Footnote In a failed acquisition, the price of the target will fall and the price of the acquirer will rise

Answer 69

A variety of merger arbitrage that involves 2 countries and 2 regulatory authorities.

Answer 70

Compares the ROI w/ its risk. Calculation: (Rp - Rf) ÷ σp ## Footnote - Rp = return on portfolio - σp = standard deviation of the portfolio's excess return

Answer 71

An event-driven strategy that takes positions in the securities of companies that are experiencing financial difficulties, including firms in or near bankruptcy. Hedge funds will often look to buy distressed securities from insurance companies or banks since these two entities often cannot hold non-investment grade securities. This can create significant pricing inefficiencies and can open up opportunities for hedge funds seeking profit. The hedge funds often look for profit in the form of liquidation (redeem par value when they paid a significant discount) or if the distressed firm reorganizes it may be able to renegotitate its debt liabilities in exchange for equity. Generally, these strategies use long positions w/ low use of leverage. ## Footnote * This strategy is primarily used by hedge funds since PMs have extended lockup periods compared to other funds. * These strategies have a lack of liquidity. * Virtually all distressed security strategies take the form of long positions and ***low use of leverage***.

Answer 72

Relative value strategies that take advantage of temporary mispricing of fixed-income instruments by longing undervalued securities and simultaneously shorting overvalued securities. Yield curve kinks or anticipated changes in the shape of the yield curve also may be exploited. ***Substantial leverage is usually applied to fixed-income arbitrage strategies: 400% is typical***. ## Footnote * These strategies often use significant amounts of leverage. * The liquidity of these strategies depends on the types of securities. Treasuries are very liquid, whereas foreign instruments can be illiquid.

Answer 73

A type of fixed-income arbitrage strategy where the PM will make long or short strategies based on their anticipation of whether the yield curve will flatten or steepen. The PM profits when the price of the long securities risk and the short securities fall.

Answer 74

A type of fixed-income arbitrage strategy where a PM shorts a low-yielding securities and goes long a high-yielding security. The source of return here is twofold: first, from the yield differential (receiving a high interest rate from the long and paying a lower interest rate from the short) and second, from the price changes as mean reversion occurs.

Answer 75

A relative value strategy that involves attempting to profit based on the pricing discrepancy between a firm's convertible bonds and its underlying stock. Essentially, a PM will buy a convertible bond of which they think the underlying stock is underpriced, and then the convertible bond will become more valuable. To accomplish this without taking on excess potential for loss, convertible bond arbitrageurs will take other positions in an attempt to hedge the delta and gamma risk of the convertible bond. ## Footnote * These strategies perform best during periods of normal market conditions when liquidity is available, volatility is modest, and there is a good selection of convertible bonds.

Answer 76

False, priority of claims are as follows: first senior secured debt, junior secured debt, unsecured debt, convertible debt, PS, and lastly CS

Answer 77

A broad class of investing approaches that looks for profits in a wide range of techniques in a broad range of securities. PMs use a top down approach rather than looking at individual securities. These strategies are vulnerable to the business cycle.

Answer 78

Systematic: Strategies that employ computer algorithms and rules to determine which trades to make Discretionary: When PMs use their instinct to trade

Answer 79

A form of opportunistic strategy where PMs attempt to make correct assessments and forecasts of various global economic variables including inflation, currency exchange rates, yield curves, central bank policies, and the general economic health of different countries. PMs using global macro strategies can take directional or thematic positions. ***These strategies most commonly apply leverage of 600% - 700% of the fund's assets***. ## Footnote * Low-volatility mean-reverting markets are not generally favorable for global macro returns. * Global macro managers tend to use discretionary approaches more than managed futures managers. * The Big Short describes global macro strategies.

Answer 80

Directional: Long stocks that are expected to rise due to some economic indicator and short stocks that are expected to fall. Thematic: Buy stocks of firms that will benefit from some political or economic event (ex: a free trade deal might make a stock rise).

Answer 81

A form of opportunistic strategy where a PM takes long and short positions in a variety of derivative contracts. Managed futures strategies can be as simple as trading index futures on a particular sector, or it can involve very exotic contracts such as futures on the weather. These strategies do not involve buying and selling assets, but rather gaining exposure from entering into derivative positions. Since futures contracts only require small amounts of upfront collateral, ***PMs can easily apply large amounts of leverage***. While some of the fund's capital will be used as collateral, the rest is typically used in highly liquid securities (ex: Treasuries) that can also serve as collateral for a futures clearinghouse. Since futures are extremely liquid, managers often rely on a trade signal, most often based on volatility or momentum, to prompt a trade. ## Footnote * This strategy does especially well in times of market stress. * Typically exhibits a negative skew.

Answer 82

A downside of the popularity of managed futures strategies when many market participants pursue the same trades and use similar signals. Execution slippage is a result of crowding as participants pursue similar strategies.

Answer 83

1/2 primary ways to implement a managed futures strategy. PMs simply follow the trend: buy securities that have been rising in price and sell securities that have been trending downward.

Answer 84

1/2 primary ways to implement a managed futures strategy. PMs invest in a particular asset class (cross section of assets) that is rising and sell cross sections that are trending downward.

Answer 85

* Trade signals * Price targets * Momentum reversal * Time * Trailing stop-loss * A combo of these approaches.

Answer 86

PMs that use their knowlege of a particular market to pursue niche investment opportunities. The goal of specialist strategies is to generate high risk-adjusted returns that are uncorrelated with those of traditional assets. The risks of such strategies are often unique to the particular niche securities being invested in.

