Chap 020

Chapter 20 - Hedge Funds
Chapter 20
Hedge Funds

Multiple Choice Questions

1. Which of the following are characteristics of a hedge fund?
I. Pooling of assets
II. Strict regulator o!ersight " the S#C
III. In!esting in e$uities% de"t instru&ents% and deri!ati!e instru&ents
I'. Professional &anage&ent of assets
(. I and II onl
). II and III onl
C. III and I' onl
*. I% III% and I' onl

2. ( ++++++++++ is a pri!ate in!est&ent pool open onl to wealth or institutional in!estors
that is e,e&pt fro& S#C regulation and can therefore pursue &ore speculati!e policies than
&utual funds.
(. co&&ingled pool
). unit trust
C. hedge fund
*. &one &ar-et fund

.. ++++++ are partnerships of wealth in!estors "ut too s&all to warrant &anaging on a
separate "asis.
(. Co&&ingled funds
). Hedge funds
C. /#I0s
*. 1utual funds

2. (d!antages of hedge funds include all "ut which one of the following?
(. /ecord -eeping and ad&inistration
). 3ow transaction costs
C. Professional &anage&ent
*. Consistentl high rates of return

20-1
4. ++++++ are pri!ate partnerships of s&all nu&"er of wealth in!estors who are organi5ed as
pri!ate partnerships% often su"6ect to loc--up period% and allowed to pursue a wide range of
in!est&ent acti!ities.
(. Hedge funds
). Closed-end funds
C. /#I0s
*. 1utual funds

7. Which of the following tpicall e&plo significant a&ounts of le!erage?
I. Hedge funds
II. #$uit &utual funds
III. 1one &ar-et funds
I'. Inco&e &utual funds
(. I onl
). I and II onl
C. III and I' onl
*. I% II and III onl

8. (s of late 2009% hedge funds had appro,i&atel +++++ under &anage&ent.
(. :0.4 trillion
). :1 trillion
C. :1.7 trillion
*. :2.. trillion

9. ( restriction where in!estors cannot withdraw their funds for as long as se!eral &onths or
ears is called ++++++++++.
(. transparenc
). a loc- up period
C. a "ac- end load
*. con!erti"le ar"itrage

20-2
;. Hedge funds &anagers are co&pensated " +++++++++++++++++++.
(. deducting &anage&ent fees fro& fund assets and recei!ing incenti!e "onuses for "eating
inde, "ench&ar-s
). deducting a percentage of an gains in asset !alue
C. selling shares in the trust at a pre&iu& to the cost of ac$uiring the underling assets
*. charging portfolio turno!er fees

10. 1anage&ent fees for hedge funds% tpicall range "etween +++++ and +++++.
(. 0.4<= 1.4<
). 1<= .<
C. 2<= 4<
*. 4<= 9<

11. Hedge funds can in!est in !arious in!est&ent options which not generall a!aila"le to
&utual funds. 0hese include +++++++++++++.
I. futures and options
II. &erger ar"itrage
III. currenc contracts
I'. co&panies undergoing Chapter 11 restructuring and reorgani5ation
(. I onl
). I and II onl
C. I% II% and III onl
*. I% II% III% and I'

12. 0pical initial in!est&ent in a hedge fund generall is in the range "etween +++++ and
+++++.
(. :1%000= :4000
). :4%000= :24%000
C. :24%000= :240%000
*. :240%000= :1%000%000

20-.
1.. 0he difference "etween &ar-et neutral and long>short hedges is that &ar-et neutral hedge
funds +++++++++.
(. esta"lish long and short position on "oth sides of the &ar-et to eli&inate ris- and to "enefit
fro& securit asset &ispricing% whereas long>short hedge esta"lish positions onl on one side
of the &ar-et
). allocate &one to se!eral other funds while long>short funds do not
C. in!est in relati!el sta"le proportions of stoc-s and "onds while the proportions &a !ar
dra&aticall for long>short funds
*. in!est onl in e$uities and "onds while long>short funds use onl deri!ati!es

12. Con!erti"le ar"itrage hedge funds +++++++++.
(. atte&pt to profit fro& &ispriced interest sensiti!e securities
). hold long positions in con!erti"le "onds and offsetting short positions in stoc-s
C. esta"lish long and short positions in glo"al capital &ar-ets
*. use deri!ati!e products to hedge their short positions in con!erti"le "onds

14. (ssu&ing positi!e "asis and negligi"le "orrowing cost% which of the following set of
transactions could ield positi!e ar"itrage profits a hedge fund &ight pursue?
(. )u gold in the spot &ar-et and sell the futures contract
). )u the futures contract and sell the gold spot and in!est the &one earned
C. )u gold spot with "orrowed &one and "u the futures contract
*. )u the futures contract and "u the gold spot using "orrowed &one

17. (n e,a&ple of a neutral pure pla is +++++++.
(. pairs trading
). statistical ar"itrage
C. con!ergence ar"itrage
*. directional strateg

