Alternative Investments 8.1. Traditional Investment vs. Alternative Investment 8.1.1. 8.1.1.1

8.
Alternative Investments
8.1. Traditional Investment vs. Alternative Investment
8.1.1.
8.1.1.1.
➢ Narrow specialization of the investment managers

➢ Relatively low correlation of returns with those of traditional investments
➢ Less regulation and less transparency than traditional investments
➢ Limited historical risk and return data (leptokurtic, left-tailed)
➢ Unique legal and tax considerations
➢ Higher fees, often including performance or incentive fees
➢ Concentrated portfolios
➢ Restrictions on redemptions (i.e., “lockups” and “gates”)
8.1.1.2.
➢ High return;
➢ Low correlation(improve both portfolio risk and expected return);
8.1.1.3.
➢ Fund investing (indirect)

➢ Co-investing (direct & indirect)
➢ Direct investing (direct)
8.1.2.
Q-1. The potential benefits of allocating a portion of a portfolio to alternative investments

include:
A. ease of manager selection.
B. improvement in the portfolio’s risk–return relationship.
C. accessible and reliable measures of risk and return.
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Q-2. Categories of alternative investments would least likely be described by which of the
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following?
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A. Fine wine and other tangibles

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B. Schools and other long-lived real assets

C. Cash and other liquid investments
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此预测为考点预测，考题仅为复习参考
内部使用资料，严禁传播，否则追究法律责任
Q-3. Compared to traditional investments, alternative investments least likely demonstrate
which of the following characteristics?
A. Narrow manager specialization
B. Underlying investments that are illiquid
C. A high degree of regulation
Q-4. Compared with long-only investments in stocks and bonds, alternative investments are
most likely characterized by less:
A. flexibility to use derivatives.
B. manager specialization.
C. transparency.
Q-5. The investment method that typically requires the greatest amount of or most thorough
due diligence from an investor is:
A. fund investing.
B. co-investing.
C. direct investing.
Q-6. Identify the most appropriate advantage of direct investing for an investor:
A. Potential diversification benefits.
B. Highest level of control over how asset is managed.
C. Access to alternative investment without possessing a high degree of investment expertise.
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8.2. Investment and Compensation Structure
8.2.1.
8.2.1.1. Most common structure: Partnership

➢ Limited partner (LP): LP is the investors who understand and able to assume
the risks in the investment.
◼ LP owns a fractional interest (share of the partnership) based on their
investment and as agreed to by the partners.
➢ General partner (GP): GP runs the fund.
8.2.1.2. Compensation structure
➢ Management fee
◼ Based on assets under management (for hedge funds) or committed
capital (for PE funds)
➢ Performance fee (incentive fee, carried interest)
◼ Based on profits net of (or before) management fee.
◼ E.g. “2 and 20”
◆ 2% management fee.
◆ 20% incentive fee for hedge funds.
◼ Hurdle rate
◆ A minimum rate of return that the GP must exceed in order to earn
the performance fee.
◆ hard hurdle rate
◆ soft hurdle rate
◼ High water mark: highest value reported
◆ Protect clients from paying twice for the same performance.
8.2.2.
Q-7. High-water marks are typically used when calculating the incentive fee on hedge funds.
They are most likely used by clients to:
A. avoid prime brokerage fees.
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B. avoid paying twice for the same performance.

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C. claw back the management fees.

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Q-8. An alternative investment fund’s hurdle rate is a:

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A. rate unrelated to a catch-up clause.

B. tool to protect clients from paying twice for the same performance.
C. minimum rate of return the GP must exceed in order to earn a performance fee.
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8.3. Hedge Fund
8.3.1.
8.3.1.1.
➢ Return objective
◼ Absolute return: e.g. total return of 12%.
◼ Relative return: e.g. the return is 6% higher than DJIA.
➢ Restrictions on redemptions
◼ Lockup period: the minimum period before investors are allowed to make
withdrawals or redeem shares from a fund;
◼ Notice period: the length of time (typically 30 to 90 days) in advance that
investors may be required to notify a fund of their intent to redeem;
➢ Fund of fund: funds that hold a portfolio of hedge fund.
◼ FoF benefits and drawbacks
◆ FOFs enable small investors to have returns in hedge funds;
◆ FOFs have some expertise in conducting due diligence on hedge funds;
◆ Negotiate better redemption terms for investors;
◆ FOFs invest in numerous hedge funds, diversifying across fund
strategies, investment regions, and management styles;
◆ FOFs managers charge an additional layer of fees beyond the fees
charged by the individual hedge funds in the portfolio.

➢ Strategies
◼ Event-driven strategies
◆ Merger arbitrage: going long (buying) the stock of the company being
acquired and going short (selling) the stock of the acquiring company;
◆
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Distressed/restructuring: focus on the securities of companies either in

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◆ Activist shareholder: purchase of sufficient equity in order to influence

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a company’s policies or direction;

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◆ Special situations: focus on companies that are currently engaged in
restructuring activities other than merger/acquisitions and bankruptcy.

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◼ Relative value strategies
◆ Fixed income convertible arbitrage: market neutral (zero beta)
strategies that seek to exploit a perceived mispricing between a
convertible bond and its component parts;
◆ Fixed income asset backed: take advantage of mispricing across
different asset backed securities;
◆ Fixed income general: focus on the relative value within the fixed
income markets;
◆ Volatility: use options to go long or short market volatility;
◆ Multi-strategy: looks for investment opportunities wherever they
might exist.
◼ Macro strategies and CTA strategie
◼ Equity hedge strategies
◆ Market neutral: Maintain a net position that is neutral with respect to
market risk. The intent is to profit from individual securities movements
while hedging against market risk;
◆ Fundamental growth: fundamental analysis to identify companies
expected to exhibit high growth and capital appreciation;
◆ Fundamental value: buy equity securities believed to be undervalued
based on fundamental analysis;
◆ Sector Specific: exploit expertise in a particular sector.
◆ Short bias: varies its net short exposure based upon market
expectations, going fully short in declining markets.

