SMM519
Alternative Investments
PART A – MULTIPLE CHOICE QUESTIONS
(75 marks total - Q1-25 worth 1 mark each, Q26-50 worth 2 marks each)
(Please select one correct answer to each of the following 50 multiple-choice questions.)
1. Which of the following dominates the global value of private equity investments?
A. Investments in venture capital deals
B. Investments in buyout deals
C. Investments in Asia/Pacific deals
D. Investments in distressed company deals?
2. Which of the following best describes the investment focus of venture capitalists?
A. New commercial applications of existing technology
B. New patents
C. New technologies
D. Novel product ideas
3. Which of the following most accurately describes the economic role of venture capital?
A. Increase cash flow in order to service debt
B. Unlock value in companies that are not fulfilling their potential
C. Support development of businesses that cannot access traditional forms of capital
D. None of the above
4. Which of the following has historically been an important characteristic of
the private equity asset class?
A. Excess risk adjusted returns
B. High Sharpe Ratio
C. It is an inefficient asset class
D. None of the above
5. What is the typical length of the Venture Capital investment life cycle?
A. 5 –10+ years B. 2 –5 years
C. 2 –10+ years D. 1 –3 years
6. Which of the following concerning sourcing and evaluation of private equity
investments is NOT a true statement?
A. Due diligence of buyouts is similar to venture capital due diligence
B. People are a key focus of venture capital due diligence
C. More effort is required to identify and screen potential venture capital investments than with buyouts
D. All of the above
7. What type of exit is the most common in private equity deals?
A. IPO
B. Sale of company to a third-party
C. Write off
D. Management buy-back
8. Which of the following is NOT a reason why VCs tend to fund portfolio
companies with a series of cash injections over time based on achieving agreed milestones instead of injecting all of the cash at the beginning?
A. The profitability and growth of the company may not support achieving the desired IRR on a large up-front investment
B. VCs usually do not have very much cash available to invest
C. The funds may not be used wisely
D. The company managers’ ownership is likely to be greatly diluted
9. Which of the following documents provides the primary basis for
entrepreneurs negotiating their deal with venture capitalists?
A. Shareholders’ Agreement
B. Side-Pocket Letter
C. Reps and Warranties Agreement
D. Term Sheet
10.Which one of the following was not a “Take-Away” from the Centex
Telemanagement case?
A. Emotions are as important as the hard economic issues of a deal
B. Valuation is an art
C. It is important to eliminate all the problems of a deal before investing
D. VC deals are like getting married
11.Which of the following is a true statement about the valuation of companies?
A. Multiple valuation approaches should always be used to assess a company’s value
B. Use of comparable company ratios usually yields the most accurate result
C. Discounted cash flow techniques usually yields the most accurate result
D. Target return analysis should only be used for venture capital not buyouts
12.When are valuations of private equity investments known most accurately?
A. At quarter end when investments are marked-to-market
B. When investment bankers value the company for an IPO
C. When investments are exited
D. When new investment rounds happen
13.What key skill will buyout funds increasingly require in order to achieve
superior investment returns?
A. Superior financial engineering
B. Raising larger funds
C. Adding value to portfolio companies
D. Close relationships with investment banks
14.Which one of the following insights resulted from the Berkshire
Partners/Carters case?
A. It is important to identify and use the best valuation technique in order to determine the most accurate valuation
B. The optimal bid price can be determined directly by using multiple valuation techniques
C. Discounted cash flow techniques are the most accurate way of valuing companies
D. The seller’s circumstances can be more important than valuation in determining the price of the acquisition
15.Which Limited Partnership legal entity is responsible for day-to-day
management of the investments?
A. General Partner
B. Institutional Investor
C. Limited Partner
D. Fund-of-Funds Manager
16.Which of the following is the most significant factor explaining why the net
return of a fund is lower than the gross return?
A. Annual management fees
B. Capital gains received by portfolio company management
C. Carried interest awarded to the General Partner
D. The hurdle rate
17.Which one of the following explains why private equity fund returns provided
by industry database providers are difficult to interpret?
A. Database providers use flawed statistical techniques
B. Fund return data is often revised
C. Data samples are not comprehensive and are inconsistent amongst providers
D. None of the above
18.Which of the following techniques is most often used to make consistent
comparisons amongst the returns of private equity funds?
A. Comparing returns over a given time-horizon – eg, five years
B. Comparing vintage year returns
C. Comparing annual returns in a given year
D. Comparing gross returns
19.What is the “J-Curve”?