20-2
18. ?ou "elie!e that the spread "etween the Septe&"er S@P 400 future and S@P 400 inde, is
too large and will soon correct. 0o ta-e ad!antage of this &ispricing a hedge fund should
++++++++++++++.
(. "u all the stoc-s in the S@P 400 and write put options on the S@P 400 inde,
). sell all the stoc-s in the S@P 400 and "u call options on S@P 400 inde,
C. sell S@P 400 inde, futures and "u all the stoc-s in the S@P 400
*. sell short all the stoc-s in the S@P 400 and "u S@P 400 inde, futures

too large and will soon correct. 0his is an e,a&ple of ++++++++++++++.
(. pairs trading
). con!ergence pla
C. statistical ar"itrage
*. long>short e$uit hedge

( one-ear oil futures contract is selling for :82.40. Spot oil prices are :79 and the one ear
ris- free rate is ..24<.

1;. 0he one-ear oil futures price should "e e$ual to ++++++++++.
(. :79.00
). :80.21
C. :81.24
*. :82.99

20. 0he ar"itrage profit i&plied " these prices is +++++++++++++.
(. :7.40
). :4.22
C. :2.2;
*. :..24

20-4
21. )ased on the a"o!e data% which of the following set of transactions will ield positi!e
ris-less ar"itrage profits?
(. )u oil in the spot &ar-et with "orrowed &one and sell the futures contract
). )u the futures contract and sell the oil spot and in!est the &one earned
C. )u the oil spot with "orrowed &one and "u the futures contract
*. )u the futures contract and "u the oil spot using "orrowed &one

(ssu&e that ou ha!e in!ested :400%000 to purchase shares in a hedge fund reporting :900
&illion in assets% :100 &illion in lia"ilities% and 80 &illion shares outstanding. ?our initial
loc-out period is . ears.

22. How &an shares did ou purchase?
(. 1.%...
). 24%000
C. 40%000
*. 77%000

2.. If the share price after . ears increases to :14.29% what is the !alue of our in!est&ent?
(. :44.%700
). :724%000
C. :8..%900
*. :872%000

22. What is our annuali5ed return o!er the .-ear holding period?
(. 12.24<
). 14.19<
C. 17.00<
*. 18.8.<

20-7
24. Which of the following are not &anaged in!est&ent co&panies?
(. Hedge funds
). Anit in!est&ent trusts
C. Closed-end funds
*. Bpen-end funds

?ou &anage :14 &illion hedge fund portfolio with "eta C 1.2 and alpha C 2< per $uarter.
(ssu&e the ris- free rate 2< per $uarter and the current !alue of the S@P 400 inde, C 1200.
?ou want to e,ploit positi!e alpha "ut ou are afraid are afraid that the stoc- &ar-et &a fall
and want to hedge our portfolio " selling the .-&onth S@P 400 future contracts. 0he S@P
contract &ultiplier is :240.

27. How &an S@P 400 contracts do ou need to sell to hedge our portfolio?
(. 24
). .0
C. 20
*. 40

28. When ou hedge our stoc- portfolio with futures contracts the !alue of our portfolio
"eta is ++++++++++.
(. 0
). 1
C. 1.2
*. )eta cannot "e deter&ined fro& infor&ation gi!en

29. What is e,pected $uarterl return on the hedged portfolio?
(. 0<
). 2<
C. .<
*. 2<

20-8
2;. How &uch is the portfolio e,pected to "e worth . &onths fro& now?
(. :14%000%000
). :14%240%000
C. :14%700%000
*. :17%000%000

.0. Hedging this portfolio " selling S@P 400 futures contracts is an e,a&ple of
+++++++++++.
(. statistical ar"itrage
). pure pla
C. short e$uit hedge
*. fi,ed inco&e ar"itrage

.1. Hedge funds that change strategies and tpes of securities in!ested and also !ar the
proportions of assets and in!ested in particular &ar-et sectors according to the fund &anagerDs
outloo- are called ++++++++++++++++++++.
(. asset allocation funds
). &ulti strateg funds
C. e!ent dri!en funds
*. &ar-et neutral funds

.2. When a short-selling hedge fund ad!ertises in a prospectus that it is a 120>20 fund% it
&eans that this fund &a sell short up to ++++++ e!er :100 in net assets and increase the
long position to ++++++++++ of net assets.
(. :120= :20
). :20= :120
C. :20= :20
*. :120= :120

20-9
... 0he collapse of the 3ong 0er& Capital 1anage&ent hedge fund in 1;;9 was a case of an
e,tre&e unli-el statistical e!ent called ++++++++.
). an unhedged pla
C. a tail e!ent
*. a li$uidit trap

.2. Which of the following in!est&ent stle could "e the "est description of the 3ong 0er&
Capital 1anage&ent &ar-et neutral strategies?
(. Con!ergence ar"itrage
). Statistical ar"itrage
C. Pairs trading
*. Con!erti"le ar"itrage

.4. Consider a hedge fund with :240 &illion in assets at the start of the ear. If the gross
return on assets is 19< and the total e,pense ratio is 2.4< of the ear end !alue% what is the
rate of return on the fund?
(. 14.04<
). 14.40<
C. 18.24<
*. 19.00<

Consider a hedge fund with :200 &illion at the start of the ear. 0he "ench&ar- S@P 400
inde, was up 17.4< during the sa&e period. 0he gross return on assets is 21< and the
e,pense ratio is 2<. For each 1< a"o!e the "ench&ar- return the fund &anagers recei!e
0.1< incenti!e "onus.

