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Essentials of Investments, 11e (Bodie)
Chapter 20 Hedge Funds
1) 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
A) I and II only
B) II and III only
C) III and IV only
D) I, III, and IV only
2) A ________ is a private investment pool open only to wealthy or institutional investors that is
exempt from SEC regulation and can therefore pursue more speculative policies than mutual
funds.
A) commingled pool
B) unit trust
C) hedge fund
D) money market fund
3) Hedge funds are typically set up as ________.
A) limited liability partnerships
B) corporations
C) REITs
D) mutual funds
4) A(n) ________ hedge fund attempts to profit from situations such as mergers, acquisitions,
restructuring, bankruptcy, or reorganization.
A) multistrategy
B) managed futures
C) dedicated short bias
D) event-driven
5) ______ are private partnerships of a small number of wealthy investors, are often subject to
lock-up periods, and are allowed to pursue a wide range of investment activities.
A) Hedge funds
B) Closed-end funds
C) REITs
D) Mutual funds
6) Which of the following typically employ(s) significant amounts of leverage?
I. Hedge funds
II. Equity mutual funds
III. Money market funds
IV. Income mutual funds
A) I only
B) I and II only
C) III and IV only
D) I, II, and III only
7) As of 2017, hedge funds had approximately ________ under management.
A) $.5 trillion
B) $6.6 trillion
C) $4 trillion
D) $3.2 trillion
8) A restriction under which investors cannot withdraw their funds for as long as several months
or years is called ________.
A) transparency
B) a lock-up period
C) a back-end load
D) convertible arbitrage
9) Hedge fund managers are compensated by ________.
A) deducting management fees from fund assets and receiving incentive bonuses for beating
index benchmarks
B) deducting a percentage of any gains in asset value
C) selling shares in the trust at a premium to the cost of acquiring the underlying assets
D) charging portfolio turnover fees
10) Management fees for hedge funds typically range between ________ and ________.
A) .5%; 1.5%
B) 1%; 2%
C) 2%; 5%
D) 5%; 8%
11) Hedge funds can invest in various investment options that are not generally available to
mutual funds. These include:
I. Futures and options
II. Merger arbitrage
III. Currency contracts
IV. Companies undergoing Chapter 11 restructuring and reorganization
A) I only
B) I and II only
C) I, II, and III only
D) I, II, III, and IV
12) A typical traditional initial investment in a hedge fund generally is in the range between
________ and ________.
A) $1,000; $5,000
B) $5,000; $25,000
C) $25,000; $250,000
D) $500,000; $1,000,000
13) The difference between market-neutral and long-short hedges is that market-neutral hedge
funds ________.
A) establish long and short positions on both sides of the market to eliminate risk and to benefit
from security asset mispricing whereas long-short hedges 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 stocks 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
14) Convertible arbitrage hedge funds ________.
A) attempt to profit from mispriced interest-sensitive securities
B) hold long positions in convertible bonds and offsetting short positions in stocks
C) establish long and short positions in global capital markets
D) use derivative products to hedge their short positions in convertible bonds
15) Assuming positive basis and negligible borrowing cost, which of the following transactions
could yield positive arbitrage profits if pursued by a hedge fund?
A) Buy gold in the spot market, and sell the futures contract.
B) Buy the futures contract, and sell the gold spot and invest the money earned.
C) Buy gold spot with borrowed money, and buy the futures contract.
D) Buy the futures contract, and buy the gold spot using borrowed money.
16) An example of a neutral pure play is ________.
A) pairs trading
B) statistical arbitrage
C) convergence arbitrage
D) directional strategy
17) You believe that the spread between the September S&P 500 future and the S&P 500 Index
is too large and will soon correct. To take advantage of this mispricing, a hedge fund should
________.
A) buy all the stocks in the S&P 500 and write put options on the S&P 500 Index
B) sell all the stocks in the S&P 500 and buy call options on the S&P 500 Index
C) sell S&P 500 Index futures and buy all the stocks in the S&P 500
D) sell short all the stocks in the S&P 500 and buy S&P 500 Index futures
18) You believe that the spread between the September S&P 500 future and the S&P 500 Index
is too large and will soon correct. This is an example of ________.
A) pairs trading
B) convergence play
C) statistical arbitrage
D) a long-short equity hedge
19) 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%.
The 1-year oil futures price should be equal to ________.
A) $68
B) $70.21
C) $71.25
D) $74.88
20) 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%.
The arbitrage profit implied by these prices is ________.
A) $6.50
B) $5.44
C) $4.29
D) $3.25
21) 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?
A) Buy oil in the spot market with borrowed money, and sell the futures contract.
B) Buy the futures contract, and sell the oil spot and invest the money earned.
C) Buy the oil spot with borrowed money, and buy the futures contract.
D) Buy the futures contract, and buy the oil spot using borrowed money.
22) 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?
A) 13,333
B) 25,000
C) 50,000
D) 66,000
23) 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?
A) $553,600
B) $625,000
C) $733,800
D) $764,000
24) 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) 14.45%
B) 15.18%
C) 16%
D) 17.73%
25) Which of the following are not managed investment companies?
A) hedge funds
B) unit investment trusts
C) closed-end funds
D) open-end funds
26) 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?
A) 25
B) 35
C) 50
D) 60
27) 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
________.
A) 0
B) 1
C) 1.2
D) The answer cannot be determined from the information given.
28) 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?
A) 0%
B) 2%
C) 3%
D) 4%
29) 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?
A) $15,000,000
B) $15,450,000
C) $15,600,000
D) $16,000,000
30) 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 ________.
A) statistical arbitrage
B) pure play
C) a short equity hedge
D) fixed-income arbitrage
31) 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 ________.
A) asset allocation funds
B) multistrategy funds
C) event-driven funds
D) market-neutral funds
32) 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.
A) $120; $20
B) $20; $120
C) $20; $20
D) $120; $120
33) The collapse of the Long Term Capital Management hedge fund in 1998 was a case of an
extremely unlikely statistical event called ________.
A) statistical arbitrage
B) an unhedged play
C) a tail event
D) a liquidity trap
34) Which of the following investment styles could be the best description of the Long Term
Capital Management market-neutral strategies?
A) convergence arbitrage
B) statistical arbitrage
C) pairs trading
D) convertible arbitrage
35) 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?
A) 15.05%
B) 15.5%
C) 17.25%
D) 18%
36) 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?
A) $4,877,000
B) $4,900,000
C) $5,929,000
D) $6,446,000