A. A period of losses in the early period of a private equity company deal
B. A period of negative returns in the early stages of a private equity fund’s life
C. The characteristic shape of the graph of 1st through 4th quartile fund returns
D. The typical shape of private equity fund returns over time in emerging markets
20.What historically has been a reliable criterion to use in identifying private
equity funds that are likely to be top performers?
A. Selecting funds with low fees
B. Selecting funds with a top quartile management team
C. Selecting funds with historically top-quartile investment returns
D. Selecting funds with high risk adjusted returns
21.What is the primary factor that historically has explained the superior
investment returns of top-quartile venture capital funds, compared to funds with only average performance?
A. Outstanding due diligence
B. Fewer deals that lose money
C. High proportion of home-run deals
D. Avoidance of dilution
22.Which of the following is a cause of misleading comparisons between
buyout fund returns and stock market returns?
A. Fees charged by buyout funds
B. Estimation of underlying company valuations
C. Greater use of debt by buyout funds
D. All of the above
23.Which of the following techniques is used to make consistent comparisons
between private equity and stock market index returns?
A. Comparing returns over a given time-horizon – eg, 10 years
B. Comparing vintage year returns
C. Comparing PMEs
D. None of the above
24.Which of the following is a strategy that Yale follows in making private
equity investments?
A. Invest in a limited set of “best-of-breed” funds
B. Concentrate on funds that employ a value-added approach
C. Select funds where interests of investors and managers are aligned
D. All of the above
25.How does the median and standard deviation of private equity fund returns
compare relative to those of quoted equities?
A. Private equity median return is lower and standard deviation lower
B. Private equity median return is higher and standard deviation higher
C. Private equity median return is similar and standard deviation higher
D. Private equity median return similar and standard deviation is lower
26.Between 1997 & 2000 the total assets under management by Hedge Funds
grew by 34% but between 2000 & 2003 they grew by 67%. What is the most likely explanation for this sudden increase in growth?
A. Hedge Fund returns were much higher in the second period.
B. Poor equity market returns drove investors to look for alternative investments.
C. Changes in regulation.
D. The collapse of LTCM
27.Which of the following is a role of a Prime Broker?
A. Calculation of Net Asset Values & Fees
B. Maintenance of Partnership's books and records
C. Processing subscription applications
D. Clearing Trades
28.Why do investors expect a hedge fund manager to invest a substantial
portion of their own net worth in the fund?
A. To ensure they receive pass-through tax treatment
B. To avoid registration under the Investment Company Act 1940
C. To align the incentives of the manager & investors
D. To reduce management fees
29.Hedge fund performance fees are similar to a:
A. free call option granted to managers on an annual basis.
B. call option sold to managers on an annual basis, where the option premium is equal to the expected return on the fund.
C. free put option granted to managers on an annual basis.
D. put option sold to managers on an annual basis, where the option premium is equal to the expected return on the fund.
30.Alpha Capital Partners was established in January 2020, it does not charge
a management fee but does charge a 25% incentive fee which is collected annually & has a high-water mark provision.
The fund generated (net of fees) returns of -60% in 2020 & -50% in 2021.
Assuming there have been no redemptions or subscriptions, what rate of return does Alpha Capital Partners need to produce in 2022 before it starts charging incentive fees?
A. 50% B. 110% C. 400% D. 500%
31.Suppose a hedge fund has a 2 and 20 fee arrangement and a net asset value
(NAV) of $150 million at the beginning of the year. The high-water mark was $160 million at the beginning of the year. The NAV increased to $190 million at the end of the year, before fees. If management fees are distributed annually based on the NAV at the beginning of the year, what are the total annual fees including both management and incentive fees for this year?
A. $3.2 million B. $5.4 million C. $8.4 million D. $11.2 million
32.A long/short equity fund has a gross exposure of 160% and a net exposure
of 100%. The relative long and short positions are:
A. 100% and 60%. B. 130% and 30%. C. 160% and 60%. D. 160% and 100%.
33.A fund with capital of $100m buys $60m of a stock with a beta of 1.5 and
partially hedges this position by selling $30m notional value of index futures (which have a beta of 1.0).
What is the beta adjusted net exposure of the fund?
A. 0.30 B. 0.60 C. 0.90 D. 1.20
34.Based on historical data from Credit Suisse, which of the following hedge
fund strategies did not have positive, moderate correlation with the MSCI World Equity index?
A. Dedicated Short Bias
B. Global Macro
C. Merger/Risk Arbitrage
D. Convertible Arbitrage
35.Which of the following statements about the global macro strategy is NOT true?