.7. What was the &anage&ent cost for the ear?
(. :2%988%000
). :2%;00%000
C. :4%;2;%000
*. :7%227%000

20-;
.8. What was the annual return on this fund?
(. 17.40<
). 19.02<
C. 19.44<
*. 21.00<

.9. Consider a hedge fund with :200 &illion in assets% 70 &illion in de"t% and 17 &illion
shares at the start of the ear= and :400 &illion in assets% 20 &illion in de"t% and 20 &illion
shares at the end of the ear. *uring the ear in!estors ha!e recei!ed an inco&e di!idend of
:0.84 per share. (ssu&ing that the fund carries no de"t% and that the total e,pense ratio is
2.84<% what is the rate of return on the fund?
(. 7.24<
). 9.42<
C. 9.;4<
*. ;.27<

.;. 1ar-et neutral hedge funds &a e,perience considera"le !olatilit. 0he source of !olatile
returns is the use of +++++++++.
(. pure pla
). le!erage
C. directional "ests
*. net short positions

20. ( hedge fund has :140 &illion in assets at the "eginning of the ear and 10 &illion shares
outstanding throughout the ear. 0hroughout the ear assets grow at 12<. 0he fund charges
.< &anage&ent fee on assets. 0he fee is i&posed on ear end asset !alues. What is the end
of ear E(' for the fund?
(. :14.00
). :14.70
C. :17..0
*. :18.44

20-10
21. ?ou pa :217%000 to the Capital Hedge Fund which has a price of :19.00 per share at the
"eginning of the ear. 0he fund deducted a front-end co&&ission of 2<. 0he securities in the
fund increased in !alue " 14< during the ear. 0he fundDs e,pense ratio is 2< and is
deducted fro& ear end asset !alues. What is our rate of return on the fund if ou sell our
shares at the end of the ear?
(. 4..4<
). 8.2.<
C. 9.1;<
*. 10.00<

22. ( hedge fund owns a :14 &illion "ond portfolio with a &odified duration of 11 ears and
needs to hedge ris- "ut 0-"ond futures are onl a!aila"le with a &odified duration of the
deli!era"le instru&ent of 10 ears. 0he futures are priced at :104%000. 0he proper hedge ratio
to use is ++++++.
(. 12.
). 148
C. 1;7
*. 219

2.. Anli-e &ar-et-neutral hedge funds which ha!e "etas near ++++++++% directional long
funds e,hi"it highl +++++++ "etas.
(. 5ero= positi!e
). positi!e= negati!e
C. positi!e= 5ero
*. negati!e= positi!e

22. Portfolio ( has a "eta of 0.2 and an e,pected return of 12<. Portfolio ) has a "eta of 0.4
and an e,pected return of 17<. 0he ris--free rate of return is 10<. If ou &anage a long>short
e$uit fund and wanted to ta-e ad!antage of an ar"itrage opportunit% ou should ta-e a short
position in portfolio ++++++ and a long position in portfolio ++++++++++.
(. (= (
). (= )
C. )= (
*. )= )

20-11
24. (ccording to research conducted " Hasanhodic and 3o F2008G% a!erage returns of e$uit
hedge funds are ++++++++++ the S@P 400 inde,.
(. e$ual to
). considera"l higher than
C. slightl lower than
*. slightl higher than

27. /esearch " (ragon F2008G indicates that loc- up restrictions on rede&ptions and positi!e
serial correlations of returns indicate that hedge funds often face ++++++++++ pro"le&s.
(. li$uidit
). &aturit
C. e!ent dri!en
*. hedging

28. Higher returns of e$uit hedge funds as co&pared to the S@P 400 inde, reflect positi!e
co&pensation for ++++++++++ ris-.
(. &ar-et
). li$uidit
C. sste&atic
*. interest rate

29. Portfolio ( has a "eta of 1.. and an e,pected return of 21<. Portfolio ) has a "eta of 0.8
and an e,pected return of 18<. 0he ris--free rate of return is ;<. If a hedge fund &anager
wants to ta-e ad!antage of an ar"itrage opportunit% she should ta-e a short position in
portfolio ++++++++++ and a long position in portfolio ++++++++++.
(. (= (
). (= )
C. )= (
*. )= )