Answer 87

A type of specialist strategy where PMs trade volatility-related assets gloablly, across countries and across asset classes, in order to exploit perceived differences in volatility prices. The overall goal is to purchase underpriced volatility and sell overpriced volatility. ## Footnote * Shorts in volatility trading are betting that the market does well. Under good market conditions, they receive periodic payments. * Longs in volatility trading will exhibit positive convexity- can be useful for heding.

Answer 88

Tracks the 30-day implied volatility of the S&P 500 index. VIX contracts tend to be mean reverting because high volatility naturally tends to dissipate over time.

Answer 89

* Various option strategies * OTC options: have counterparty risk, plus potential liquidity issues. * Futures on the VIX * OTC volatility swap

Answer 90

Pros: Easy to use Cons: The VIX tends to be mean-reverting. Also, many investors crowd into the VIX futures in order to sell volatility and capture the associated premiums which makes it difficult to profit from this strategy.

Answer 91

Name is misleading- these are forward contracts w/ a payoff based on the difference between the observed variance and expected variance specified in the contract multiplied by some notional amount.

Answer 92

False, selling insurance has a negative skew: high frequency small profits with low frequency large losses. Buying insurance has a positive skew: high frequency small losses and low frequency large gains.

Answer 93

Insurance companies may choose to sell of some of their risk to reinsurance companies who may then sell the risk to hedge funds. This has become more common w/ catastrophe insurance.

Answer 94

In these strategies, pools of life insurance contracts are purchased, and the hedge fund becomes the beneficiary. The hedge fund manager looks for policies with low surrender value, low ongoing premium payments, and high probability that the insured person will die soon. ## Footnote * PMs need to have extreme expertise for these to work.

Answer 95

A type of volatility trading where the investor believes there will be a significant rise or fall in volatility.

Answer 96

A type of volatility trading where the investor has a different view in the short-term than in the long-term. ## Footnote * A long calendar spread is when the investor believes volatility will rise in the long-term but not the short-term. And vice versa for short calendar spreads.

Answer 97

* Low purchase price * Low premium payments * Expectation that the insured person will die soon

Answer 98

Takes capital from various individual investors and invests in a number of different hedge funds, generally each pursuing a different strategy. ## Footnote * Typically, a FoF will require a one-year initial lock-up for investors, and then will allow somewhat greater liquidity afterwards (e.g., monthly or quarterly).

Answer 99

Funds that hold a large # of other hedge funds w/ diverse strategies. This method is used to produce low but reliable returns. ## Footnote * There is greater operational risk w/ this compared to FoF because everything is performed by the same firm. * A major advantage to multi-strategy funds is **tactical allocation**- it's easier for these firms to reallocate capital to more profitable strategies. * Investor fees are more attractive w/ multi-strategy funds compared to FoF.

Answer 100

False, multi-strategy funds typically have more varied performance.

Answer 101

Modes that can be used to quantify the risk exposures of various hedge fund strategies. Return on hedge funds = αi + [ β1(factor 1) + β2(factor 2) ... + βn(factor n) ] + [ D1β1(factor 1) + D2β2(factor 2) ... + Dnβn(factor n) ] + εi. ## Footnote * Called conditional because funds may perform differently during different economic enviroments. * D = the incremental increase/decrease in returns on each factor in turbulent market conditions. * In normal markets, D = 0.

Answer 102

1. Equity risk (S&P 500 return) 2. IRR 3. Currency risk 4. Commodity risk 5. Credit risk 6. Volatility risk

Answer 103

A process that is useful for creating linear conditional factor models that avoid multicollinearity problems because it avoids the use of highly correlated risk factors. This process uses only four of Hasanhodzic's and Lo's factors: * Equity risk * Currency risk * Credit risk * Volatility risk

Answer 104

A risk-adjusted measure of portfolio performance. Compares the ROI w/ the portfolio's risk. Formula: (Rp - Rf) ÷ σp Rp = Return on portfolio σp = St. deviation of portoflio ## Footnote * The Sharpe Ratio increases when hedge funds are added to a portfolio * A higher Sharpe Ratio is better.

Answer 105

A variation of the Sharpe ratio that is a risk-adjusted measure of performance that only considers the standard deviation of downside risk. Formula: (Rp - Rt) ÷ σd Rt= target return σd = downside st. deviation ## Footnote * Better for hedge funds than Sharpe ratio

Answer 106

Standard deviation decreases Sharpe ratio increases Sortino ration increases Maximum drawdown decreases ## Footnote * Hede fund strategies generally increase risk-adjusted returns.

Answer 107

* Systematic futures hedge funds * Distressed securities * Fixed-income arbitrage * Global macro * Equity market neutral

Answer 108

* Equity market neural * Systematic futures * L/S equity * Event driven

Answer 109

The peak-to-trough decline for a portfolio

Answer 110

The maximum value the portoflio has ever reached

Answer 111

Rebalancing return is applicable on a commodity index (or portfolio) and is zero for a single commodity position.

Answer 112

False, production value weighted indexes have higher weight to energy (e.g., oil) as compared to equal weighted index.

Answer 113

False. Netting risk is not present in multistrategy funds whereas it IS present in a FoF.

Answer 114

A PM that does not hedge the credit risk of the convertible bond issuer.does not hedge the credit risk of the convertible bond issuer.

Answer 115

A PM that aims for a higher exposure to volatility by overhedging equity risk, thereby taking a short-biased position in the underlying stock.

Answer 116

The amount a policyholder can withdraw from their life insurance policy at any time.

Answer 117

False, operational risk

CFA L2 Alternative Investments Flashcards

(152 cards)