A. Global macro strategies may invest in commodities.
B. Global macro managers have a broad investment universe.
C. Global macro strategies tend to be unable to apply leverage.
D. Global macro funds tend to have large amounts of investor capital.
36. Why do CTA/Managed Futures funds tend to diversify across many different markets?
A. Diversification reduces volatility and makes the options cheaper.
B. It helps to avoid short squeezes.
C. Trading many markets reduces margin requirements.
D. At least one market should be trending even if others are not.
37. Which of the following statements does NOT accurately describe a risk of
convertible bond arbitrage?
A. Credit risk refers to the risk that bond prices will fall when credit spreads widen.
B. Regulatory rulings may limit the use of leverage or short selling.
C. Convertible bonds are exposed to changes in the risk-free interest rate, causing bond prices to fall when rates rise.
D. The strategy uses short correlation between the underlying stock and bond.
38. In a recent press release, Biomed Devices announced their intention to take
over Pharmacore Industries in a 1 for 1 stock swap. A merger arbitrage hedge fund manager noticed that prior to the announcement, Biomed’s stock was trading at $121 per share, while Pharmacore’s stock was trading at $98 per share. After the merger announcement, Biomed’s stock dropped to $112 per share, while Pharmacore’s stock climbed to $107 per share.
Which of the following best identifies the appropriate merger arbitrage strategy and potential profit once the deal is complete?
A. Buy Pharmacore Industries, short sell Biomed Devices; Profit = $5.00.
B. Buy Pharmacore Industries, short sell Biomed Devices; Profit = $9.00.
C. Buy Biomed Devices, short sell Pharmacore Industries; Profit = $9.00.
D. Buy Biomed Devices, short sell Pharmacore Industries; Profit = $5.00.
39.Which of the following hedge fund strategies has the least amount of market
risk?
A. Dedicated Short Bias
B. Equity Market Neutral
C. Long/Short Equity
D. Convertible Arbitrage
40.Which of the following best describes the main source of risk in a merger
arbitrage hedge fund strategy?
A. Liquidity risk. B. Credit risk.
C. Systematic risk. D. Event risk.
41.Which of the following strategies has the most extensive investment
universe?
A. Fixed Income Arbitrage
B. Merger Arbitrage
C. Global Macro
D. Long/Short Equity
42. Distressed debt hedge funds performed very badly in both 1998 and 2008,
why was that?
A. Their returns are negatively skewed.
B. Their returns are sensitive to widening credit spreads.
C. Their returns reached their capacity constraint.
D. Their returns rely on short selling equities.
43.A Hedge Fund following which of the following strategies would theoretically
require the longest lock-up & least frequent redemption frequency?
A. Distressed Securities
B. Long Short Equity
C. Global Macro
D. Managed Futures
44.Which of the following strategies has historically performed best in periods
of widening credit spreads?
A. Distressed Securities
B. Fixed Income Arbitrage
C. Managed Futures
D. Emerging Markets
45. Which of the following strategies returns would you expect to show the
highest level of serial correlation?
A. Long Short Equity
B. Distressed Securities
C. Managed Futures
D. Global Macro
46.In Fung & Hsieh (2004) the authors found that on average Long/Short Equity
Hedge Funds have which of the following exposures?
A. Net Long the Market and Short the Small versus Large cap spread
B. Net Long the Market and Long the Small versus Large cap spread
C. Net Short the Market and Long the Small versus Large cap spread
D. Net Short the Market and Short the Small versus Large cap spread
47.Which of the following statements best describes the underlying assumption
for the factor-based approach to hedge fund replication?
A. The returns are normally distributed.
B. The factors explain a significant amount of hedge fund returns.
C. The returns have autocorrelation through time.
D. The Fama-French four-factor model explains hedge fund returns.
48.Which of the following factors has been shown to have the LEAST influence
on hedge fund returns?
A. S&P 500 returns
B. Small Cap minus Large Cap returns
C. Value minus Growth returns
D. Changes in Credit Spreads
49.Various academic studies have suggested that the bulk of the diversification
benefit can be achieved with a portfolio of 10-15 hedge funds, however in practice most Funds of Hedge Funds invest in a much larger number.
What could explain the disparity between academic research & practitioner behaviour?
A. Holding more funds reduces the risk of a single catastrophic loss
B. Holding more funds increases the correlation with equity markets.
C. Holding more funds is costless
D. Holding more funds will lead to higher fees.
50.In “10 Things Investors Should Know about Hedge Funds” Harry Kat says
that hedge funds “do not combine very well with equity”, how does he explain this?
A. Introducing hedge funds to a traditional stock and bond portfolio will reduce the standard deviation.
B. Hedge funds generally have a high correlation with stocks and bonds
C. Hedge funds returns generally exhibit positive serial correlation.
D. Introducing hedge funds to a traditional stock and bond portfolio leads to a significant drop in skewness.