Question 1

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 a .1% incentive bonus.
What was the annual return on this fund?

Accepted Answer

11eaaae8_8b39_63f6_a4b8_37389a4e5afc_TB6474_11 = 18.0355%

Question 2

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?

Accepted Answer

NAV = 11eaaae8_8b38_c7b2_a4b8_7f3a456f7597_TB6474_11 = $10; 500,000 / 10 = 50,000

Question 3

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?

Accepted Answer

(50,000)($15.28) = $764,000

Question 4

You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 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?

Accepted Answer

H = 11eaaae8_8b38_eec4_a4b8_19d314e43b2b_TB6474_11 × 1.20 = 60

Question 5

You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
How much is the portfolio expected to be worth 3 months from now?

Accepted Answer

S₁ = S₀(1 + r_p) = $15,000,000(1.04) = $15,600,000

Question 6

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?

Accepted Answer

11eaaae8_8b38_eec3_a4b8_c1116999b79e_TB6474_11 − 1 = 15.18%

Question 7

A 1-year oil futures contract is selling for $74.50. Spot oil prices are $68, and the 1-year risk-free rate is 3.25%.
Based on the above data, which of the following sets of transactions will yield positive riskless arbitrage profits?

Accepted Answer

Buying oil in the spot market for $68 and selling a futures contract for $74.50, while borrowing money at a 3.25% interest rate, exploits the price difference for a riskless profit. The cost of borrowing $68 for a year at 3.25% is approximately $2.21 ($68 * 0.0325), making the total cost around $70.21. Selling the futures contract for $74.50 results in a profit, as the selling price exceeds the total cost of buying and holding the oil.

Question 8

You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
Hedging this portfolio by selling S&P 500 futures contracts is an example of ________.

Accepted Answer

The answer of You manage a $15 million hedge fund...

Question 9

You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 3-month S&P 500 future contracts. The S&P contract multiplier is $250.
What is the expected quarterly return on the hedged portfolio?

Accepted Answer

E(r_p) = E[r_f + β(r_M - r_f) + e + α] = r_f+ α = 2% + 2% = 4%

Question 10

Consider a hedge fund with $400 million in assets, $60 million in debt, and 16 million shares at the start of the year and with $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 $.75 per share. Assuming that the total expense ratio is 2.75%, what is the rate of return on the fund?

Accepted Answer

NAV₀ = 11eaaae8_8b39_8b07_a4b8_a3cac461b466_TB6474_11 = 21.25 NAV₁ = 11eaaae8_8b39_8b08_a4b8_432f39a0c111_TB6474_11 20 = 22.31 Net return = 11eaaae8_8b39_8b09_a4b8_9b304e33fdbd_TB6474_11 = 8.52%

Question 11

You manage a $15 million hedge fund portfolio with beta = 1.2 and alpha = 2% per quarter. Assume the risk-free rate is 2% per quarter and the current value of the S&P 500 Index is 1,200. You want to exploit the positive alpha, but you are afraid that the stock market may fall and you want to hedge your portfolio by selling 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 ________.

Accepted Answer

By selling S&P 500 futures contracts, you can eliminate the beta exposure of your portfolio, which means your portfolio beta becomes zero.

Question 12

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 a .1% incentive bonus.
What was the management cost for the year?

Accepted Answer

$200,000,000(1.21) = $242,000,000
21% - 16.5% = 4.5%; 2% + 4.5%(.1) = 2.45%
.0245(242,000,000) = $5,929,000

Question 13

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

$250,000,000(1.18) = $295,000,000
0.025(295,000,000) = $7,375,000 11eaaae8_8b39_3ce5_a4b8_b7666b84688b_TB6474_11 = 15.05%

Question 14

Which of the following are not managed investment companies?

Accepted Answer

Unit investment trusts are not managed investment companies; they are unmanaged and have a fixed portfolio.

Question 15

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

Accepted Answer

A 120/20 fund is structured to sell short up to $20 for every $100 in net assets, using the proceeds to increase the long position to $120 of net assets.

Question 16

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 a 3% management fee on the assets. The fee is imposed on year-end asset values. What is the end-of-year NAV for the fund?

Accepted Answer

11eaaae8_8b39_8b0a_a4b8_33b623cec90d_TB6474_11 = $16.296

Question 17

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

Accepted Answer

The collapse of the Long Term Capital Management hedge fund in 1998 was a case of a tail event, which refers to extremely rare events that fall outside of the normal distribution of statistical probabilities. It was a confluence of unpredictable factors that led to the collapse, such as the Russian debt crisis and the sudden decline in liquidity in the markets. This event highlighted the potential risks of complex financial instruments and the interconnectedness of the global financial system.

Question 18

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

Accepted Answer

Long Term Capital Management (LTCM) primarily used convergence arbitrage strategies, which involve taking advantage of price discrepancies between related financial instruments, expecting them to converge over time.

Question 19

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

Accepted Answer

Multistrategy funds change their investment strategies and asset allocation based on the fund manager's outlook. They may invest in different types of securities and vary the proportions invested in different market sectors. Asset allocation funds focus on maintaining a specific allocation of assets based on an investor's risk tolerance and investment goals. Event-driven funds invest in securities based on specific events or catalysts, such as mergers or acquisitions. Market-neutral funds aim to generate returns by exploiting differences in prices between related securities, regardless of overall market movements.

Question 20

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

Accepted Answer

Market-neutral hedge funds often use leverage to amplify their returns, which can lead to significant volatility. Pure play and directional bets do not necessarily generate volatility, while net short positions are often a means of reducing volatility through hedging.

Quiz 20: Hedge Funds

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?

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 1-year oil futures contract is selling for $74.50. Spot oil prices are $68, and the 1-year risk-free rate is 3.25%. Based on the above data, which of the following sets of transactions will yield positive riskless arbitrage profits?