Question 1

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?

Accepted Answer

The answer of Assume the risk-free interest rate is 10%...

Question 2

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

Accepted Answer

Feeder funds invest in other hedge funds, often to gain exposure to a specific strategy or market that the feeder fund does not specialize in. This allows investors to diversify their hedge fund investments and potentially achieve higher returns.

Question 3

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

Accepted Answer

A typical hedge fund incentive bonus is usually equal to 20% of investment profits beyond a predetermined benchmark index.

Question 4

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 __________.

Accepted Answer

Portfolio A has a higher beta and expected return than portfolio B, so it is more risky. The hedge fund manager should take a short position in portfolio A and a long position in portfolio B to take advantage of the arbitrage opportunity.

Question 5

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

Accepted Answer

The answer of According to research conducted by Hasanhodic and...

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

The quote states that the survivorship bias for hedge funds equals 4.4%, which means that the percentage of hedge funds that go out of business and are not included in performance data is 4.4%. This is higher than the survivorship bias for mutual funds, meaning a greater percentage of hedge funds fail and are not included in the data compared to mutual funds.

Question 7

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

Hedge ratio = Bond portfolio market value / (Futures price x Futures conversion factor x Futures modified duration)
Futures conversion factor = Bonds underlying futures contract / Bond price
Futures conversion factor for T-bonds is $100,000 par value / Bond price, which for a bond yielding 5% and maturing in 15 years is $128.11.
Hence, Hedge ratio = 15,000,000 / (105,000 x 128.11 x 10) = 157.12 (rounded to nearest whole number)
Therefore, the best choice is B) 157 as it is the closest to hedge ratio obtained.

Question 8

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 __________.

Accepted Answer

The answer of Portfolio A has a beta of 0.2...

Question 9

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

The exercise price on the incentive fee is calculated by applying the risk-free rate to the portfolio's net asset value. With a risk-free rate of 10%, the exercise price is $100 * (1 + 0.10) = $110.

Question 10

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

Accepted Answer

A high water mark ensures that a hedge fund manager only receives an incentive fee when the fund exceeds its previous highest value. Therefore, if a fund falls and does not recover to its previous high value, the manager cannot charge an incentive fee until the fund surpasses the previous high water mark. This is the purpose of the high water mark – to align the interests of the manager with the investors and ensure that the manager only earns performance fees when the investors' capital is actually growing. A high water mark does not affect a manager's ability to charge an incentive fee when a fund stays flat or experiences a loss of less than 10%.

Question 11

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 __________.

Accepted Answer

Receiving a free call option means that the manager has the right to buy the portfolio assets at a certain price, but is not obligated to do so. If the portfolio assets increase in value, the manager can exercise the option and buy them at the lower price, making a profit. If the portfolio assets decrease in value, the manager can simply let the option expire, losing nothing. This is equivalent to the situation described in the question, where the manager receives a bonus if the portfolio assets increase in value, but loses nothing if they decrease in value.

Question 12

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

Accepted Answer

This phenomenon is known as the Santa effect and can be attributed to overvaluation of illiquid assets, is more pronounced in lower-liquidity funds, and may be driven by managers inflating asset values to earn higher bonuses.

Question 13

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 ________.

Accepted Answer

The answer of If the risk-free interest rate is r_f...

Question 14

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?

Accepted Answer

First, calculate the number of shares purchased:
$216,000 / $18 = 12,000 shares

Next, calculate the front-end commission:
$216,000 x 0.04 = $8,640

Subtract the commission from the total:
$216,000 - $8,640 = $207,360

Calculate the ending value of the investment:
$207,360 x 1.15 = $238,464

Calculate the expenses for the year:
$207,360 x 0.02 = $4,147.20

Subtract the expenses from the ending value:
$238,464 - $4,147.20 = $234,316.80

Calculate the selling price:
$234,316.80 / 12,000 = $19.53 per share

Calculate the rate of return:
($19.53 - $18) / $18 = 8.17%

Therefore, the answer is C, 8.19%.

Question 15

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

Accepted Answer

The practice of selecting reporting periods to show abnormally high returns is called backfill bias. Choice A (long/short bias) refers to a bias towards long or short positions in a fund's portfolio. Choice B (survivorship bias) refers to the bias in data caused by only considering the surviving funds that have performed well, while ignoring those that have failed. Choice D (incentive bias) is not a commonly used term in finance and is not relevant to this context.

Question 16

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

Lock up restrictions on redemptions and positive serial correlations of returns indicate that hedge funds often face liquidity problems. Lock up restrictions limit an investor's ability to withdraw their money from the hedge fund, which could make it difficult for the fund to meet redemptions if too many investors try to cash out at the same time. Positive serial correlations of returns can also indicate that the fund is invested in illiquid assets, which can make it difficult to sell those assets in a hurry if needed.

Question 17

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

Survivorship bias is the tendency for only successful funds to report returns. This is because unsuccessful funds often cease operations and are not included in the dataset, leading to an overestimation of returns. Reporting bias (A) refers to intentionally misreporting data, backfill bias (C) refers to adding historical data to a fund's performance record, and incentive bias (D) refers to managers having a personal interest in reporting high returns.

Question 18

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?

Accepted Answer

To calculate the Black-Scholes value of the call option on management incentive fee, we need the following inputs:
1. Strike Price: There is no information given about the strike price, so we assume it to be equal to the net asset value of the portfolio, which is $100.
2. Time to expiration (in years): The time horizon is given as 1 year.
3. Risk-free interest rate: Given as 10%.
4. Stock price volatility: Given as 20%, which is the standard deviation of the portfolio.

We do not have any information about the expected return or dividend yield of the portfolio, which are the other inputs needed for the Black-Scholes model. However, we can assume the portfolio return to follow a log-normal distribution, as is commonly done in option pricing models.

Using the Black-Scholes formula, the value of the call option on management incentive fee is:
C = S*N(d1) - Ke^(-rt)*N(d2)
where,
S = Portfolio net asset value = $100
K = Strike price = $100
r = Risk-free interest rate = 10%
T = Time to expiration = 1 year
sigma = Stock price volatility (annualized) = 20%

d1 = [ln(S/K) + (r + sigma^2/2)T]/(sigma*sqrt(T))
= [ln(100/100) + (0.1 + 0.2^2/2)*1]/(0.2*sqrt(1))
= 0.40

d2 = d1 - sigma*sqrt(T)
= 0.40 - 0.2*sqrt(1)
= 0.20

N(d1) = 0.6554 (from standard normal distribution table)
N(d2) = 0.5793 (from standard normal distribution table)

Plugging in the values, we get:
C = 100*0.6554 - 100*e^(-0.1*1)*0.5793
= $8.20

Question 19

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

Accepted Answer

Higher returns of equity hedge funds compared to the S&P 500 index often reflect compensation for liquidity risk, as hedge funds may invest in less liquid assets that require a premium for their illiquidity.

Question 20

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

Accepted Answer

Market-neutral hedge funds aim to have a beta near zero by having a balance of long and short positions. On the other hand, directional long funds take on more risk and have higher betas, meaning they are more sensitive to market movements. Therefore, the correct choice is A, where directional long funds have positive betas and market-neutral hedge funds have betas near zero.

Quiz 20: Hedge Funds

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

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

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

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 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 ______.

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

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 __________.

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 __.

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

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

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

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?

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

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

Quiz 20: Hedge Funds

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

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

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

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 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 ______.

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

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 __________.

If the risk-free interest rate is rf 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 ________.

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

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

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

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?

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

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

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 __.

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