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37) 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?
A) 16.5%
B) 18.04%
C) 18.55%
D) 21%
38) 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?
A) 6.45%
B) 8.52%
C) 8.95%
D) 9.46%
39) Market-neutral hedge funds may experience considerable volatility. The source of volatile
returns is the use of ________.
A) pure play
B) leverage
C) directional bests
D) net short positions
40) 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?
A) $15
B) $15.60
C) $16.30
D) $17.55
41) You pay $216,000 to the Capital Hedge Fund, which has a price of $18 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?
A) 5.35%
B) 7.23%
C) 8.19%
D) 10%
42) 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 available only 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 ________.
A) 143
B) 157
C) 196
D) 218
43) Unlike market-neutral hedge funds, which have betas near ________, directional long funds
exhibit highly ________ betas.
A) zero; positive
B) positive; negative
C) positive; zero
D) negative; positive
44) Portfolio A has a beta of .2 and an expected return of 14%. Portfolio B has a beta of .5 and an
expected return of 16%. The risk-free rate of return is 10%. If you manage a long-short equity
fund and want to take advantage of an arbitrage opportunity, you should take a short position in
portfolio ________ and a long position in portfolio ________.
A) A; A
B) A; B
C) B; A
D) B; B
45) According to a model that was estimated using monthly excess returns over a 5 year period,
ending in October of 2014, average returns of equity hedge funds are ________ the S&P 500
Index.
A) equal to
B) considerably higher than
C) slightly lower than
D) slightly higher than
46) Research by Aragon (2007) indicates that lock-up restrictions tend to hold ________
portfolios.
A) less liquid
B) more liquid
C) event-driven
D) shorter-maturity
47) Higher returns of equity hedge funds as compared to the S&P 500 Index reflect positive
compensation for ________ risk.
A) market
B) liquidity
C) systematic
D) interest rate
48) Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of .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 ________.
A) A; A
B) A; B
C) B; A
D) B; B
49) In a 2011 study, Agarwal, Daniel, and Naik documented that hedge funds tend to report
average returns in ________ that are ________ than their average returns in other months.
A) September; lower
B) January; higher
C) January; lower
D) December; higher
50) To attract new clients, hedge funds often include past returns of funds only if they were
successful. This is called ________.
A) long-short bias
B) survivorship bias
C) backfill bias
D) incentive bias
51) Some argue that abnormally high returns of hedge funds are tainted by ________, which
arises when unsuccessful funds cease operations, leaving only successful ones.
A) reporting bias
B) survivorship bias
C) backfill bias
D) incentive bias
52) Malkiel and Saha (2005) estimate that the survivorship bias for hedge funds equals 4.4%,
which is ________ the survivorship bias for mutual funds.
A) about the same as
B) much lower than
C) much higher than
D) only slightly lower than
53) Hedge fund managers receive incentive bonuses when they increase portfolio assets beyond
a stipulated benchmark but lose nothing when they fail to perform. This is equivalent to
________.
A) writing a call option
B) receiving a free call option
C) writing a put option
D) receiving a free put option
54) A typical hedge fund incentive bonus is usually equal to ________ of investment profits
beyond a predetermined benchmark index.
A) 5%
B) 10%
C) 20%
D) 25%
55) The fastest-growing category of hedge funds is feeder funds. These funds invest in
________.
A) other hedge funds
B) convertible securities and preferred stock
C) equities and bonds
D) managed futures and options
56) A high water mark is a limiting factor of hedge fund manager compensation. This means that
managers can't charge incentive fees ________.
A) when a fund stays flat
B) when a fund falls and does not recover to its previous high value
C) when a fund falls by 10% or more
D) none of these options. (Managers can always charge incentive fees.)
57) If the risk-free interest rate is rf and equals the fund's benchmark, the portfolio's net asset
value is S0, and the hedge fund manager incentive fee is 20% of profit beyond that, the incentive
fee is equivalent to receiving ________ call(s) with exercise price ________.
A) .2; S0
B) 1; S0(1 + rf)
C) 1.2; S0
D) .2; S0(1 + rf)
58) Assume the risk-free interest rate is 10% and is equal to the fund's benchmark, the portfolio's
net asset value is $100, and the fund's standard deviation is 20%. Also assume a time horizon of
1 year.
What is the exercise price on the incentive fee?
A) $100
B) $105
C) $110
D) $115
59) Assume the risk-free interest rate is 10% and is equal to the fund's benchmark, the portfolio's
net asset value is $100, and the fund's standard deviation is 20%. Also assume a time horizon of
1 year.
What is the Black-Scholes value of the call option on the management incentive fee?
A) $6.67
B) $8.18
C) $9.74
D) $10.22
60) Assume the risk-free interest rate is 10% and is equal to the fund's benchmark, the portfolio's
net asset value is $100, and the fund's standard deviation is 20%. Also assume a time horizon of
1 year.
Assuming a 2% management fee and a 20% incentive bonus, what is the expected management
compensation per share if the fund's net asset value exceeds the stated benchmark?
A) $4.24
B) $4
C) $3.84
D) $2.20
61) You manage a hedge fund with $400 million in assets. Your fee structure provides for a 1%
annual management fee with a 20% incentive on returns over an 8% benchmark. If the fund
value is $445 million at the end of the year, what is your fee?
A) $2,600,000
B) $4,000,000
C) $6,600,000
D) $8,400,000
62) You manage a hedge fund with $300 million in assets. Your fee structure provides for a 1%
annual management fee with a 20% incentive on returns over a 12% benchmark. If the fund
value, before fees, is $345 million at the end of the year, what is the net return to the investors?
A) 13.33%
B) 13.40%
C) 14.00%
D) 14.42%
63) If a long-short hedge fund were banned by government regulation from short selling, which
statement would no longer be true?
A) they are not market neutral.
B) they may establish a concentrated focus on economic regions.
C) they are equity oriented.
D) derivatives may be used.
64) A market neutral hedge fund is likely to have ________.
A) various derivative strategies designed to create stability
B) a low beta compared to other equity only investments
C) a beta well above 1.0 compared to other equity investments
D) a beta near 1.0
65) What strategy might a hedge fund use to take advantage of positive alpha in a long equity
position?
A) short sell the security with positive alpha
B) leverage and use the proceeds to go long in the alpha security
C) create a neutral position and gain from the alpha value increase
D) reduce reliance on margin