20-12
2;. Hedge funds report a!erage returns in *ece&"er that are higher than their a!erage returns
in other &onths. 0his pheno&enon ++++++++++.
I. is called the Santa effect
II. often results fro& o!er generous !aluation of illi$uid assets
III. appears stronger for lower-li$uidit funds
I'. can "e e,plained " &anagersD atte&pts to inflate assets to collect higher perfor&ance
"onuses
(. I onl
). I and II onl
*. I% II% III% and I'

40. 0o attract new clients hedge funds often select reporting periods which show a"nor&all
high returns. 0his is called ++++++++++.
(. long>short "ias
). sur!i!orship "ias
C. "ac-fill "ias
*. incenti!e "ias

41. So&e argue that a"nor&all high returns of hedge funds are tainted " ++++++++++%
which arises when unsuccessful funds cease operations lea!ing onl successful ones.
(. reporting "ias
C. "ac-fill "ias
*. incenti!e "ias

42. 1al-iel and SahaF2004G esti&ate that the sur!i!orship "ias for hedge funds e$uals 2.2<%
which is ++++++++++ than the sur!i!orship "ias for &utual funds.
(. a"out the sa&e as
). &uch lower
C. &uch higher
*. onl slightl lower

20-1.
4.. Hedge fund &anagers recei!e incenti!e "onuses when the increase portfolio assets
"eond a stipulated "ench&ar- "ut lose nothing when the fail to perfor&. 0his e$ui!alent to
++++++++++.
(. writing a call option
). recei!ing a free call option
C. writing a put option
*. recei!ing a free put option

42. 0pical hedge fund incenti!e "onus is usuall e$ual to ++++++++ of in!est&ent profits
"eond a predeter&ined "ench&ar- inde,.
(. 4<
). 10<
C. 20<
*. 24<

44. 0he fastest growing categor of hedge funds are feeder funds. 0hese funds in!est in
++++++++.
(. other hedge funds
). con!erti"le securities and preferred stoc-
C. e$uities and "onds
*. &anaged futures and options

47. ( high water &ar- is a li&iting factor of hedge fund &anager co&pensation. 0his &eans
that &anagers canDt charge incenti!e fees ++++++++.
(. when a fund stas flat
). when a fund falls and does not reco!er to its pre!ious high !alue
C. when a fund falls " 10< or &ore
*. Eone of the a"o!e occurs. 1anagers can alwas charge incenti!e fee

20-12
48. If the ris--free interest rate is r
f
and e$uals the fundDs "ench&ar-% the portfolio net asset
!alue is S
0
% and a hedge fund &anager incenti!e fee is 20< of profit "eond that% the incenti!e
fee is e$ui!alent to recei!ing ++++++ callFsG with e,ercise price ++++++++.
(. 0.2= S
0
). 1= S
0
F1 H r
f
G
C. 1.2= S
0
*. 0.2= S
0
F1 H r
f
G

(ssu&e the ris--free interest rate is 10< and is e$ual to fundDs "ench&ar-% the portfolio net
asset !alue is :100% and the fundDs standard de!iation is 20<. (lso assu&e ti&e hori5on of 1
ear.

49. What is the e,ercise price on the incenti!e fee?
(. :100
). :104
C. :110
*. :114

4;. What is the )lac--Scholes !alue of the call option on &anage&ent incenti!e fee?
(. :7.78
). :9.20
C. :;.82
*. :10.22

70. (ssu&ing 2< &anage&ent fee% what is the e,pected &anage&ent co&pensation per share
if the fund net asset !alue e,ceeds the stated "ench&ar-?
(. :2.22
). :2.00
C. :..92
*. :2.20

20-14
Chapter 20 Hedge Funds (nswer Ie

Multiple Choice Questions

1. Which of the following are characteristics of a hedge fund?
I. Pooling of assets
II. Strict regulator o!ersight " the S#C
III. In!esting in e$uities% de"t instru&ents% and deri!ati!e instru&ents
I'. Professional &anage&ent of assets
(. I and II onl
). II and III onl
C. III and I' onl
D. I% III% and I' onl

Difficulty: Easy

2. ( ++++++++++ is a pri!ate in!est&ent pool open onl to wealth or institutional in!estors
that is e,e&pt fro& S#C regulation and can therefore pursue &ore speculati!e policies than
&utual funds.
(. co&&ingled pool
). unit trust
C. hedge fund
*. &one &ar-et fund

Difficulty: Easy

.. ++++++ are partnerships of wealth in!estors "ut too s&all to warrant &anaging on a
separate "asis.
A. Co&&ingled funds
). Hedge funds
C. /#I0s
*. 1utual funds

Difficulty: Medium

20-17
2. (d!antages of hedge funds include all "ut which one of the following?
(. /ecord -eeping and ad&inistration
). 3ow transaction costs
C. Professional &anage&ent
D. Consistentl high rates of return

Difficulty: Easy

4. ++++++ are pri!ate partnerships of s&all nu&"er of wealth in!estors who are organi5ed as
pri!ate partnerships% often su"6ect to loc--up period% and allowed to pursue a wide range of
in!est&ent acti!ities.
A. Hedge funds
). Closed-end funds
C. /#I0s
*. 1utual funds

