Deck 26: Hedge Funds

Question 1

A hedge fund pursuing a ______ strategy is betting one sector of the economy will outperform other sectors.

A) directional
B) nondirectional
C) stock or bond
D) arbitrage or speculation
E) None of the options are correct.

Answer 1

A
Explanation: A hedge fund pursuing a directional strategy is betting one sector of the economy will outperform other sectors.

Question 2

Alpha-seeking hedge funds typically ______ relative mispricing of specific securities and ______ broad market exposure.

A) bet on; bet on
B) hedge; hedge
C) hedge; bet on
D) bet on; hedge
E) None of the options are correct.

Answer 2

D
Explanation: Alpha seeking hedge funds typically bet on relative mispricing of specific securities and hedge broad market exposure.

Question 3

______ are the dominant form of investing in securities markets for most individuals, but ______ have enjoyed a far greater growth rate in the last decade.

A) Hedge Funds; hedge funds
B) Mutual funds; hedge funds
C) Hedge Funds; mutual funds
D) Mutual funds; mutual funds
E) None of the options are correct.

Answer 3

B
Explanation: Mutual funds are the dominant form of investing in securities markets for most individuals, and hedge funds have enjoyed a far greater growth rate in the last decade.

Question 4

Hedge funds may invest or engage in

A) distressed firms.
B) convertible bonds.
C) currency speculation.
D) merger arbitrage.
E) All of the options are correct.

Question 5

A hedge fund pursuing a ______ strategy is trying to exploit relative mispricing within a market but is hedged to avoid taking a stance on the direction of the broad market.

A) directional
B) nondirectional
C) market neutral
D) arbitrage or speculation
E) nondirectional and market neutral

Question 6

A hedge fund pursuing a ______ strategy is attempting to exploit temporary misalignments in relative pricing.

A) directional
B) nondirectional
C) stock or bond
D) arbitrage or speculation
E) None of the options are correct.

Question 7

Hedge funds differ from mutual funds in terms of

A) transparency.
B) investors.
C) investment strategy.
D) liquidity.
E) All of the options are correct.

Question 8

Hedge fund strategies can be classified as

A) directional or nondirectional.
B) stock or bond.
C) arbitrage or speculation.
D) stock or bond and arbitrage or speculation.
E) directional or nondirectional and stock or bond.

Question 9

Unlike mutual funds, hedge funds

A) allow private investors to pool assets to be managed by a fund manager.
B) are commonly organized as private partnerships.
C) are subject to extensive SEC regulations.
D) are typically only open to wealthy or institutional investors.
E) are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

Question 10

______ must periodically provide the public with information on portfolio composition.

A) Hedge funds
B) Mutual funds
C) ADRs
D) Hedge funds and ADRs
E) Hedge funds and mutual funds

Question 11

______ are subject to the Securities Act of 1933 and the Investment Company Act of 1940 to protect unsophisticated investors.

A) Hedge funds
B) Mutual funds
C) ADRs
D) Hedge funds and ADRs
E) Mutual funds and ADRs

Question 12

The risk profile of hedge funds ______, making performance evaluation ______.

A) can shift rapidly and substantially; challenging
B) can shift rapidly and substantially; straightforward
C) is stable; challenging
D) is stable; straightforward
E) None of the options are correct.

Question 13

Hedge funds are prohibited from investing or engaging in

A) distressed firms.
B) convertible bonds.
C) currency speculation.
D) merger arbitrage.
E) None of the options are correct.

Question 14

Like mutual funds, hedge funds

A) allow private investors to pool assets to be managed by a fund manager.
B) are commonly organized as private partnerships.
C) are subject to extensive SEC regulations.
D) are typically only open to wealthy or institutional investors.
E) are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

Question 15

Hedge funds ______ engage in market timing ______ take extensive derivative positions.

A) cannot; and cannot
B) cannot; but can
C) can; and can
D) can; but cannot
E) None of the options are correct.

Question 16

Hedge funds traditionally have ______ than 100 investors and ______ to the general public.

A) more; advertise
B) more; do not advertise
C) less; advertise
D) less; do not advertise

Question 17

Hedge funds are typically set up as ______ and provide ______ information about portfolio composition and strategy to their investors.

A) limited liability partnerships; minimal
B) limited liability partnerships; extensive
C) investment trusts; minimal
D) investment trusts; extensive

Question 18

Shares in hedge funds are priced

A) at NAV.
B) a significant premium to NAV.
C) a significant discount from NAV.
D) a significant premium to NAV or a significant discount from NAV.
E) None of the options are correct.

Question 19

Hedge funds are ______ transparent than mutual funds because of ______ strict SEC regulation on hedge funds.

A) more; more
B) more; less
C) less; less
D) less; more

Question 20

Hedge funds often have ______ provisions as long as ______, which preclude redemption.

A) crackdown; 2 months
B) lock-up; 2 months
C) crackdown; several years
D) lock-up; several years
E) None of the options are correct.

Question 21

Assume that you manage a $3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A) selling 1
B) selling 14
C) buying 1
D) buying 14
E) selling 6

Question 22

Performance evaluation of hedge funds is complicated by

A) liquidity premiums.
B) survivorship bias.
C) unreliable market valuations of infrequently-traded assets.
D) merger arbitrage.
E) All of the options are correct.

