Chapter 26
Hedge Funds
Multiple Choice Questions
1. ______ are the dominant form of investing in securities markets for most individuals and
______ have enjoyed far greater growth rate in the last decade.
A. Hedge funds; hedge funds
B. Mutual funds; hedge funds
C. Hedge funds; mutual funds
D. Mutual funds; mutual funds
E. none of the above
Mutual funds are the dominant form of investing in securities markets for most individuals
and hedge funds have enjoyed far greater growth rate in the last decade.
Difficulty: Easy
Difficulty: Easy
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Difficulty: Easy
4. Hedge funds typically ______ relative mispricing of specific securities and ______ broad
market exposure.
A. bet on; bet on
B. hedge; hedge
C. hedge; bet on
D. bet on; hedge
E. none of the above
Hedge funds typically bet on relative mispricing of specific securities and hedge broad market
exposure.
Difficulty: Moderate
5. Hedge funds ______ engage in market timing ______ take extensive derivative positions.
A. cannot; and cannot
B. cannot; but can
C. can; and can
D. can; but cannot
E. none of the above
Hedge funds can engage in market timing and can take extensive derivative positions.
Difficulty: Moderate
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6. The risk profile of hedge funds ______, making performance evaluation ______.
A. can shift rapidly and substantially; challenging
B. can shift rapidly and substantially; straightforward
C. is stable; challenging
D. is stable; straightforward
E. none of the above
The risk profile of hedge funds can shift rapidly and substantially,making performance
evaluation challenging.
Difficulty: Moderate
Difficulty: Easy
8. Hedge funds are typically set up as ______ and provide ______ information about portfolio
composition and strategy to their investors.
A. limited partnerships; minimal
B. limited partnerships; extensive
C. investment trusts; minimal
D. investment trusts; extensive
E. none of the above
Hedge funds are typically set up as limited partnerships and provide minimal information
about portfolio composition and strategy to their investors.
Difficulty: Moderate
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9. Hedge funds are ______ transparent than mutual funds because of ______ strict SEC
regulation on hedge funds.
A. more; more
B. more; less
C. less; less
D. less; more
E. none of the above
Hedge funds are less transparent than mutual funds because of less strict SEC regulation on
hedge funds.
Difficulty: Moderate
10. ______ must periodically provide the public with information on portfolio composition.
A. Hedge funds
B. Mutual funds
C. ADRs
D. A and C
E. A and B
Mutual funds must periodically provide the public with information on portfolio composition.
Difficulty: Moderate
11. ______ are subject to the Securities act of 1933 and the Investment Company Act of 1940
to protect unsophisticated investors.
A. Hedge funds
B. Mutual funds
C. ADRs
D. A and C
E. B and C
Mutual funds are subject to the Securities act of 1933 and the Investment Company Act of
1940 to protect unsophisticated investors.
Difficulty: Moderate
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12. Hedge funds traditionally have ______ than 100 investors and ______ to the general
public.
A. more; advertise
B. more; do not advertise
C. less; advertise
D. less; do not advertise
E. none of the above
Hedge funds traditionally have less than 100 investors and do not advertise to the general
public.
Difficulty: Moderate
13. The minimum investment in some new hedge funds is as low as $______, compared to a
traditional minimum of $______.
A. 50,000; 500,000 to 1 million
B. 25,000; 250,000 to 1 million
C. 175,000; 400,000 to 1 million
D. 10,000; 750,000
E. 5,000; 2 million
The minimum investment in some new hedge funds is as low as 25,000 compared to a
traditional minimum of 500,000 to 1million.
Difficulty: Moderate
Difficulty: Moderate
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Difficulty: Moderate
Difficulty: Moderate
17. Hedge funds often have ______ provisions as long as ______, which preclude
redemption.
A. crackdown, 2 months
B. lock-up; 2 months
C. crackdown; several years
D. lock-up; several years
E. none of the above
Hedge funds often have lock-up provisions as long as several years, which preclude
redemption.
Difficulty: Moderate
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Difficulty: Moderate
19. A hedge fund pursuing a ______ strategy is betting one sector of the economy will
outperform other sectors.
