Deck 20: Hedge Funds

Question 1

Which of the following are characteristics of a hedge fund?
I)Pooling of assets
II)Strict regulatory oversight by the SEC
III)Investing in equities,debt instruments,and derivative instruments
IV)Professional management of assets

A) I and II only
B) II and III only
C) III and IV only
D) I, III, and IV only

Answer 1

D

Question 2

Which of the following typically employ significant amounts of leverage?
I)Hedge funds
II)Equity mutual funds
III)Money market funds
IV)Income mutual funds

A) I only
B) I and II only
C) III and IV only
D) I, II and III only

Answer 2

A

Question 3

Assuming positive basis and negligible borrowing cost,which of the following set of transactions could yield positive arbitrage profits a hedge fund might pursue?

A) Buy gold in the spot market and sell the futures contract
B) Buy the futures contract and sell the gold spot and invest the money earned
C) Buy gold spot with borrowed money and buy the futures contract
D) Buy the futures contract and buy the gold spot using borrowed money

Answer 3

A

Question 4

______ are partnerships of wealthy investors but too small to warrant managing on a separate basis.

A) Commingled funds
B) Hedge funds
C) REITs
D) Mutual funds

Question 5

Typical initial investment in a hedge fund generally is in the range between _____ and _____.

A) $1,000; $5000
B) $5,000; $25,000
C) $25,000; $250,000
D) $250,000; $1,000,000

Question 6

You believe that the spread between the September S&P 500 future and S&P 500 index is too large and will soon correct.To take advantage of this mispricing a hedge fund should ______________.

A) buy all the stocks in the S&P 500 and write put options on the S&P 500 index
B) sell all the stocks in the S&P 500 and buy call options on S&P 500 index
C) sell S&P 500 index futures and buy all the stocks in the S&P 500
D) sell short all the stocks in the S&P 500 and buy S&P 500 index futures

Question 7

Advantages of hedge funds include all but which one of the following?

A) Record keeping and administration
B) Low transaction costs
C) Professional management
D) Consistently high rates of return

Question 8

Management fees for hedge funds,typically range between _____ and _____.

A) 0.5%; 1.5%
B) 1%; 3%
C) 2%; 5%
D) 5%; 8%

Question 9

Hedge funds managers are compensated by ___________________.

A) deducting management fees from fund assets and receiving incentive bonuses for beating index benchmarks
B) deducting a percentage of any gains in asset value
C) selling shares in the trust at a premium to the cost of acquiring the underlying assets
D) charging portfolio turnover fees

Question 10

A restriction where investors cannot withdraw their funds for as long as several months or years is called __________.

A) transparency
B) a lock up period
C) a back end load
D) convertible arbitrage

Question 11

The difference between market neutral and long/short hedges is that market neutral hedge funds _________.

A) establish long and short position on both sides of the market to eliminate risk and to benefit from security asset mispricing, whereas long/short hedge establish positions only on one side of the market
B) allocate money to several other funds while long/short funds do not
C) invest in relatively stable proportions of stocks and bonds while the proportions may vary dramatically for long/short funds
D) invest only in equities and bonds while long/short funds use only derivatives

Question 12

______ are private partnerships of small number of wealthy investors who are organized as private partnerships,often subject to lock-up period,and allowed to pursue a wide range of investment activities.

A) Hedge funds
B) Closed-end funds
C) REITs
D) Mutual funds

Question 13

You believe that the spread between the September S&P 500 future and S&P 500 index is too large and will soon correct.This is an example of ______________.

A) pairs trading
B) convergence play
C) statistical arbitrage
D) long/short equity hedge

Question 14

A __________ is a private investment pool open only to wealthy or institutional investors that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds.

A) commingled pool
B) unit trust
C) hedge fund
D) money market fund

Question 15

A one-year oil futures contract is selling for $74.50. Spot oil prices are $68 and the one year risk free rate is 3.25%.
The one-year oil futures price should be equal to __________.

