Chap 1 - What Is an Alternative Investment?

Question 1

What are the 4 specific types of alternative investment ?

Answer 1

Real assets
Hedge funds
Private equity
Structured products

Question 2

What is a real asset and what are the types ?

Answer 2

Definition : Direct ownership of non-financial assets

Type: Natural resources
Goods
Real estate
Infrastructure
Intellectuel property

Question 3

What is a hedge fund and what are the strategies ?

Answer 3

Definition : Private investment véhicule that uses it’s less regulated nature to generate investment opportunities.

Strategies:
Long/short equity
Event driven
Macro

Question 4

What is Private Equity and what are the types ?

Answer 4

Definition : Debt or equity investments not listed on a stock exchange (CAIA)

Types:
Venture capital
Leverage Buyout
Mezzanine debt
Distressed debt

Question 5

What is a structured product and some examples ?

Answer 5

Definition : Instruments created to present a specific return, risk, tax or other attributes

Example :
Collateralized Debt Obligations (CDOS)
Credit derivatives

Question 6

What are the characteristics of alternative investments ;
Yield characteristics ?

Answer 6

Returns are substantially different from returns on long positions in traditional equities only.

• Diversification
• Illiquidity
• Inefficiency
• Distribution of observations, i.e., non-normality

Question 7

What are the characteristics of alternative investments structures ?

Answer 7

Characteristics that distinguish alternative investments from traditional investments.

• Regulatory structures
• Security structures
• Trading structures
• Compensation
  structures
• Institutional structures

Question 8

What are the characteristics of alternative investments Analysis methods ?

Answer 8

Analysis methods for traditional assets are often inappropriate (structural differences).

• Yield calculation methods
• Statistical methods
• Valuation methods
• Portfolio management methods

Question 9

What are the alternative investment goals (objectives) ?

Answer 9

The 5 objectives of alternative investments:

• Adding value with Active Management
• Absolute rather than relative returns
• Enhancing returns with arbitrage
• Risk diversification
• Avoiding obsolescence

Question 10

What is an institutional-quality investment ?

Answer 10

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. For example, a pension fund would consider holding the publicly traded equities of a major corporation but may be reluctant to hold collectibles such as baseball cards or stamps. Also, investments in very small and very speculative projects are typically viewed as being inappropriate for such an institution due to its responsibility to select investments that offer suitable risk levels and financial return prospects for its clients.

Question 11

How are alternative investements sometimes viewed ?

Answer 11

Alternative investments are sometimes viewed as including any investment that is not
simply a long position in traditional investments. Typically, traditional investments
include publicly traded equities, fixed-income securities, and cash.

Question 12

What could be a good definition of investement ?

Answer 12

First, the term investment covers a very broad spectrum. A good definition of an investment is that it is deferred consumption. Any net
outlay of cash made with the prospect of receiving future benefits might be considered an investment. So investments can range from planting a tree to buying stocks
to acquiring a college education.

Question 13

For example, why is private equity considered an alternative investment but other equities are considered traditional investments?

Answer 13

The answer is that traditional equities are listed on major stock exchanges whereas private equity is not. In this case, traditional equities possess the characteristic of being publicly
traded, while private equity does not.

Question 14

The decision of whether to classify a structured product as an alternative investment should be based on the extent to which the product offers nontraditional risk and return
exposures and requires investment management methods that differ markedly from traditional investment management methods.

Answer 14

True

Question 15

What is a moral hazard ?

Answer 15

Moral hazard is risk that the behavior of one or more parties will change after
entering into a contract. As a result of this inability to contract efficiently, the
investor might be unable to diversify perfectly.

Question 16

What are eight additional characteristics or factors that often play a role in distinguishing alternative and traditional investments ?

Answer 16

1. 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.
2. Structuring; refers to the partitioning of claims to cash flows through leverage and securitization. Securitization is the process of transforming asset ownership into
   tradable units.
3. 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.
4. Compensation structures; refer to the ways that organizations distribute rewards. In the case of a hedge fund, compensation structures would include the financial arrangements contained in the limited partnership formed by the investors and the entity used by the fund’s managers.
5. 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.
6. Information asymmetries; refer to the extent to which market participants possess different data and knowledge. In traditional investments, most securities are regulated and are required to disclose substantial information to the public.
7. Incomplete markets; refer to markets with insufficient distinct investment opportunities. The lack of distinct investment opportunities can prevent market participants from implementing an investment strategy that satisfies their exact preferences, such as their preferences regarding risk exposures.
8. Innovation; is the application of creativity.

Question 17

An important goal in alternative
investing is to use active management to generate an improved combination of risk and return.

Answer 17

True

Question 18

What is an absolute return ?

Answer 18

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. Thus, an investment
program with an absolute return strategy seeks attractive absolute returns—returns unaffected by market directions.

Example: An example of an absolute return investment fund is an equity market-neutral hedge fund with equal-size long and short positions in
stocks that the manager perceives as being undervalued and overvalued, respectively.

The fund’s goal is to hedge away the return risk related to the level of the equity market and to exploit security mispricings to generate returns in excess of the riskless rate.

Question 19

What is an relative return ?

Answer 19

A relative return standard means that returns are to be evaluated relative to a variable benchmark. An investment program with a relative return standard seeks attractive relative returns—returns that move in tandem with a particular market but consistently outperform that market.

Example : An example of a fund with a relative return strategy is a long-only global equity fund that diversifies across various equity sectors
and uses security selection in an attempt to identify underpriced stocks. The fund’s goal is to earn the benchmark return from the fund’s exposure to the global equity
market and to earn a consistent premium on top of that return through superior security selection.

Question 20

What is a pure arbritage ?

Answer 20

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.