A. directional
B. non-directional
C. stock or bond
D. arbitrage or speculation
E. none of the above
A hedge fund pursuing a directional strategy is betting one sector of the economy will
outperform other sectors.
Difficulty: Moderate
Difficulty: Moderate
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21. A hedge fund pursuing a ______ strategy is trying to exploit relative mispricing within a
market, but is hedged to avoid taking a stance on the direction of the broad market.
A. directional
B. non-directional
C. market neutral
D. arbitrage or speculation
E. none of the above
A hedge fund pursuing a market neutral strategy is trying to exploit relative mispricing within
a market, but is hedged to avoid taking a stance on the direction of the broad market.
Difficulty: Moderate
22. An example of a ______ strategy is the mispricing of a futures contract that must be
corrected by contract expiration.
A. market neutral
B. directional
C. relative value
D. divergence
E. convergence
An example of a convergence strategy is the mispricing of a futures contract that must be
corrected by contract expiration.
Difficulty: Moderate
23. A hedge fund attempting to profit from a change in the spread between mortgages and
Treasuries is using a ______ strategy.
A. market neutral
B. directional
C. relative value
D. divergence
E. convergence
A hedge fund attempting to profit from a change in the spread between mortgages and
Treasuries is using a relative value strategy.
Difficulty: Moderate
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24. If the yield on mortgage-backed securities was abnormally high compared to Treasury
bonds, a hedge fund pursuing a relative value strategy would _______.
A. short sell the Treasury and short sell the mortgage-backed securities
B. short sell the Treasury and buy the mortgage-backed securities
C. buy the Treasury and buy the mortgage-backed securities
D. buy the Treasury and short sell the mortgage-backed securities
E. C only since short sales are prohibited
If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds,
a hedge fund pursuing a non-directional strategy would short sell the Treasury and buy the
mortgage-backed securities.
Difficulty: Moderate
25. Assume newly issued 30-year-on-the-run bonds sell at higher yields (lower prices) than 29
year bonds with a nearly identical duration. A hedge fund that buys 29 year bonds and
sells 30 year bonds is taking a ______.
A. market neutral position
B. conservative position
C. bullish position
D. bearish position
E. none of the above
Assume newly issued 30-year-on-the-run bonds sell at higher yields (lower prices) than 29
year bonds with a nearly identical duration. A hedge fund that buys 29 year bonds and sells
30 year bonds is taking a market neutral position.
Difficulty: Moderate
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26. A bet on particular mispricing across two or more securities, with extraneous sources of
risk such as general market exposure hedged away is a ______.
A. pure play
B. relative play
C. long shot
D. sure thing
E. B and D
A bet on particular mispricing across two or more securities, with extraneous sources of risk
such as general market exposure hedged away is a pure play.
Difficulty: Moderate
27. Assume newly issued 30-year-on-the-run bonds sell at lower yields (higher prices) than 29
year bonds with a nearly identical duration. A hedge fund that sells 29 year bonds and
buys 30 year bonds is taking a ______.
A. market neutral position
B. conservative position
C. bullish position
D. bearish position
E. none of the above
A hedge fund that sells 29 year bonds and buys 30 year bonds is taking a market neutral
position.
Difficulty: Moderate
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28. If the yield on mortgage-backed securities was abnormally low compared to Treasury
bonds, a hedge fund pursuing a relative value strategy would _______.
A. short sell the Treasury and short sell the mortgage-backed securities
B. short sell the Treasury and buy the mortgage-backed securities
C. buy the Treasury and buy the mortgage-backed securities
D. buy the Treasury and short sell the mortgage-backed securities
E. C only since short sales are prohibited
If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a
hedge fund pursuing a non-directional strategy would buy the Treasury and short sell the
mortgage-backed securities.
Difficulty: Moderate
Difficulty: Moderate
30. ______ uses quantitative techniques and often automated trading systems to seek out
many temporary misalignments among securities.
A. Covered interest arbitrage
B. Locational arbitrage
C. Triangular arbitrage
D. Statistical arbitrage
E. All arbitrage
Statistical arbitrage uses quantitative techniques and often automated trading systems to seek
out many temporary misalignments among securities.