A) $68.00
B) $70.21
C) $71.25
D) $74.88

Question 16

Hedge funds can invest in various investment options which not generally available to mutual funds.These include _____________.
I)futures and options
II)merger arbitrage
III)currency contracts
IV)companies undergoing Chapter 11 restructuring and reorganization

A) I only
B) I and II only
C) I, II, and III only
D) I, II, III, and IV

Question 17

As of late 2008,hedge funds had approximately _____ under management.

A) $0.5 trillion
B) $1 trillion
C) $1.6 trillion
D) $2.3 trillion

Question 18

Convertible arbitrage hedge funds _________.

A) attempt to profit from mispriced interest sensitive securities
B) hold long positions in convertible bonds and offsetting short positions in stocks
C) establish long and short positions in global capital markets
D) use derivative products to hedge their short positions in convertible bonds

Question 19

An example of a neutral pure play is _______.

A) pairs trading
B) statistical arbitrage
C) convergence arbitrage
D) directional strategy

Question 20

A one-year oil futures contract is selling for $74.50. Spot oil prices are $68 and the one year risk free rate is 3.25%.
The arbitrage profit implied by these prices is _____________.

A) $6.50
B) $5.44
C) $4.29
D) $3.25

Question 21

Hedging this portfolio by selling S&P 500 futures contracts is an example of ___________.

A) statistical arbitrage
B) pure play
C) short equity hedge
D) fixed income arbitrage

Question 22

Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.
What is your annualized return over the 3-year holding period?

A) 14.45%
B) 15.18%
C) 16.00%
D) 17.73%

Question 23

When a short-selling hedge fund advertises in a prospectus that it is a 120/20 fund,it means that this fund may sell short up to ______ every $100 in net assets and increase the long position to __________ of net assets.

A) $120; $20
B) $20; $120
C) $20; $20
D) $120; $120

Question 24

Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.
If the share price after 3 years increases to $15.28,what is the value of your investment?

A) $553,600
B) $625,000
C) $733,800
D) $764,000

Question 25

Which of the following investment style could be the best description of the Long Term Capital Management market neutral strategies?

A) Convergence arbitrage
B) Statistical arbitrage
C) Pairs trading
D) Convertible arbitrage

Question 26

You manage $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk free rate 2% per quarter and the current value of the S&P 500 index = 1200. You want to exploit positive alpha but you are afraid are afraid that the stock market may fall and want to hedge your portfolio by selling the 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
When you hedge your stock portfolio with futures contracts the value of your portfolio beta is __________.

A) 0
B) 1
C) 1.2
D) Beta cannot be determined from information given

Question 27

A hedge fund has $150 million in assets at the beginning of the year and 10 million shares outstanding throughout the year.Throughout the year assets grow at 12%.The fund charges 3% management fee on assets.The fee is imposed on year end asset values.What is the end of year NAV for the fund?

A) $15.00
B) $15.60
C) $16.30
D) $17.55

Question 28

Consider a hedge fund with $250 million in assets at the start of the year.If the gross return on assets is 18% and the total expense ratio is 2.5% of the year end value,what is the rate of return on the fund?

A) 15.05%
B) 15.50%
C) 17.25%
D) 18.00%

Question 29

How much is the portfolio expected to be worth 3 months from now?

A) $15,000,000
B) $15,450,000
C) $15,600,000
D) $16,000,000

Question 30

Consider a hedge fund with $400 million in assets,60 million in debt,and 16 million shares at the start of the year; and $500 million in assets,40 million in debt,and 20 million shares at the end of the year.During the year investors have received an income dividend of $0.75 per share.Assuming that the fund carries no debt,and that the total expense ratio is 2.75%,what is the rate of return on the fund?

A) 6.45%
B) 8.52%
C) 8.95%
D) 9.46%

Question 31

Hedge funds that change strategies and types of securities invested and also vary the proportions of assets and invested in particular market sectors according to the fund manager's outlook are called ____________________.