Difficulty: Easy

7. Which of the following tpicall e&plo significant a&ounts of le!erage?
I. Hedge funds
II. #$uit &utual funds
III. 1one &ar-et funds
I'. Inco&e &utual funds
A. I onl
). I and II onl
C. III and I' onl
*. I% II and III onl

Difficulty: Easy

20-18
8. (s of late 2009% hedge funds had appro,i&atel +++++ under &anage&ent.
(. :0.4 trillion
). :1 trillion
C. :1.7 trillion
*. :2.. trillion

Difficulty: Medium

9. ( restriction where in!estors cannot withdraw their funds for as long as se!eral &onths or
ears is called ++++++++++.
(. transparenc
B. a loc- up period
C. a "ac- end load
*. con!erti"le ar"itrage

Difficulty: Easy

;. Hedge funds &anagers are co&pensated " +++++++++++++++++++.
A. deducting &anage&ent fees fro& fund assets and recei!ing incenti!e "onuses for "eating
inde, "ench&ar-s
). deducting a percentage of an gains in asset !alue
C. selling shares in the trust at a pre&iu& to the cost of ac$uiring the underling assets
*. charging portfolio turno!er fees

Difficulty: Easy

10. 1anage&ent fees for hedge funds% tpicall range "etween +++++ and +++++.
(. 0.4<= 1.4<
B. 1<= .<
C. 2<= 4<
*. 4<= 9<

Difficulty: Easy

20-19
11. Hedge funds can in!est in !arious in!est&ent options which not generall a!aila"le to
&utual funds. 0hese include +++++++++++++.
I. futures and options
II. &erger ar"itrage
III. currenc contracts
I'. co&panies undergoing Chapter 11 restructuring and reorgani5ation
(. I onl
). I and II onl
D. I% II% III% and I'

Difficulty: Easy

12. 0pical initial in!est&ent in a hedge fund generall is in the range "etween +++++ and
+++++.
(. :1%000= :4000
). :4%000= :24%000
C. :24%000= :240%000
D. :240%000= :1%000%000

Difficulty: Medium

1.. 0he difference "etween &ar-et neutral and long>short hedges is that &ar-et neutral hedge
funds +++++++++.
A. esta"lish long and short position on "oth sides of the &ar-et to eli&inate ris- and to "enefit
fro& securit asset &ispricing% whereas long>short hedge esta"lish positions onl on one side
of the &ar-et
). allocate &one to se!eral other funds while long>short funds do not
C. in!est in relati!el sta"le proportions of stoc-s and "onds while the proportions &a !ar
dra&aticall for long>short funds
*. in!est onl in e$uities and "onds while long>short funds use onl deri!ati!es

Difficulty: Medium

20-1;
12. Con!erti"le ar"itrage hedge funds +++++++++.
(. atte&pt to profit fro& &ispriced interest sensiti!e securities
B. hold long positions in con!erti"le "onds and offsetting short positions in stoc-s
C. esta"lish long and short positions in glo"al capital &ar-ets
*. use deri!ati!e products to hedge their short positions in con!erti"le "onds

Difficulty: Medium

14. (ssu&ing positi!e "asis and negligi"le "orrowing cost% which of the following set of
transactions could ield positi!e ar"itrage profits a hedge fund &ight pursue?
A. )u gold in the spot &ar-et and sell the futures contract
). )u the futures contract and sell the gold spot and in!est the &one earned
C. )u gold spot with "orrowed &one and "u the futures contract
*. )u the futures contract and "u the gold spot using "orrowed &one

Difficulty: Medium

17. (n e,a&ple of a neutral pure pla is +++++++.
(. pairs trading
). statistical ar"itrage
C. con!ergence ar"itrage
*. directional strateg

Difficulty: Medium

too large and will soon correct. 0o ta-e ad!antage of this &ispricing a hedge fund should
++++++++++++++.
(. "u all the stoc-s in the S@P 400 and write put options on the S@P 400 inde,
). sell all the stoc-s in the S@P 400 and "u call options on S@P 400 inde,
C. sell S@P 400 inde, futures and "u all the stoc-s in the S@P 400
*. sell short all the stoc-s in the S@P 400 and "u S@P 400 inde, futures

Difficulty: Medium

20-20
too large and will soon correct. 0his is an e,a&ple of ++++++++++++++.
(. pairs trading
B. con!ergence pla
C. statistical ar"itrage
*. long>short e$uit hedge

Difficulty: Medium

( one-ear oil futures contract is selling for :82.40. Spot oil prices are :79 and the one ear
ris- free rate is ..24<.

