Assume the risk-free interest rate is 10% and is equal to fund's benchmark, the portfolio net asset value is $100 and the fund's standard deviation is 20%. Also assume time horizon of 1 year. What is the exercise price on the incentive fee?

Question

Quizplus · Accepted Answer

To determine the exercise price on the incentive fee, we need to calculate the fund's hurdle rate. The hurdle rate is the minimum rate of return that the fund needs to achieve before the incentive fee is charged. The hurdle rate is calculated as the risk-free rate plus a risk premium, which is typically based on the fund's risk level or benchmark index. In this case, the risk-free rate is 10%, and we assume that it's also the fund's benchmark.

To calculate the hurdle rate, we need to add a risk premium to the risk-free rate. The risk premium is calculated as the product of the fund's standard deviation and a factor, which is typically set between 1 and 3, depending on the fund's risk level. In this case, the standard deviation is 20%, and we'll assume a factor of 2.

Risk premium = 20% x 2 = 40%
Hurdle rate = 10% + 40% = 50%

The exercise price is then calculated as the net asset value (NAV) plus the hurdle rate. In this case, the exercise price is $110 ($100 + 50%). Therefore, the answer is C) $110.

Assume the Risk-Free Interest Rate Is 10% and Is Equal