Question 1

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

Accepted Answer

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 fees.

Question 2

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?

Accepted Answer

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

Question 3

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

Accepted Answer

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

Question 4

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

Accepted Answer

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

Question 5

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

Accepted Answer

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

Question 6

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

Accepted Answer

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

Question 7

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

Accepted Answer

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 shares 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 8

Management fees for hedge funds typically range between ________ and ________.

Accepted Answer

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

Question 9

You manage $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume that the risk-free rate is 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 share market may fall and 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?

Accepted Answer

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

Question 10

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

Accepted Answer

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

Question 11

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

Accepted Answer

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

Question 12

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.

Accepted Answer

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

Question 13

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

Accepted Answer

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

Question 14

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 ________.

Accepted Answer

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

Question 15

________ allow for more active short-selling and derivatives positions.

Accepted Answer

A) Commingled funds 
B) REITs 
C) ETFs 
D) 130/30 Funds

Question 16

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

Accepted Answer

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

Question 17

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?

Accepted Answer

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

Question 18

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

Accepted Answer

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

Question 19

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 lock-out period is 3 years. If the share price after 3 years increases to $15.28, and using your calculation for how many shares you purchased, what is the value of your investment?

Accepted Answer

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

Question 20

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 ________.

Accepted Answer

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

Exam 17: Hedge Funds