1;. 0he one-ear oil futures price should "e e$ual to ++++++++++.
(. :79.00
B. :80.21
C. :81.24
*. :82.99
Parit F
0
C S
0
F1 H r
f
- dG
0
C :79F1 H .0.24 - .0G
1
C :80.21

Difficulty: Medium

20. 0he ar"itrage profit i&plied " these prices is +++++++++++++.
(. :7.40
). :4.22
C. :2.2;
*. :..24
(r"itrage profit 82.40 - 80.21 C :2.2;

Difficulty: Medium

20-21
21. )ased on the a"o!e data% which of the following set of transactions will ield positi!e
ris-less ar"itrage profits?
A. )u oil in the spot &ar-et with "orrowed &one and sell the futures contract
). )u the futures contract and sell the oil spot and in!est the &one earned
C. )u the oil spot with "orrowed &one and "u the futures contract
*. )u the futures contract and "u the oil spot using "orrowed &one

Difficulty: Medium

(ssu&e that ou ha!e in!ested :400%000 to purchase shares in a hedge fund reporting :900
&illion in assets% :100 &illion in lia"ilities% and 80 &illion shares outstanding. ?our initial
loc-out period is . ears.

22. How &an shares did ou purchase?
(. 1.%...
). 24%000
C. 40%000
*. 77%000
400%000>10 C 40%000

Difficulty: Easy

2.. If the share price after . ears increases to :14.29% what is the !alue of our in!est&ent?
(. :44.%700
). :724%000
C. :8..%900
D. :872%000
F40%000GF:14.29G C :872%000

Difficulty: Medium

20-22
22. What is our annuali5ed return o!er the .-ear holding period?
(. 12.24<
B. 14.19<
C. 17.00<
*. 18.8.<

Difficulty: Medium

24. Which of the following are not &anaged in!est&ent co&panies?
(. Hedge funds
B. Anit in!est&ent trusts
C. Closed-end funds
*. Bpen-end funds

Difficulty: Easy

?ou &anage :14 &illion hedge fund portfolio with "eta C 1.2 and alpha C 2< per $uarter.
(ssu&e the ris- free rate 2< per $uarter and the current !alue of the S@P 400 inde, C 1200.
?ou want to e,ploit positi!e alpha "ut ou are afraid are afraid that the stoc- &ar-et &a fall
and want to hedge our portfolio " selling the .-&onth S@P 400 future contracts. 0he S@P
contract &ultiplier is :240.

20-2.
27. How &an S@P 400 contracts do ou need to sell to hedge our portfolio?
(. 24
). .0
C. 20
D. 40

Difficulty: Hard

28. When ou hedge our stoc- portfolio with futures contracts the !alue of our portfolio
"eta is ++++++++++.
A. 0
). 1
C. 1.2
*. )eta cannot "e deter&ined fro& infor&ation gi!en

Difficulty: Medium

29. What is e,pected $uarterl return on the hedged portfolio?
(. 0<
). 2<
C. .<
D. 2<
#Fr
p
G C #Jr
f
H Fr
1
- r
f
G H e H K C r
f
H C 2< H 2< C 2<

Difficulty: Medium

20-22
2;. How &uch is the portfolio e,pected to "e worth . &onths fro& now?
(. :14%000%000
). :14%240%000
C. :14%700%000
*. :17%000%000
S
1
C S
0
F1 H r
p
G C :14%000%000F1.02G C :14%700%000

Difficulty: Medium

.0. Hedging this portfolio " selling S@P 400 futures contracts is an e,a&ple of
+++++++++++.
B. pure pla
C. short e$uit hedge
*. fi,ed inco&e ar"itrage

Difficulty: Medium

.1. Hedge funds that change strategies and tpes of securities in!ested and also !ar the
proportions of assets and in!ested in particular &ar-et sectors according to the fund &anagerDs
outloo- are called ++++++++++++++++++++.
(. asset allocation funds
B. &ulti strateg funds
C. e!ent dri!en funds
*. &ar-et neutral funds

Difficulty: Easy

20-24
.2. When a short-selling hedge fund ad!ertises in a prospectus that it is a 120>20 fund% it
&eans that this fund &a sell short up to ++++++ e!er :100 in net assets and increase the
long position to ++++++++++ of net assets.
(. :120= :20
B. :20= :120
C. :20= :20
*. :120= :120

Difficulty: Medium

... 0he collapse of the 3ong 0er& Capital 1anage&ent hedge fund in 1;;9 was a case of an
e,tre&e unli-el statistical e!ent called ++++++++.
B. an unhedged pla
C. a tail e!ent
*. a li$uidit trap

Difficulty: Medium

.2. Which of the following in!est&ent stle could "e the "est description of the 3ong 0er&
Capital 1anage&ent &ar-et neutral strategies?
A. Con!ergence ar"itrage
). Statistical ar"itrage
C. Pairs trading
*. Con!erti"le ar"itrage

Difficulty: Medium

20-27
.4. Consider a hedge fund with :240 &illion in assets at the start of the ear. If the gross
return on assets is 19< and the total e,pense ratio is 2.4< of the ear end !alue% what is the
rate of return on the fund?
A. 14.04<
). 14.40<
C. 18.24<
*. 19.00<

Difficulty: Medium

Consider a hedge fund with :200 &illion at the start of the ear. 0he "ench&ar- S@P 400
inde, was up 17.4< during the sa&e period. 0he gross return on assets is 21< and the
e,pense ratio is 2<. For each 1< a"o!e the "ench&ar- return the fund &anagers recei!e
0.1< incenti!e "onus.