➢ Potential benefits and risks
◼ Hedge fund strategies that generate the highest returns in some years can
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be the ones to perform the most poorly in subsequent years;

◼ In periods of financial crisis, the correlation of returns between global
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equities and hedge funds tends to increase, which limits hedge funds’
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effectiveness as a diversifying asset class.

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➢ Valuation
◼ The valuation of hedge fund may use market or estimated values of
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underlying positions.
➢ Key due diligence points to consider include investment strategy, investment
process, competitive advantage, track record, size and longevity, management
style, key-person risk, reputation, investor relations, plans for growth, and
systems risk management.
8.3.2.
Q-9. In valuing underlying hedge fund positions, the most conservative approach is most likely
one that uses: (Mock 2018)
A. the average of the bid and ask prices.
B. bid prices for longs and ask prices for shorts.
C. the most recent market prices.
Q-10. A hedge fund that implements trades based on a top-down analysis of expected
movements in economic variables most likely uses a(n):（2021 MOCK B）
A. macro strategy.
B. relative value strategy.
C. event-driven strategy.
Q-11. Hedge funds are least likely to have restrictions concerning:

A. the withdrawal of invested funds.
B. the use of derivatives.
C. the number of investors in the fund.
Q-12. Which of the following least likely describes an advantage of investing in hedge funds
through a fund of funds? A fund of funds may provide investors with:
A. access to due diligence expertise.
B. lower fees because of economies of scale.
C. access to managers who can negotiate better redemption terms.
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Q-13. Which type of strategy is considered the Equity Hedge Strategies:

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A. Sector specific.
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B. Distressed/restructuring.
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C. Volatility.
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8.4. Private Capital
8.4.1.
8.4.1.1. PE PE
➢ Strategies
◼ Leveraged buyouts (LBOs): acquire companies with a significant percentage
of the purchase price financed through debt. LBO :MBO 和 MBI
◆ Management buyout(MBO): the current management team is involved
in the acquisition;
◆ Management buy-ins(MBI): an current management team is being
replaced and the acquiring team will be involved in managing the
company.
◼ Venture capital (VC): invest in private companies with high growth potential.
◆ Formative stage:
 Angel investing: at the idea stage, funds are used to transform the
idea into a business plan and to assess market potential.
 seed stage: support product development and/or marketing
efforts. The first stage at which VC funds invest.
 early stage: help companies move toward operation but before
commercial production and sales have occurred.
◆ Later stage: after commercial production and sales have begun, but
before any IPO. Funds may be used for expansion.
◆ Mezzanine-stage financing: pre IPO
◼ Growth capital (growth equity)
◆ Earns profits from funding business growth or restructuring.
◆ Initiated and sought by management, which is interested in realizing
earnings from selling a portion of its shares before the company can go
public.
➢ Exit strategies
◼ Trade Sale: sale of company to a strategic buyer such as a competitors;
◼ IPO: the portfolio company selling its shares to public investors through an
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IPO;
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◼ Special purpose acquisition company (SPAC): The special purpose

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acquisition company technique starts as a shell company via an IPO through

which sponsors raise a blind pool of cash aimed for merger or acquisition
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with private firms.

◼ Recapitalization: the private equity firm re-leverages or introduces leverage
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to the company and pays itself a dividend;
◼ Secondary Sale: a sale to another private equity firm or a group of investors;
◼ Write-off/Liquidation: when a transaction has no gone well, the private
equity firm is updating its value of the investment or liquidating the portfolio
company to move on to other projects.
➢ Private debt : Refers to the various forms of debt provided by investors to
private entities.
◼ Direct Lending
◼ Mezzanine Debt
◼ Venture Debt
◼ Distressed Debt
◼ Other Private Debt Strategies
◆ Collateralized loan obligations (CLOs)
◆ Unitranche debt
◆ Infrastructure debt
◆ Real estate debt
◆ Specialty loans
8.4.2.
Q-14. A Private capital is:

A. accurately described by the generic term “private equity.”
B. a source of diversification benefits from both debt and equity.
C. predisposed to invest in both the debt and equity of a client’s firm.
Q-15. Hedge funds are similar to private equity funds in that both: （原版书课后题）
A. are typically structured as partnerships.
B. assess management fees based on assets under management.
C. do not earn an incentive fee until the initial investment is repaid.
Q-16. A collateralized loan obligation specialist is most likely to:

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A. sell its debt at a single interest rate.

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B. cater to niche borrowers in specific situations.

C. rely on diverse risk profiles to complete deals.
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Q-17. Capital provided for companies beginning operation but before commercial
manufacturing and sales have occurred best describes which stage in venture capital
investing?
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A. Seed-stage.
B. Early-stage.
C. Later-stage.
Q-18. The majority of private equity activity involves:（MOCK 2020 B）

A. derivative positions.
B. leveraged buyouts.
C. investing in mortgaged-backed securities.
Q-19. Illiquidity is most likely a major concern when investing in:（2017 Mock PM）
A. private equity.
B. real estate investment trusts.
C. commodities.
Q-20. With regard to venture capital, which of the following statements is most likely true
regarding venture capital?
A. Investments typically are in later stage and more established companies.
B. Investors tend to have short time horizons.
C. Investors require a higher return than investors in publicly traded equity.
Q-21. Which of the following is most likely a private equity strategy?（2015 Mock PM）
A. Merger arbitrage
B. Quantitative directional
C. Venture capital
Q-22. In a secondary sale, a private capital firm sells one of its portfolio companies to:
A. the public.
B. a competitor in its industry.
C. another private capital fund.
Q-23. Which of the following is NOT an advantage of a SPAC exit:

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A. Fixed valuation with lower volatility of share pricing.