A) asset allocation funds
B) multi strategy funds
C) event driven funds
D) market neutral funds

Question 32

The collapse of the Long Term Capital Management hedge fund in 1998 was a case of an extreme unlikely statistical event called ________.

A) statistical arbitrage
B) an unhedged play
C) a tail event
D) a liquidity trap

Question 33

Consider a hedge fund with $200 million at the start of the year. The benchmark S&P 500 index was up 16.5% during the same period. The gross return on assets is 21% and the expense ratio is 2%. For each 1% above the benchmark return the fund managers receive 0.1% incentive bonus.
What was the management cost for the year?

A) $4,877,000
B) $4,900,000
C) $5,929,000
D) $6,446,000

Question 34

You manage $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk free rate 2% per quarter and the current value of the S&P 500 index = 1200. You want to exploit positive alpha but you are afraid are afraid that the stock market may fall and want to hedge your portfolio by selling the 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
How many S&P 500 contracts do you need to sell to hedge your portfolio?

A) 25
B) 30
C) 40
D) 50

Question 35

You manage $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk free rate 2% per quarter and the current value of the S&P 500 index = 1200. You want to exploit positive alpha but you are afraid are afraid that the stock market may fall and want to hedge your portfolio by selling the 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
What is expected quarterly return on the hedged portfolio?

A) 0%
B) 2%
C) 3%
D) 4%

Question 36

Market neutral hedge funds may experience considerable volatility.The source of volatile returns is the use of _________.

A) pure play
B) leverage
C) directional bests
D) net short positions

Question 37

Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.
Which of the following are not managed investment companies?

A) Hedge funds
B) Unit investment trusts
C) Closed-end funds
D) Open-end funds

Question 38

Assume that you have invested $500,000 to purchase shares in a hedge fund reporting $800 million in assets, $100 million in liabilities, and 70 million shares outstanding. Your initial lockout period is 3 years.
How many shares did you purchase?

A) 13,333
B) 25,000
C) 50,000
D) 66,000

Question 39

A one-year oil futures contract is selling for $74.50. Spot oil prices are $68 and the one year risk free rate is 3.25%.
Based on the above data,which of the following set of transactions will yield positive riskless arbitrage profits?

A) Buy oil in the spot market with borrowed money and sell the futures contract
B) Buy the futures contract and sell the oil spot and invest the money earned
C) Buy the oil spot with borrowed money and buy the futures contract
D) Buy the futures contract and buy the oil spot using borrowed money

Question 40

Consider a hedge fund with $200 million at the start of the year. The benchmark S&P 500 index was up 16.5% during the same period. The gross return on assets is 21% and the expense ratio is 2%. For each 1% above the benchmark return the fund managers receive 0.1% incentive bonus.
What was the annual return on this fund?

A) 16.50%
B) 18.04%
C) 18.55%
D) 21.00%

Question 41

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.
Assuming 2% management fee,what is the expected management compensation per share if the fund net asset value exceeds the stated benchmark?

A) $4.24
B) $4.00
C) $3.84
D) $2.20

Question 42

The fastest growing category of hedge funds are feeder funds.These funds invest in ________.

A) other hedge funds
B) convertible securities and preferred stock
C) equities and bonds
D) managed futures and options

Question 43

Typical hedge fund incentive bonus is usually equal to ________ of investment profits beyond a predetermined benchmark index.

A) 5%
B) 10%
C) 20%
D) 25%

Question 44

Portfolio A has a beta of 1.3 and an expected return of 21%.Portfolio B has a beta of 0.7 and an expected return of 17%.The risk-free rate of return is 9%.If a hedge fund manager wants to take advantage of an arbitrage opportunity,she should take a short position in portfolio __________ and a long position in portfolio __________.

A) A; A
B) A; B
C) B; A
D) B; B

Question 45

According to research conducted by Hasanhodic and Lo (2007),average returns of equity hedge funds are __________ the S&P 500 index.