.7. What was the &anage&ent cost for the ear?
(. :2%988%000
). :2%;00%000
C. :4%;2;%000
*. :7%227%000
:200%000%000F1.21G C :222%000%000
21< - 17.4< C 2.4<= 2< H 2.4<F0.1G C 2.24<
.0224F222%000%000G C :4%;2;%000

Difficulty: Hard

20-28
.8. What was the annual return on this fund?
(. 17.40<
B. 19.02<
C. 19.44<
*. 21.00<

Difficulty: Hard

.9. Consider a hedge fund with :200 &illion in assets% 70 &illion in de"t% and 17 &illion
shares at the start of the ear= and :400 &illion in assets% 20 &illion in de"t% and 20 &illion
shares at the end of the ear. *uring the ear in!estors ha!e recei!ed an inco&e di!idend of
:0.84 per share. (ssu&ing that the fund carries no de"t% and that the total e,pense ratio is
2.84<% what is the rate of return on the fund?
(. 7.24<
B. 9.42<
C. 9.;4<
*. ;.27<
Eet return C

Difficulty: Hard

20-29
.;. 1ar-et neutral hedge funds &a e,perience considera"le !olatilit. 0he source of !olatile
returns is the use of +++++++++.
(. pure pla
B. le!erage
C. directional "ests
*. net short positions

Difficulty: Easy

20. ( hedge fund has :140 &illion in assets at the "eginning of the ear and 10 &illion shares
outstanding throughout the ear. 0hroughout the ear assets grow at 12<. 0he fund charges
.< &anage&ent fee on assets. 0he fee is i&posed on ear end asset !alues. What is the end
of ear E(' for the fund?
(. :14.00
). :14.70
C. :17..0
*. :18.44

Difficulty: Hard

20-2;
21. ?ou pa :217%000 to the Capital Hedge Fund which has a price of :19.00 per share at the
"eginning of the ear. 0he fund deducted a front-end co&&ission of 2<. 0he securities in the
fund increased in !alue " 14< during the ear. 0he fundDs e,pense ratio is 2< and is
deducted fro& ear end asset !alues. What is our rate of return on the fund if ou sell our
shares at the end of the ear?
(. 4..4<
). 8.2.<
C. 9.1;<
*. 10.00<

Difficulty: Hard

22. ( hedge fund owns a :14 &illion "ond portfolio with a &odified duration of 11 ears and
needs to hedge ris- "ut 0-"ond futures are onl a!aila"le with a &odified duration of the
deli!era"le instru&ent of 10 ears. 0he futures are priced at :104%000. 0he proper hedge ratio
to use is ++++++.
(. 12.
B. 148
C. 1;7
*. 219

Difficulty: Hard

20-.0
2.. Anli-e &ar-et-neutral hedge funds which ha!e "etas near ++++++++% directional long
funds e,hi"it highl +++++++ "etas.
A. 5ero= positi!e
). positi!e= negati!e
C. positi!e= 5ero
*. negati!e= positi!e

Difficulty: Medium

22. Portfolio ( has a "eta of 0.2 and an e,pected return of 12<. Portfolio ) has a "eta of 0.4
and an e,pected return of 17<. 0he ris--free rate of return is 10<. If ou &anage a long>short
e$uit fund and wanted to ta-e ad!antage of an ar"itrage opportunit% ou should ta-e a short
position in portfolio ++++++ and a long position in portfolio ++++++++++.
(. (= (
). (= )
C. )= (
*. )= )
Portfolio ( has higher return per unit of ris-.

Difficulty: Medium

24. (ccording to research conducted " Hasanhodic and 3o F2008G% a!erage returns of e$uit
hedge funds are ++++++++++ the S@P 400 inde,.
(. e$ual to
B. considera"l higher than
C. slightl lower than
*. slightl higher than

Difficulty: Medium

20-.1
27. /esearch " (ragon F2008G indicates that loc- up restrictions on rede&ptions and positi!e
serial correlations of returns indicate that hedge funds often face ++++++++++ pro"le&s.
A. li$uidit
). &aturit
C. e!ent dri!en
*. hedging

Difficulty: Medium

28. Higher returns of e$uit hedge funds as co&pared to the S@P 400 inde, reflect positi!e
co&pensation for ++++++++++ ris-.
(. &ar-et
B. li$uidit
C. sste&atic
*. interest rate