B. Flexibility of transaction structure to best suit the company’s context.
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C. Fast and simple execution.

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8.5. Natural Resources
8.5.1.
8.5.1.1.
➢ Forms
◼ Futures, forwards, options and swaps;
◼ Commodity ETF;
◼ Managed futures funds;
◼ Specialized funds in specific commodity sectors.
➢ Potential benefits and risks
◼ Potential for returns;
◼ Portfolio diversification;
◼ Inflation protection.
➢ Pricing
◼ Futures price ≈ spot price × (1 + r) + storage cost – convenience yield;
◼ Convenience yield: the value of the convenience of having physical
possession of the commodity and having it immediately available for use;
◼ Contango: futures price > spot price;
◼ Backwardation: futures price < spot price.
➢ Sources of commodities futures returns
◼ Roll yield: the difference between the spot price of a commodity and the
price specified by its futures contracts;
◼ Collateral yield: the interest earned on the collateral posted as a good-faith
deposit for the futures contracts;
◼ Spot prices: the primary determinant of spot (or current) prices is the
relationship between current supply and demand, as discussed earlier.
8.5.1.2.
➢ Timber (trees) can be grown and easily “stored” by simply not harvesting.
◼ The three primary return:
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◆ biological growth;
◆ changes in spot prices and futures prices of lumber (cut wood);
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◆ changes in the price of the underlying land.

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➢ Farm products must be harvested when ripe, so there is little flexibility in the
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production process.
◼ The three primary return:
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◆ harvest quantities;
◆ commodity prices (e.g., the price of corn);
◆ land price changes.
➢ Potential benefits and risk of commodities
◼ Return on commodities over time have been lower than returns on the
global stocks or bonds. Sharpe ratios for the commodities as an asset class
have been low due to these lower return and the high volatility of
commodities prices.
◼ Historically ,correlation of commodity return with those of global equities
and global bonds have been low, typically less than 0.2, so adding
commodities to a traditional portfolio can provide diversification benefits.
◼ Because commodity prices tend to move with inflation rates, holding
commodities can act as a hedge of inflation risk.
➢ Instruments of Timberland and Farmland
◼ Indirect investments: Investment funds offered on the public markets, such
as REITs.
◼ Direct investments
◆ for larger investors.
◆ limited price transparency or information to guide investment
decisions.
◆ The direct farm and timberland investments is illiquid.
8.5.2.
Q-24. The most likely impact of adding commodities to a portfolio of equities and bonds is to:
A. increase risk. （2017 Mock AM）
B. reduce exposure to inflation.
C. provide higher current income.
Q-25. A significant challenge to investing in timber is most likely its:

A. high correlation with other asset classes.
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B. dependence on an international competitive context.

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C. return volatility compounded by financial market exposure.

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Q-26. With regard to commodities, it is most likely true that:（2020 mock C）

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A. exposure is most commonly achieved via commodity derivatives.

B. their returns are based on an income stream such as interest or dividends.
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C. they are physical products so most investors prefer to trade the actual commodity.
Q-27. The return on a commodity index is likely to be different from returns on the underlying
commodities because:（2013 Mock AM）
A. assets are not marked to market.
B. data are subject to survivorship bias.
C. indices are constructed using futures contracts.
Q-28. Which of the following wheat prices is most likely indicating the wheat price are referred
to as being in contango? （2018 Mock）
A. $70 of spot price, $75 of September, and $80 of December.
B. $75 of spot price, $75 of September, and $70 of December.
C. $75 of spot price, $70 of September, and $75 of December.
Q-29. A characteristic of farmland strongly distinguishing it from timberland is its:

A. commodity price-driven returns.
B. inherent rigidity of production for output.
C. value as an offset to other human activities.
Q-30. Which of the following statement of features of Digital Asset is WRONG:

A. A digital asset can represent only virtual assets, a value, or a use right/service .
B. Digital assets have a varied set of features and applications that touch a range of regulatory
domains.
C. Depending on its design, function, and use, a digital asset may be characterized differently,
including as a commodity, swap, or other derivative.
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8.6. Real Estate
8.6.1.
8.6.1.1.
➢ Forms
Equity Debt
• Direct ownership of real estate:

ownership through sole ownership,
• Mortgages
joint ventures, separate accounts, or
Private • Construction lending
real estate limited partnerships
• Mezzanine debt
• Indirect ownership via real estate funds
• Private REITs
• MBS(residential and
commercial)
• Shares in real estate operating and
• Collateralized
development corporations
mortgage
• Listed REIT shares
Public obligations
• Mutual funds
• Mortgage REITs
• Index funds
• ETFs that own
• ETFs
securitized
mortgage debt
➢ Performance measure
◼ Appraisal index
◆ Use estimates of value (appraisals) as inputs to the indices;
◆ Rely on comparable sales and cash flow analysis techniques;
◆ Understate volatility.
◼ Repeat sales index
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◆ Use changes in prices of properties to construct the indices;

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◆ Sample selection bias.

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◼ REIT indices
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◆ Use the prices of publicly traded shares of REITs to construct the indices;
◆ More frequently traded, more reliable is the index.

➢ Real estate returns are highly correlated with global equity returns but less
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correlated with global bond returns.
➢ Real Estate Investment Categories
◼ The majority of real estate property may be classified as either commercial
or residential.
◼ Residential property—single-family residential property.
◼ Commercial property—produces income and capital appreciation.
◆ Residential properties owned with the intention to let, lease, or rent
them are classified as commercial.

◼ REIT investing
◆ Risk and return characteristics depend on the type of investment
◆ Equity must report EPS based on net income as defined by GAAP or
IFRS.
◼ Mortgage-backed securities (MBS)
◆ MBS structure is buying a pool of assets and assigning the income and
principal returns into individual security tranches.
◆ The most junior tranche is referred to as the first-loss tranche.
◆ When interest rates rise, prepayments will likely slow down.
◆ When interest rates fall, the low-risk senior tranche will amortize more
quickly.
8.6.2.
Q-31. Direct commercial real estate ownership least likely requires investing in:
A. large amounts.
B. illiquid assets.
C. a short time horizon.
Q-32. A real estate investor looking for equity exposure in the public market is most likely to
invest in:
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A. real estate limited partnerships.