A) equal to
B) considerably higher than
C) slightly lower than
D) slightly higher than

Question 46

Malkiel and Saha(2005)estimate that the survivorship bias for hedge funds equals 4.4%,which is __________ than the survivorship bias for mutual funds.

A) about the same as
B) much lower
C) much higher
D) only slightly lower

Question 47

A hedge fund owns a $15 million bond portfolio with a modified duration of 11 years and needs to hedge risk but T-bond futures are only available with a modified duration of the deliverable instrument of 10 years.The futures are priced at $105,000.The proper hedge ratio to use is ______.

A) 143
B) 157
C) 196
D) 218

Question 48

Portfolio A has a beta of 0.2 and an expected return of 14%.Portfolio B has a beta of 0.5 and an expected return of 16%.The risk-free rate of return is 10%.If you manage a long/short equity fund and wanted to take advantage of an arbitrage opportunity,you should take a short position in portfolio ______ and a long position in portfolio __________.

A) A; A
B) A; B
C) B; A
D) B; B

Question 49

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?

A) $100
B) $105
C) $110
D) $115

Question 50

A high water mark is a limiting factor of hedge fund manager compensation.This means that managers can't charge incentive fees ________.

A) when a fund stays flat
B) when a fund falls and does not recover to its previous high value
C) when a fund falls by 10% or more
D) None of the above occurs. Managers can always charge incentive fee

Question 51

Hedge fund managers receive incentive bonuses when they increase portfolio assets beyond a stipulated benchmark but lose nothing when they fail to perform.This equivalent to __________.

A) writing a call option
B) receiving a free call option
C) writing a put option
D) receiving a free put option

Question 52

Hedge funds report average returns in December that are higher than their average returns in other months.This phenomenon __________.
I)is called the Santa effect
II)often results from over generous valuation of illiquid assets
III)appears stronger for lower-liquidity funds
IV)can be explained by managers' attempts to inflate assets to collect higher performance bonuses

A) I only
B) I and II only
C) I, II, and III only
D) I, II, III, and IV

Question 53

If the risk-free interest rate is r_f and equals the fund's benchmark,the portfolio net asset value is S₀,and a hedge fund manager incentive fee is 20% of profit beyond that,the incentive fee is equivalent to receiving ______ call(s)with exercise price ________.

A) 0.2; S₀
B) 1; S₀(1 + r_f)
C) 1.2; S₀
D) 0.2; S₀(1 + r_f)

Question 54

You pay $216,000 to the Capital Hedge Fund which has a price of $18.00 per share at the beginning of the year.The fund deducted a front-end commission of 4%.The securities in the fund increased in value by 15% during the year.The fund's expense ratio is 2% and is deducted from year end asset values.What is your rate of return on the fund if you sell your shares at the end of the year?

A) 5.35%
B) 7.23%
C) 8.19%
D) 10.00%

Question 55

To attract new clients hedge funds often select reporting periods which show abnormally high returns.This is called __________.

A) long/short bias
B) survivorship bias
C) backfill bias
D) incentive bias

Question 56

Research by Aragon (2007)indicates that lock up restrictions on redemptions and positive serial correlations of returns indicate that hedge funds often face __________ problems.

A) liquidity
B) maturity
C) event driven
D) hedging

Question 57

Some argue that abnormally high returns of hedge funds are tainted by __________,which arises when unsuccessful funds cease operations leaving only successful ones.

A) reporting bias
B) survivorship bias
C) backfill bias
D) incentive bias

Question 58

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 Black-Scholes value of the call option on management incentive fee?

A) $6.67
B) $8.20
C) $9.74
D) $10.22

Question 59

Higher returns of equity hedge funds as compared to the S&P 500 index reflect positive compensation for __________ risk.

A) market
B) liquidity
C) systematic
D) interest rate

Question 60

Unlike market-neutral hedge funds which have betas near ________,directional long funds exhibit highly _______ betas.

A) zero; positive
B) positive; negative
C) positive; zero
D) negative; positive