Difficulty: Medium

29. Portfolio ( has a "eta of 1.. and an e,pected return of 21<. Portfolio ) has a "eta of 0.8
and an e,pected return of 18<. 0he ris--free rate of return is ;<. If a hedge fund &anager
wants to ta-e ad!antage of an ar"itrage opportunit% she should ta-e a short position in
portfolio ++++++++++ and a long position in portfolio ++++++++++.
(. (= (
B. (= )
C. )= (
*. )= )
Portfolio ) has higher return per unit of ris-

Difficulty: Medium

20-.2
2;. Hedge funds report a!erage returns in *ece&"er that are higher than their a!erage returns
in other &onths. 0his pheno&enon ++++++++++.
I. is called the Santa effect
II. often results fro& o!er generous !aluation of illi$uid assets
III. appears stronger for lower-li$uidit funds
I'. can "e e,plained " &anagersD atte&pts to inflate assets to collect higher perfor&ance
"onuses
(. I onl
). I and II onl
D. I% II% III% and I'

Difficulty: Medium

40. 0o attract new clients hedge funds often select reporting periods which show a"nor&all
high returns. 0his is called ++++++++++.
(. long>short "ias
C. "ac-fill "ias
*. incenti!e "ias

Difficulty: Medium

41. So&e argue that a"nor&all high returns of hedge funds are tainted " ++++++++++%
which arises when unsuccessful funds cease operations lea!ing onl successful ones.
(. reporting "ias
B. sur!i!orship "ias
C. "ac-fill "ias
*. incenti!e "ias

Difficulty: Medium

20-..
42. 1al-iel and SahaF2004G esti&ate that the sur!i!orship "ias for hedge funds e$uals 2.2<%
which is ++++++++++ than the sur!i!orship "ias for &utual funds.
(. a"out the sa&e as
). &uch lower
C. &uch higher
*. onl slightl lower

Difficulty: Medium

4.. Hedge fund &anagers recei!e incenti!e "onuses when the increase portfolio assets
"eond a stipulated "ench&ar- "ut lose nothing when the fail to perfor&. 0his e$ui!alent to
++++++++++.
(. writing a call option
B. recei!ing a free call option
C. writing a put option
*. recei!ing a free put option

Difficulty: Medium

42. 0pical hedge fund incenti!e "onus is usuall e$ual to ++++++++ of in!est&ent profits
"eond a predeter&ined "ench&ar- inde,.
(. 4<
). 10<
C. 20<
*. 24<

Difficulty: Medium

44. 0he fastest growing categor of hedge funds are feeder funds. 0hese funds in!est in
++++++++.
A. other hedge funds
). con!erti"le securities and preferred stoc-
C. e$uities and "onds
*. &anaged futures and options

Difficulty: Easy

20-.2
47. ( high water &ar- is a li&iting factor of hedge fund &anager co&pensation. 0his &eans
that &anagers canDt charge incenti!e fees ++++++++.
(. when a fund stas flat
B. when a fund falls and does not reco!er to its pre!ious high !alue
C. when a fund falls " 10< or &ore
*. Eone of the a"o!e occurs. 1anagers can alwas charge incenti!e fee

Difficulty: Medium

48. If the ris--free interest rate is r
f
and e$uals the fundDs "ench&ar-% the portfolio net asset
!alue is S
0
% and a hedge fund &anager incenti!e fee is 20< of profit "eond that% the incenti!e
fee is e$ui!alent to recei!ing ++++++ callFsG with e,ercise price ++++++++.
(. 0.2= S
0
). 1= S
0
F1 H r
f
G
C. 1.2= S
0
*. 0.2= S
0
F1 H r
f
G

Difficulty: Medium

(ssu&e the ris--free interest rate is 10< and is e$ual to fundDs "ench&ar-% the portfolio net
asset !alue is :100% and the fundDs standard de!iation is 20<. (lso assu&e ti&e hori5on of 1
ear.

49. What is the e,ercise price on the incenti!e fee?
(. :100
). :104
C. :110
*. :114
Stri-e price C S
0
F1 H r
f
G C 100F1 H 0.1G C :110

Difficulty: Medium

20-.4
4;. What is the )lac--Scholes !alue of the call option on &anage&ent incenti!e fee?
(. :7.78
B. :9.20
C. :;.82
*. :10.22
d
2
= d
1
- 0.2F1G
0.4
C 0.12.2 - 0.2 C - 0.877= EFd
2
G C 0.27;8
Call !alue C S
0
EFd
1
G - Le
-r0
EFd
2
G C F100GF0.42;4G - F110Ge
-F.1G
F0.27;8G C :9.20

Difficulty: Hard

70. (ssu&ing 2< &anage&ent fee% what is the e,pected &anage&ent co&pensation per share
if the fund net asset !alue e,ceeds the stated "ench&ar-?
(. :2.22
). :2.00
C. :..92
*. :2.20
#,pected incenti!e fee is 2< of ear-end E(' H 20< of the !alue of :110 call option C .
02F110G H .2F9.20G C :..92

Difficulty: Hard

20-.7

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Chapter 20 - Hedge Funds

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