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B. shares of real estate investment trusts.

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C. collateralized mortgage obligations.

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Q-33. The real estate index most likely to suffer from sample selection bias is a(n):
A. REIT index.
B. appraisal index.
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C. repeat sales index.
Q-34. Compared with other investment asset classes, an investment in real estate is least likely
to be characterized by:（2017 Mock PM）
A. basic indivisibility.
B. homogeneity.
C. fixed location.
Q-35. Which of the following statement regarding Mortgage-backed securities(MBS) is WRONG:

A. If mortgage defaults and losses are high, all tranches bear the cost of the shortfall on pro rata
basis.
B. When rates rise, property owner prepayments can also slow, lengthening the duration of most
MBS tranches and contributing to further price weakness.
C. An MBS issuer forms a special purpose vehicle (SPV) to buy mortgages from lenders and other
mortgage owners and use them to create a diversified mortgage pool.
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8.7. Infrastructure
8.7.1.
8.7.1.1. Infrastructure
➢ Definition: real, capital intensive, long-lived assets, which are intended for public
use and provide essential services;
➢ Characteristics of infrastructure
◼ Strategically important;
◼ Monopolistic and regulated;
◼ Stable long-term cash flows;
◼ Significant capital investment;
◼ Long operational lives;
◼ Defined risks;
◼ Highly leveraged financial structure.
➢ Categories of Infrastructure Investments
◼ Economic VS social infrastructure assets;
◼ Brownfield VS greenfield infrastructure investments
◆ Investing in existing investable infrastructure assets may be referred to as
brownfield investments;
◆ Investing in infrastructure assets that are to be constructed may be
referred to as greenfield investments.

➢ Forms of infrastructure investments
◼ Invest directly in the underlying assets;
◼ Indirect investment vehicles.
◆ ETFs, mutual funds, private equity funds, or master limited
partnerships(MLP).
➢ Risk and returns overview
◼ Risk depends on underlying asset.
◼ An inherent risk to many infrastructure investments is regulatory risk.
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8.7.2.
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Q-36. Greenfield investments in infrastructure are most accurately described as investments ín

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A. that are operating profitably.

B. that have not yet been constructed.
C. related to environmental technology.
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Q-37. Which of the following infrastructure investments would most likely be easiest to value?
A. private equity fund holding brownfield investments.
B. master limited partnership holding greenfield investments.
C. master limited partnership holding brownfield investments.
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8.8. Issues in Performance Appraisal
8.8.1.
8.8.1.1. Performance Appraisal Approaches

➢ Sharpe ratio and Treynor ratio may be misleading for alternatives.
◼ Sharpe Ratio
◆ Sharpe ratio assumes normal (symmetrical) distributed returns
◆ Alternatives have non-normal distribution cannot use standard
deviation for risk measure.

◼ Treynor Ratio
◆ A measure of the excess average return of an investment relative to its
beta to a relevant benchmark.
◆ Uses beta as a risk measure.

➢ Appraisal Approaches suitable for addressing left-tail returns.
◼ VaR, Sortino Ratio- More valuable
◆ Quantitative measure of performance is return relative to downside
volatility.
◼ Calmar ratio= E(Rp)/Maximum drawdown (MDD) risk
◆ MDD: The maximum observed loss from a peak to a trough of a
portfolio, before a new peak is attained.
◆ The higher the Calmar ratio, the better.
◆ Using the prior three years of performance, and it thus adjusts over
time.
◼ MAR ratio
◆ Using a full investment history and the average drawdown.
◆ More appropriate for hedge funds and commodity trading advisers

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8.8.2.
Q-38. A measure that is most likely well-suited to analyzing the performance of alternative
investments that may exhibit negative skewness in returns is the:（2016 Mock PM）
A. safety-first measure.
B. Sortino ratio.
C. Sharpe ratio.
Q-39. An analyst who intends to assess the downside risk of an alternative investment is least
likely to use the investment’s:（原版书课后题）
A. Sortino ratio.
B. Value at risk (VaR).
C. Standard deviation of returns.
Q-40. Which of the following is true regarding private equity performance calculations?
A. The money multiple calculation relies on the amount and timing of cash flows.
B. The IRR calculation involves the assumption of two rates.
C. Because private equity funds have low volatility, accounting conventions allow them to use a
lagged mark-to- market process.
Q-41. A credit hedge fund has a very short redemption notice period— one week. The fund
has a small number of holdings that represent a significant portion of the outstanding
issue of each holding. The fund’s lockup period has expired. Unfortunately, in one
particular month, because of the downgrades of two large holdings, the hedge fund has
a drawdown (decline in NAV) of more than 10%. The declines in value of the two holdings
result in margin calls from their prime broker, and the drawdown results in requests to
redeem 50% of total partnership interests. The combined requests are most likely to:
A. force the hedge fund to liquidate or unwind 50% of its positions in an orderly fashion
throughout the week.
B. have little effect on the prices received when liquidating the positions because the hedge fund
has a week before the partnership interests are redeemed.
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C. result in a forced liquidation, which is likely to further drive down prices and result in ongoing
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pressures on the hedge fund as it tries to convince nervous investors to remain in the fund.
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Q-42. A shortcut methodology involving measuring the total value of all distributions and
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residual asset values relative to an initial total investment often cited by private equity
and real estate managers is the:
A. MAR ratio.
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B. capital loss ratio.
C. multiple of invested capital.
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8.9. Calculating fees and returns
8.9.1.
8.9.1.1. hedge funds
➢ Management fee
◼ Based on capital under management
◼ Attractive to portfolio managers because the management fee alone will generate
significant revenue if assets under management are large.