Difficulty: Moderate
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31. Assume that you manage a $3 million portfolio that pays no dividends, has a beta of 1.45
and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per month)
and the S&P 500 is at 1220. If you expect the market to fall within the next 30 days you can
hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a
multiplier of $250).
A. selling 1
B. selling 14
C. buying 1
D. buying 14
E. selling 6
The hedge ratio is [$3M/(1220 x 250)] x 1.45 = 14.26. Thus, you would need to sell 14
contracts.
Difficulty: Difficult
32. Assume that you manage a $1.3 million portfolio that pays no dividends, has a beta of
1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is 0.025% (per
month) and the S&P 500 is at 1220. If you expect the market to fall within the next 30 days
you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a
multiplier of $250).
A. selling 1
B. selling 6
C. buying 1
D. buying 6
E. selling 4
The hedge ratio is [$1.3M/(1220 x 250)] x 1.45 = 6.18. Thus, you would need to sell 6
contracts.
Difficulty: Difficult
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33. Assume that you manage a $2 million portfolio that pays no dividends, has a beta of 1.25
and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and
the S&P 500 is at 1300. If you expect the market to fall within the next 30 days you can hedge
your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of
$250).
A. selling 1
B. selling 8
C. buying 1
D. buying 8
E. selling 6
The hedge ratio is [$2M/(1300 x 250)] x 1.25 = 7.69. Thus, you would need to sell 8
contracts.
Difficulty: Difficult
34. Assume that you manage a $2 million portfolio that pays no dividends, has a beta of 1.3
and an alpha of 2% per month. Also, assume that the risk-free rate is 0.05% (per month) and
the S&P 500 is at 1500. If you expect the market to fall within the next 30 days you can hedge
your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of
$250).
A. selling 1
B. selling 7
C. buying 1
D. buying 7
E. selling 11
The hedge ratio is [$2M/(1500 x 250)] x 1.3 = 6.93. Thus, you would need to sell 7 contracts.
Difficulty: Difficult
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35. Market neutral bets can result in ______ volatility because hedge funds use ______.
A. very low; hedging techniques to eliminate risk
B. low; risk management techniques to reduce risk
C. considerable; risk management techniques to reduce risk
D. considerable; considerable leverage
E. none of the above
Market neutral bets can result in considerable volatility because hedge funds use considerable
leverage.
Difficulty: Moderate
Difficulty: Moderate
37. ______ bias arises because hedge funds only report returns to database publishers if they
want to.
A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. none of the above
Backfill bias arises because hedge funds only report returns to database publishers if they
want to.
Difficulty: Moderate
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38. ______ bias arises when the returns of unsuccessful funds are left out of the sample.
A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. none of the above
Survivorship bias arises when the returns of unsuccessful funds are left out of the sample.
Difficulty: Moderate
Difficulty: Moderate
40. Lo (2201) examined up and down betas of hedge funds and concluded that up market
betas were ______ down market betas.
A. generally larger than
B. generally smaller than
C. the same size as
D. twice the size of
E. half the size of
Lo (2201) examined up and down betas of hedge funds and concluded that up market betas
were generally smaller than down market betas.
Difficulty: Difficult
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Difficulty: Moderate
Difficulty: Moderate
43. Regarding hedge fund incentive fees, hedge fund managers ______ if the portfolio return
is very large and ______ if the portfolio return is negative.
A. get nothing; get nothing
B. refund the fee; get the fee
C. get the fee; lose nothing except the incentive fee
D. get the fee; lose the management fee
E. none of the above
Regarding hedge fund incentive fees, hedge fund managers get the fee if the portfolio return is
very large and lose nothing except the incentive fee if the portfolio return is negative.
Difficulty: Moderate
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44. The previous value of a portfolio that must be reattained before a hedge fund can charge
incentive fees is known as a ______.
A. benchmark
B. water stain
C. water mark
D. high water mark
E. low water mark
The previous value of a portfolio that must be reattained before a hedge fund can charge
incentive fees is known as a high water mark.
Difficulty: Moderate
Difficulty: Moderate
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