Chapter 26 – Hedge Funds
26-1
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.
Difficulty: Easy
2. Like mutual funds, hedge funds
Difficulty: Easy
26-2
3. Unlike mutual funds, hedge funds
Difficulty: Easy
4. Hedge funds typically ______ relative mispricing of specific securities and ______ broad
market exposure.
Difficulty: Moderate
5. Hedge funds ______ engage in market timing ______ take extensive derivative positions.
Difficulty: Moderate
26-3
6. The risk profile of hedge funds ______, making performance evaluation ______.
Difficulty: Moderate
7. Shares in hedge funds are priced
Difficulty: Easy
8. Hedge funds are typically set up as ______ and provide ______ information about portfolio
composition and strategy to their investors.
Difficulty: Moderate
26-4
9. Hedge funds are ______ transparent than mutual funds because of ______ strict SEC
regulation on hedge funds.
Difficulty: Moderate
10. ______ 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.
Difficulty: Moderate
26-5
12. Hedge funds traditionally have ______ than 100 investors and ______ 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 $______.
Difficulty: Moderate
14. Hedge funds differ from mutual funds in terms of ______.
Difficulty: Moderate
26-6
15. Hedge funds may invest or engage in
Difficulty: Moderate
16. Hedge funds are prohibited from investing or engaging in
Difficulty: Moderate
17. Hedge funds often have ______ provisions as long as ______, which preclude
redemption.
Difficulty: Moderate
26-7
18. Hedge fund strategies can be classified as ______.
Difficulty: Moderate
19. A hedge fund pursuing a ______ strategy is betting one sector of the economy will
outperform other sectors.
Difficulty: Moderate
20. A hedge fund pursuing a ______ strategy is attempting to exploit temporary
misalignments in relative pricing.
Difficulty: Moderate
26-8
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.
Difficulty: Moderate
22. An example of a ______ 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.
Difficulty: Moderate
26-9
24. If the yield on mortgage-backed securities was abnormally high compared to Treasury
bonds, a hedge fund pursuing a relative value strategy would _______.
Difficulty: Moderate
25. Assume newly issued 30-year-on-the-run bonds sell at higher yields (lower prices) than 29
½ year bonds with a nearly identical duration. A hedge fund that buys 29 ½ year bonds and
sells 30 year bonds is taking a ______.
Difficulty: Moderate
26–10
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 ______.
Difficulty: Moderate
27. Assume newly issued 30-year-on-the-run bonds sell at lower yields (higher prices) than 29
½ year bonds with a nearly identical duration. A hedge fund that sells 29 ½ year bonds and
buys 30 year bonds is taking a ______.
Difficulty: Moderate
26–11
28. If the yield on mortgage-backed securities was abnormally low compared to Treasury
bonds, a hedge fund pursuing a relative value strategy would _______.
Difficulty: Moderate
29. Statistical arbitrage is a version of a ______ strategy.
Difficulty: Moderate
30. ______ uses quantitative techniques and often automated trading systems to seek out
many temporary misalignments among securities.
Difficulty: Moderate
26–12
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).
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).
Difficulty: Difficult
26–13
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).
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).
Difficulty: Difficult
26–14
35. Market neutral bets can result in ______ volatility because hedge funds use ______.
Difficulty: Moderate
36. Hedge funds exhibit a pattern known as a
Difficulty: Moderate
37. ______ bias arises because hedge funds only report returns to database publishers if they
want to.
Difficulty: Moderate
26–15
38. ______ bias arises when the returns of unsuccessful funds are left out of the sample.
Difficulty: Moderate
39. Performance evaluation of hedge funds is complicated by ______.
Difficulty: Moderate
40. Lo (2201) examined up and down betas of hedge funds and concluded that up market
betas were ______ down market betas.
Difficulty: Difficult
26–16
41. The typical hedge fund fee structure is
Difficulty: Moderate
42. Hedge fund incentive fees are essentially
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.
Difficulty: Moderate
26–17
44. The previous value of a portfolio that must be reattained before a hedge fund can charge
incentive fees is known as a ______.
Difficulty: Moderate
Short Answer Questions
45. Explain the five major differences between hedge funds and mutual funds.
The five major categories of differences are transparency, investors, investment strategies,
liquidity, and compensation structure. Mutual funds are more highly regulated by the SEC and
thus are required to be far more transparent. However, hedge funds provide only minimal
information about portfolio composition or strategy. Investors in hedge funds differ in that
Difficulty: Moderate