◼ Earned irrespective of returns
➢ Incentive fee
◼ Based on profits net of (or before) management fee;
◼ Only earned if the return exceeds a hurdle rate;
◼ High water mark: highest value reported
◼ The hedge fund must recover past losses and return to previous high water mark
before any additional incentive fee is earned;
◼ Protect clients from paying twice for the same performance.

◼ “2 and 20” means 2% management fee and 20% incentive fee for hedge funds;
◼ FoFs may charge extra 1% management fee and 10% incentive fee.
8.9.1.2.
➢ Waterfall
◼ Represents the distribution method that defines the order in which allocations are
made to LPs and GPs.
◼ Deal-by-deal (American) waterfalls
◼ performance fees are collected on a per-deal basis.
◼ more advantageous to the GP.

◼ Whole-of-fund (European) waterfalls
◼ performance fees occur at the aggregate fund level (i.e., after all investments have
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been exited).
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◼ more advantageous to the LP.

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➢ Clawback provision
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◼ A clawback provision reflects the right of LPs to reclaim part of the GP’s performance
fee.
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8.9.2.
Q-43. A hedge fund with $100 million of initial capital charges a management fee of 2% and an
incentive fee of 20%. The management fee is based on assets under management at
year-end, and the incentive fee is calculated independently from the management fee.
Assuming the fund earns a 20% return at year-end, total fees earned by the hedge fund
during the year are closest to:（2018 Mock）
A. $6.4 million.
B. $5.92million.
C. $5.63 million.
Q-44. For an investor in a private equity fund , the least advantageous of the following limited
partnership terms is:
A. a clawback provision.
B. a European-style waterfall provision.
C. an American-style waterfall provision.
Q-45. An investor in a private equity fund is concerned that the general partner can receive
incentive fees in excess of the agreed-on incentive fees by making distributions over time
based on profits earned rather than making distributions only at exit from investments
of the fund. Which of the following is most likey to protect the investor from the general
partner receiving excess fees?
A. A high hurdle rate
B. A clawback provision
C. A lower capital commitment
Q-46. A private equity fund has a “2 and 20" fee structure with the incentive fee independent
of management fees. The fund will sell a holding for a profit of 9%. The hurdle rate is
specified as 8%. The provision that would result in an incentive fee of 1 % is:
A. a hard hurdle rate.
B. a soft hurdle rate.
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C. a catch-up provision.
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Q-47. A GF hedge fund begins the year with $235million and earns a30% return for the year.
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The fund charges a 2% management fee on end-of-year fund value and a 20% incentive
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fee on the return, net of the management fees, that is in excess of a 8% fixed hurdle rate.
The fund's investors' return for the year, net of fees, is closest to:（2014 Mock AM）
A. 21.92%.
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B. 23.52%.
C. 23%.
Q-48. A hedge fund has the following fee structure:

⚫ Annual management fee based on year-end AUM 2%
⚫ Incentive fee 20%
⚫ Hurdle rate before incentive fee collection starts 4%
⚫ Current high-water mark $610 million
⚫ The fund has a value of $583.1 million at the beginning of the year. After one year,
it has a value of $642 million before fees. The net return to an investor for this year
is closest to:
A. 6.72%.
B. 6.80%.
C. 7.64%.
Q-49. A hedge fund has a “2 and 20” compensation structure with incentive fee independent
of management fees. The GP has earned an 20% IRR on an investment, the hurdle rate
is 8%, and the partnership agreement includes a catch-up clause. What is total return for
LP:
A. 14%.
B. 13.68%.
C. 16%.
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Solution
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8. Alternative Investments
8.1.
Q-1. Solution: B.
Adding alternative investments to a portfolio may provide diversification benefits because of these
investments’ less than perfect correlation with other assets in the portfolio. As a result, allocating
a portion of one’s funds to alternatives could potentially result in an improved risk–return
relationship. Challenges to allocating a portion of a portfolio to alternative investments include
obtaining reliable measures of risk and return as well as selecting portfolio managers for the
alternative investments.
Q-2. Solution: C.
Cash and other short-term liquid investments would not generally be considered alternative
investments. Alternative investments fall outside of the definition of long-only publicly traded
investments in stocks, bonds, and cash (often referred to as traditional investments). In other
words, these investments are alternatives to long-only positions in stocks, bonds, and cash.
Q-3. Solution: C.
Alternative investments are less regulated and transparent than traditional investments such as
equity and debt securities. A is incorrect because narrow manager specialization is a characteristic
of alternative investments. B is incorrect because a characteristic of alternative investments is that
the underlying investments are illiquid.
Q-4. Solution: C.
Alternative investments are typically expected to have a lower level of regulation and less
transparency than traditional long-only investments. B is incorrect because alternative
investments are often characterized by narrow manager specialization, as compared with
traditional long-only investments. A is incorrect because alternative investments typically give the
manager more flexibility to use derivatives and leverage, invest in illiquid assets, and take short
positions, as compared with traditional investments.
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Q-5. Solution: C.
Due diligence in direct investing will usually be more thorough and more rigid from an investor’s
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perspective because of the absence of a fund manager that would otherwise conduct a large
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portion of the necessary due diligence.

