Chapter 11 – Overview of Hedge Funds
Q1. Unlike most mutual funds, why are hedge funds able to charge performance fees on
top of management fees?
Q2. Describe side pockets.
A. Side pockets are where hedge funds house illiquid investments (often private
Q3. Where does the name “hedge funds” come from?
A. The first fund of this category was created in 1949 by Alfred W. Jones, who
Q4. Describe two types of direct leverage employed by hedge funds.
A. Hedge funds can take out margin loans by banks. This involves borrowing from
banks to buy securities. Hedge funds must deposit collateral to borrow, and if
Q5. Describe a margin loan.
A. Hedge funds frequently borrow (creating “leverage”) in order to increase the size
of their investment portfolio and to increase returns (if asset values increase).
Q6. Why is it especially important to adjust hedge fund returns data for survivorship
bias?
A. A lot of funds were under water coming out of the crisis and some funds chose
Q7. Discuss why hedge funds may or may not welcome investment by fund of funds?
A. Some hedge funds welcome the large investment of capital provided by fund of
Q8. What are some positive consequences resulting from the proliferation of hedge
funds?
Q9. What are some unforeseen consequences resulting from the proliferation of hedge
funds?
A. When hedge funds buy the same assets, in a down market, as funds move to sell
Q10. Discuss the dangers of asset/liability mismatch. What are some strategies hedge
funds employ to mitigate this issue?
Q11. What differences between the hedge fund industry and the mutual fund industry led
to the creation of fund of hedge funds, but not fund of mutual funds?
Q12. Although hedge funds are less regulated than mutual funds, what type of indirect
regulation affects the hedge fund industry?
A. Many of the counterparties for hedge funds are banks, which are heavily
Q13. What are the three key benefits touted by fund of funds? Do you think that fund of
funds usually achieve these benefits? Why or why not?
A. Fund of funds have sold themselves to investors on the basis that they offer