Question 23

Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.3 and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,500. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A) selling 1
B) selling 7
C) buying 1
D) buying 7
E) selling 11

Question 24

______ bias arises when the returns of unsuccessful funds are left out of the sample.

A) Survivorship
B) Backfill
C) Omission
D) Incubation
E) None of the options are correct.

Question 25

An example of a ______ strategy is the mispricing of a futures contract that must be corrected by contract expiration.

A) market neutral
B) directional
C) relative value
D) divergence
E) convergence

Question 26

If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a hedge fund pursuing a relative value strategy would

A) short sell the Treasury bonds and short sell the mortgage-backed securities.
B) short sell the Treasury bonds and buy the mortgage-backed securities.
C) buy the Treasury bonds and buy the mortgage-backed securities.
D) buy the Treasury bonds and short sell the mortgage-backed securities.

Question 27

If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a relative value strategy would

A) short sell the Treasury bonds and short sell the mortgage-backed securities.
B) short sell the Treasury bonds and buy the mortgage-backed securities.
C) buy the Treasury bonds and buy the mortgage-backed securities.
D) buy the Treasury bonds and short sell the mortgage-backed securities.
E) None of the options are correct.

Question 28

Hedge fund incentive fees are essentially

A) put options on the portfolio with a strike price equal to the current portfolio value.
B) put options on the portfolio with a strike price equal to the expected future portfolio value.
C) call options on the portfolio with a strike price equal to the expected future portfolio value.
D) call options on the portfolio with a strike price equal to the current portfolio value times one plus the benchmark return.
E) straddles.

Question 29

Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A) market neutral position.
B) conservative position.
C) bullish position.
D) bearish position.

Question 30

Assume that you manage a $1.3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A) selling 1
B) selling 6
C) buying 1
D) buying 6
E) selling 4

Question 31

The previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees is known as a

A) benchmark.
B) water stain.
C) water mark.
D) high water mark.
E) low water mark.

Question 32

Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A) market neutral position.
B) conservative position.
C) bullish position.
D) bearish position.

Question 33

The typical hedge fund fee structure is

A) a management fee of 1% to 2%.
B) an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance.
C) a 12-b1 fee of 1%.
D) a management fee of 1% to 2% and an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance.
E) a management fee of 1% to 2% and a 12-b1 fee of 1%.

Question 34

Statistical arbitrage is a version of a ______ strategy.

A) market neutral
B) directional
C) relative value
D) divergence
E) convergence

Question 35

A bet on particular mispricing across two or more securities with extraneous sources of risk, such as general market exposure hedged away, is a

A) pure play.
B) relative play.
C) long shot.
D) sure thing.
E) relative play and sure thing.

Question 36

Market neutral bets can result in ______ volatility because hedge funds use ______.

A) very low; hedging techniques to eliminate risk
B) low; risk management techniques to reduce risk
C) considerable; risk management techniques to reduce risk
D) considerable; considerable leverage

Question 37

______ bias arises because hedge funds only report returns to database publishers if they want to.

A) Survivorship
B) Backfill
C) Omission
D) Incubation
E) None of the options are correct.

Question 38

Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.25 and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,300. If you expect the market to fall within the next 30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A) selling 1
B) selling 8
C) buying 1
D) buying 8
E) selling 6

Question 39

______ uses quantitative techniques, and often automated trading systems, to seek out many temporary misalignments among securities.

A) Covered interest arbitrage
B) Locational arbitrage
C) Triangular arbitrage
D) Statistical arbitrage
E) All arbitrage

Question 40

A hedge fund attempting to profit from a change in the spread between mortgages and Treasuries is using a ______ strategy.

A) market neutral
B) directional
C) relative value
D) divergence
E) convergence

Question 41

Regarding hedge fund incentive fees, hedge fund managers ______ if the portfolio return is very large and ______ if the portfolio return is negative.

A) get nothing; get nothing
B) refund the fee; get the fee
C) get the fee; lose nothing except the incentive fee
D) get the fee; lose the management fee
E) None of the options are correct.

Question 42

Hedge fund performance may reflect significant compensation for ________ risk.

A) liquidity
B) systematic
C) unsystematic
D) default
E) unsystematic and default

Question 43

Hedge funds often employ ______ that require investors to provide ________ notice of their desire to redeem funds.

A) redemption notices; several weeks to several months
B) redemption notices; several hours to several days
C) redemption notices; several days to several weeks
D) lock-up; several years
E) lock-up; several hours

Question 44

Pairs trading is associated with

A) triangular arbitrage.
B) statistical arbitrage.
C) data mining.
D) triangular arbitrage and data mining.
E) statistical arbitrage and data mining.

Question 45

________ refers to sorting through huge amounts of historical data to uncover systematic patterns in returns that can be exploited by traders.

A) Data mining
B) Pairs trading
C) Alpha transfer
D) Beta shifting

Question 46

A ________ is an investment fraud in which a manager collects funds from clients, claims to invest those funds on their behalf, and reports extremely favorable investment returns, but in fact uses the funds for his or her own use.

A) Ponzi scheme
B) bonsai scheme
C) statistical arbitrage scheme
D) pairs trading scheme
E) None of the options are correct.

Question 47

Sadka (2010) shows that exposure to unexpected declines in ________ is an important determinant of average hedge fund returns, and that the spreads in average returns across funds with the highest and lowest ________ may be as much as 6% annually.

A) market risk; systematic risk
B) market liquidity; liquidity risk
C) unsystematic risk; unique risk
D) default risk; default risk