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Q-6. Solution: B.
Direct investing has following advantages:
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Avoids paying ongoing management fees to an external manager.
Greatest amount of flexibility for the investor.
Highest level of control over how the asset is managed.
Q-7. Solution: B.
High-water marks help clients avoid paying twice for the same performance. When a hedge fund’s
value drops, the manager will not receive an incentive fee until the value of the fund returns to its
previous level.
A is incorrect because high-water marks are not linked to prime brokerage fees.
C is incorrect because management fees are paid irrespective of returns.
Q-8. Solution: C.
An alternative investment fund’s hurdle rate is a minimum rate of return the GP must exceed in
order to earn a performance fee.
A is incorrect because if a catch-up clause is included in the partnership agreement, the catch-up
clause permits distributions in relation to the hurdle rate.
B is incorrect because it is a high-water mark (not a hurdle rate) that protects clients from paying
twice for the same performance.
Q-9. Solution: B.
A conservative and theoretically accurate approach is to use bid prices for longs and ask prices for
shorts because these are the prices at which the positions could be closed.
A is incorrect because although using the average quote [(bid + ask)/2] is a common approach, a
more conservative and theoretically accurate approach is to use bid prices for longs and ask prices
for shorts as these are the prices at which the positions could be closed.
C is incorrect because when market prices or quotes are used for valuation, funds may differ in
which price or quote they use (for example, bid price, ask price, average quote, and median quote).
Q-10. Solution: A.
Macro strategies emphasize a top-down approach, and trades are made based on expected
movements of economic variables.
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B is incorrect. Relative value strategies focus on pricing discrepancies between related securities.
C is incorrect. Event-driven strategies focus on short-term events that are expected to affect
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individual companies. The approach is thus “bottom up.”

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Q-11. Solution: B.
The use of derivatives is a typical feature of contemporary hedge funds.
A is incorrect. Hedge funds tend to impose restrictions on the withdrawal of funds.
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C is incorrect. Investing in hedge funds is open only to a limited number of investors.
Q-12. Solution: B.
The fees on funds of funds are usually higher. The fund of funds manager charges a fee, and there
is a fee charged by each hedge fund. A is incorrect because this is an advantage of investing
through funds of funds. C is incorrect because this is an advantage of investing through funds of
funds.
Q-13. Solution: A.
Equity Hedge Strategies include Market neutral, Fundamental L/S growth, Fundamental value,
Short-biased, Sector specific.
Q-14. Solution: B.
Investments in private capital funds can add diversity to a portfolio composed of publicly traded
stocks and bonds because they have less-than- perfect correlation with those investments. There
is also the potential to offer further diversification within the private capital asset class. For
example, private equity investments may also offer vintage diversification since capital is not
deployed at a single point in time but is invested over several years. Private debt provides investors
with the opportunity to diversify the fixed-income portion of their portfolios since private debt
investments offer more options than bonds and other public forms of traditional fixed income.
A is incorrect because although private equity is considered by many to be the largest component
of private capital, using “private equity” as a generic term could be less accurate and possibly
misleading since other private forms of alternative finance have grown considerably in size and
popularity.
C is incorrect because although many private investment firms often have private equity and
private debt arms, these teams typically won’t invest in the same assets or businesses to avoid
overexposure to a single investment.
Q-15. Solution: A.
Private equity funds and hedge funds are typically structured as partnerships where investors are
:
limited partners (LP) and the fund is the general partner (GP). The management fee for private
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equity funds is based on committed capital whereas for hedge funds the management fees are
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based on assets under management. For most private equity funds, the general partner does not
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earn an incentive fee until the limited partners have received their initial investment back.
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Q-16. Solution: C.
A CLO manager will extend several loans to corporations (usually to firms involved in LBOs,
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corporate acquisitions, or other similar types of transactions), pool these loans, and then divide
that pool into various tranches of debt and equity that range in seniority and security. The CLO
manager will then sell each tranche to different investors according to their risk profiles; the most
senior portion of the CLO will be the least risky, and the most junior portion of the CLO (i.e., equity)
will be the riskiest.
A is incorrect because with the different CLO tranches having distinct risks varying with their
seniority and security, they will be priced over a range of interest rates. In contrast, unitranche
debt combines different tranches of secured and unsecured debt into a single loan with a single,
blended interest rate.
B is incorrect because debt extended to niche borrowers in specific situations is more commonly
offered through specialty loans. For example, in litigation finance, a specialist funding company
provides debt to a client to finance the borrower’s legal fees and expenses in exchange for a
portion of any case winnings.
Q-17. Solution: B.
Early-stage financing is capital provided for companies moving into operation and before
commercial manufacturing and sales have occurred.
Q-18. Solution: B.
B is correct. The majority of private equity fund activity involves leveraged buyouts of established
profitable and cash generative companies.
A is incorrect because, although a private equity fund may use derivatives, this use is not a defining
characteristic of private equity investing. Derivative strategies are most likely used in hedge fund
and commodity investment strategies.
C is incorrect because private equity funds generally invest in non-publicly traded companies or
public companies with the intent to take them private, not mortgage-backed securities which are
a form of publicly traded real estate debt.
Q-19. Solution: A.
Once a commitment in a private equity fund has been made, the investor has very limited liquidity
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options.
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Q-20. Solution: C.
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C is correct. The historical standard deviations of annual return for venture capital are higher than
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that of common stocks. Investors should therefore require a higher return in exchange for
accepting this higher risk, along with the illiquidity of venture capital investing. A is incorrect
because the venture capital strategy typically invests in start-up or early stage companies, not later
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stage companies. B is incorrect because venture capital investments require long time horizons.
Q-21. Solution: C.
Venture capital is a private equity strategy in which private equity companies invest and get actively
involved in the management of portfolio companies.
Q-22. Solution: C.
In a secondary sale, a private capital firm sells one of its portfolio companies to another private
capital fund or group of private investors. Selling a portfolio company to a competitor in its industry
is known as a trade sale. Selling a portfolio company to the public requires an initial public offering.
Q-23. Solution: C.
Advantages of a SPAC exit include:
1. extended time for public disclosure on company prospects to build investor interest
2. fixed valuation with lower volatility of share pricing
3. flexibility of transaction structure to best suit the company’s context
4. association with potentially high-profile and seasoned sponsors and their extensive investor
network.
Q-24. Solution: B.
Over the long term, commodity prices are closely related to inflation and thus including
commodities in a portfolio of equities and bonds will reduce its exposure to inflation.
Q-25. Solution: B.
A primary risk of timber is the international competitive landscape. Timber is a globally sold and
consumed commodity subject to world trade interruptions. So the international context can be
considered one of its major risk factors. A is incorrect because timberland offers an income stream
based on the sale of trees, wood, and other timber products that has not been highly correlated
with other asset classes. C is incorrect because investors are interested in timber because of its
global nature (everyone requires shelter), the current income generated from the sale of the crop,
inflation protection from holding the land, and its safe haven characteristics (it offers some
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insulation from financial market volatility).

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Q-26. Solution: A.
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Commodity exposure is most commonly accessed via commodity derivatives.

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B is incorrect because commodities returns are based on changes in price rather than income
streams.
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C is incorrect because holding commodities (i.e., the physical products) incurs costs for
transportation and storage. Thus, most commodity investors do not trade actual physical
commodities, but rather trade commodity derivatives.
Q-27. Solution: C.
Since commodity indices are constructed using commodity futures and not the underlying
commodities there can be differences between commodity index returns and the returns of the
underlying commodities.
Q-28. Solution: A.
If a price curve for a commodity is in contango, the curve is most likely be upward slopping and
the forward price for this commodity will be higher than the current price. In this case, only $80 is
higher than the spot price of wheat.
Q-29. Solution: B.
Unlike timberland products, farm products must be harvested when ripe, so there is little flexibility
in the production process. In contrast, timber (trees) can be grown and easily “stored” by simply
not harvesting. This feature offers the flexibility of harvesting more trees when timber prices are
up and delaying harvests when prices are down.
Q-30. Solution: A.
A digital asset can represent physical or virtual assets, a value, or a use right/service.
Q-31. Solution: C.
Commercial real estate ownership requires long time horizons and purchasing illiquid assets that
require large investment amounts.
Q-32. Solution: B.
B is correct. Shares in real estate investment trusts are publicly traded and represent an equity
investment in real estate. A is incorrect. Real estate limited partnerships are an example of a
private real estate investment. C is incorrect. A collateralized mortgage obligation is an example
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of debt-based exposure to real estate.

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Q-33. Solution: C.
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Only properties that sell in each period and are included in the index and vary over time which
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may not be representative of the whole market.
Q-34. Solution: B.
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Because no two properties are identical, homogeneity is not a feature of an investment in real
estate.
Q-35. Solution: A.
If mortgage defaults and losses are high, the lowest-ranked tranches bear the cost of the shortfall.
The most junior tranche is referred to as the first-loss tranche.
Q-36. Solution: B.
Greenfield investments refer to infrastructure assets that are yet to be constructed.
Q-37. Solution: C.
A master limited partnership (MLP) is publicly traded, whereas a private equity fund is not.
Therefore the MLP will have market pricing information to help with valuation. A brownfield
investment is an existing asset that likely has operational and financial history to aid in valuation;
whereas a greenfield investment is in new construction.
Q-38. Solution: B.
The Sharpe ratio and the safety-first measure use standard deviation as the measure of risk, which
ignore the negative skewness in returns. The Sortino ratio uses the downside deviation as the
measure of risk, which will reflect negative skewness if present.
Q-39. Solution: C.
Downside risk measures focus on the left side of the return distribution curve where losses occur.
The standard deviation of returns assumes that returns are normally distributed. Many alternative
investments do not exhibit close-to-normal distribution of returns, which is a crucial assumption
for the validity of a standard deviation as a comprehensive risk measure. Assuming normal
probability distributions when calculating these measures will lead to an underestimation of
downside risk for a negatively skewed distribution. Both the Sortino ratio and the value-at-risk
measure are both measures of downside risk.
Q-40. Solution: B.
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The determination of an IRR involves certain assumptions about a financing rate to use for outgoing
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cash flows (typically a weighted average cost of capital) and a reinvestment rate assumption to
make on incoming cash flows (which must be assumed and may or may not actually be earned).
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A is incorrect because the money multiple calculation completely ignores the timing of cash flows.
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C is incorrect because it is somewhat of a reversal of cause and effect: Private equity (PE) funds can
appear to have low volatility because of the lag in their mark-to-market process. It’s not that PE
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investments don’t actually rise and fall behind the scenes with economic influences, but
accounting conventions may simply leave longer-lived investments marked at their initial cost for
some time or with only modest adjustments to such carrying value until known impairments or
realization events begin to transpire. Also, because PE funds are not easily marked to market, their
returns can appear somewhat smoothed, making them appear more resilient and less correlated
with other assets than they really are. The slowness to re-mark them can unfortunately be
confused by investors as an overall lack of volatility.
Q-41. Solution: C.
One week may not be enough time to unwind such a large portion of the fund’s positions in an
orderly fashion that does not also further drive down prices. A downgrade is not likely to have a
temporary effect, so even if other non-losing positions are liquidated to meet the redemption
requests, it is unlikely that the two large holdings will return to previous or higher values in short
order. Also, the hedge fund may have a week to satisfy the requests for redemptions, but the
margin call must be met immediately. Overall, sudden redemptions at the fund level can have a
cascading negative impact on a fund.
Q-42. Solution: C.
Private equity and real estate managers often cite a multiple of invested capital ratio, where one
simply measures the total value of all distributions and residual asset values (assets that may still
be awaiting their ultimate sale) relative to the initial total investment.
Q-43. Solution: A.
Total fees earned by the hedge fund are closest to $6.4 million:
Year-end value = $100 million ×1.2= $120million
Management fee = Year-end value × Management fee %
= $120 million ×2% = $2.4 million
Incentive fee = (Year-end value – Beginning value) × Incentive fee %
= ($120million – $100million) ×20% = $4million
Total fees = Management fee + Incentive fee
:
= $2.4 million+ $4 million = $6.4 million

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Q-44. Solution: C.
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An American-style waterfall structure has a deal-by-deal calculation of incentive fees to the general
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partner. In this case, a successful deal where incentive fees are paid, followed by the sale of a
holding that has losses in the same year, can result in incentive fees greater than those calculated
with a European-style (whole-of-fund) waterfall. A clawback provision benefits the limited partner
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investors by allowing them to recover incentive fees paid earlier if the fund realizes losses later. A
clawback provision coupled with a American-style waterfall will result in the same overall incentive
fees as a European-style waterfall if the transactions occur in subsequent years.
Q-45. Solution: B.
A clawback provision requires the general partner in a private equity fund to return any funds
distributed (to the general partner) as incentive fees until the limited partners have received back
their initial investments and the contracted portion of the total profits. A high hurdle rate will result
in distributions occurring only after the fund achieves a specified return. A high hurdle rate
decreases the likelihood of, but does not prevent, excess distributions. Management fees, not
incentive fees, are based on committed capital.
Q-46. Solution: C.
With a catch-up provision, the limited partners get the first 8% of gross return and the general
partner gets all returns above that to a maximum of 2%, and gains above that are shared 80% to
the limited partners and 20% to the general partner.
With a soft hurdle rate of 8%, the incentive fee would be 20% of 9%, or 1.8%.
With a hard hurdle rate of 8%, the incentive fee would be 20% of (9%-8%), or 0.2%.
Q-47. Solution: B.
The $235 million grows by 30% to $305.5 million [= $235 million × (1 +0.3)]. The management fee
is $6.11 million (= $305.5million × 0.02), leaving $299.39million, net of the management fee, or an
increase of $64.39million over the beginning value of $235 million.
The8% hurdle rate requires an increase of $18.8 million (= $235 million ×0.08), so the fund has
earned $45.59 million (= $64.39million – $18.8million) over the hurdle rate, net of the
management fee.
The incentive fee is 20% of this, or $9.118 million (= $45.59 million × 0.2), leaving an increase in
fund assets, net of management and incentive fees, of $55.272 million (=$64.39million – $9.118
million) . The investor's return, net of fees, is $55.272/$235 million =23.52%.
Q-48. Solution: C.
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C is correct. The management fee for the year is

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$642 × 0.02 = $12.84 million.

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Because the ending value exceeds the high-water mark, the hedge fund can collect an incentive
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fee. The incentive fee is

{$642 – [$610 × (1 + 0.04)]} × 0.20 = $1.52 million.
The net return to the investor for the year is
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[($642–$12.84–$1.52)/$583.1]–1≈0.07638≈7.64%.
Q-49. Solution: A.
With catch-up clause, after first 8% distributed to investors. GP will catch up to receive
(8%/80%)*20%=2%---because 2% out of 10% amounts to 20% of the profits accounted for so far,
as the catch-up clause stipulates—and the remaining 10% would be split 80/20 between the LPs
and the GP. Total incentive fee=2%+2%=4%. Total return of LP=20%-2%(MF)-4%(IF)=14%
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8.

➢ Narrow specialization of the investment managers

➢ Fund investing (indirect)

Q-1. The potential benefits of allocating a portion of a portfolio to alternative investments

A. Fine wine and other tangibles

B. Schools and other long-lived real assets

8.2.1.1. Most common structure: Partnership

B. avoid paying twice for the same performance.

C. claw back the management fees.

Q-8. An alternative investment fund’s hurdle rate is a:

A. rate unrelated to a catch-up clause.

◆ FOFs enable small investors to have returns in hedge funds;

◆ FOFs have some expertise in conducting due diligence on hedge funds;

◆ Negotiate better redemption terms for investors;

◆ FOFs invest in numerous hedge funds, diversifying across fund

strategies, investment regions, and management styles;

◆ FOFs managers charge an additional layer of fees beyond the fees

charged by the individual hedge funds in the portfolio.

Distressed/restructuring: focus on the securities of companies either in

bankruptcy or perceived to be near to bankruptcy;

◆ Activist shareholder: purchase of sufficient equity in order to influence

a company’s policies or direction;

◆ Special situations: focus on companies that are currently engaged in

restructuring activities other than merger/acquisitions and bankruptcy.

◆ Fixed income convertible arbitrage: market neutral (zero beta)

strategies that seek to exploit a perceived mispricing between a

convertible bond and its component parts;

◆ Fixed income asset backed: take advantage of mispricing across

different asset backed securities;

◆ Volatility: use options to go long or short market volatility;

◆ Multi-strategy: looks for investment opportunities wherever they

market risk. The intent is to profit from individual securities movements

while hedging against market risk;

◆ Fundamental growth: fundamental analysis to identify companies

expected to exhibit high growth and capital appreciation;

◆ Fundamental value: buy equity securities believed to be undervalued

based on fundamental analysis;

◆ Sector Specific: exploit expertise in a particular sector.

expectations, going fully short in declining markets.

be the ones to perform the most poorly in subsequent years;

effectiveness as a diversifying asset class.

Q-11. Hedge funds are least likely to have restrictions concerning:

Q-13. Which type of strategy is considered the Equity Hedge Strategies:

◼ Special purpose acquisition company (SPAC): The special purpose

acquisition company technique starts as a shell company via an IPO through

with private firms.

Q-14. A Private capital is:

Q-16. A collateralized loan obligation specialist is most likely to:

A. sell its debt at a single interest rate.

B. cater to niche borrowers in specific situations.

Q-18. The majority of private equity activity involves:（MOCK 2020 B）

Q-23. Which of the following is NOT an advantage of a SPAC exit:

A. Fixed valuation with lower volatility of share pricing.

C. Fast and simple execution.

◆ changes in the price of the underlying land.

Q-25. A significant challenge to investing in timber is most likely its:

B. dependence on an international competitive context.

C. return volatility compounded by financial market exposure.