Kingpin804

Which of the following strategies is least likely to be used by a hedge fund to increase leverage?

A) Borrowing external funds.

B) Margin borrowing.

C) Pursuing arbitrage opportunities.

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Borrowing through a margin account and borrowing external funds are methods commonly used by hedge funds to increase leverage. Hedge funds are generally allowed to pursue arbitrage opportunities, which may or may not increase leverage.

Kingpin804

In periods of high volatility, hedge funds may encounter broker-dealers that adopt policies of extremely conservative marking-to-market of fund assets. This is called:

A) counterparty risk.

B) pricing risk.

C) settlement risk.

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Counterparty risk is the exposure to the creditworthiness of the broker-dealers that hedge funds transact with. Settlement risk describes the risk that a counterparty, such as a broker-dealer, fails to deliver a security as agreed. Pricing risk occurs when broker-dealers, in order to protect themselves, adopt extremely conservative pricing policies, which in turn requires hedge funds to post a greater margin.

Kingpin804

Biases in hedge fund performance measurement are least likely to include:

A) incomplete historical data.

B) smoothed pricing.

C) correlation bias.

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The six most common biases present in hedge funds are: “Cherry Picking” by managers. Incomplete historical data. Survival of the fittest. Smoothed pricing. Asymmetrical returns. Fee structures and incentives.

Kingpin804

Which of the following statements regarding hedge fund performance is NOT correct?

A) Hedge funds have historically underperformed the S&P 500.

B) Hedge funds have demonstrated a lower risk profile than traditional equity investments.

C) The Sharpe ratio for hedge funds has been consistently higher than for most traditional equity investments.

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Hedge funds have demonstrated a lower risk profile than equities when measured by standard deviation. The Sharpe ratio, which is a reward-to-risk ratio, has been higher for hedge funds than for equities. Hedge funds have historically outperformed the S&P 500.

mouse123

The fee structure of a hedge fund may lead to biases in performance data because:

A) hedge fund managers are not required to disclose information regarding fee structures.

B) hedge fund managers charge higher fees than managers of traditional funds.

C) fund managers have incentives to take big risks if past performance has been poor.

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Hedge fund managers have the potential to earn more than managers of traditional funds, but this does not bias performance data. Hedge fund managers typically receive a modest base fee (1%) and then a large incentive fee based upon performance. If past performance has been poor, then fund managers feel they have “nothing to lose” and may invest more aggressively.

mouse123

Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

A) there is not a reliable index that tracks hedge fund performance.

B) hedge funds as an asset class have not been in existence long enough to have meaningful performance data.

C) fund managers tend to submit only favorable performance data.

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Hedge funds have been in existence since the early 1990’s, long enough to compile meaningful data. There are several reliable indexes designed to track hedge funds. One of the primary reasons why performance data has biases is that submission is strictly voluntary, so managers tend to only submit impressive performance information.

mouse123

Which of the following statements regarding survivorship bias in hedge funds is most accurate? Survivorship bias tends to:

A) overstate the performance and understate the volatility of hedge funds.

B) overstate both the performance and volatility of hedge funds.

C) understate the performance and overstate the volatility of hedge funds.

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Survivorship bias exists because only the successful hedge funds submit performance data, thus overstating performance when the index is considered to be representative of the entire hedge fund population. Likewise, stable funds tend to succeed, while more volatile funds tend to go out of business, causing the database to tend to understate volatility for hedge funds as an asset class.

mouse123

Survivorship bias is acute with hedge fund databases because hedge:

A) funds experience higher volatility of returns than traditional investments.

B) funds are more highly leveraged than other asset classes.

C) fund managers often do not have to comply with performance presentation standards.

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The main reason behind the survivorship bias problem in hedge fund reporting is that hedge funds are exempt from most SEC regulations, including performance presentation standards. This lack of standards leads to many inconsistencies in reporting that are not present in other asset classes.

mouse123

Only successful, ongoing hedge funds are included in hedge fund databases. The resulting inflation of reported hedge fund performance can be best described as:

A) survivorship bias.

B) asymmetrical returns.

C) self-selection bias.

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Asymmetrical returns refers to the option-like return profiles that result from some hedge fund strategies. Self-selection bias reflects the fact that submission of data by fund managers is voluntary, and they tend to submit only impressive results. Survivorship bias does result from the fact that only successful hedge funds with ongoing operations are included in databases, thus putting an upward bias on the returns of hedge funds as an asset class.

mouse123

Hedge funds are generally not required to publicly disclose their performance, however, some managers choose to make performance information available to the public. This information is then included in hedge fund indexes and some conclusions about the performance of hedge funds can be drawn. Which of the following statements regarding hedge fund performance is least accurate?

A) When measured by standard deviation, hedge funds are less risky than traditional equity investments.

B) In recent years, the Sharpe ratio for hedge funds has been higher than that of most equity investments.

C) The reported volatility of hedge fund returns may be higher than the actual volatility of returns.

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Many assets that are included in a hedge fund portfolio are not actively traded. Managers utilize estimates to report the market value and performance of their hedge funds. Using estimates rather than actual market transactions may result in smoothed pricing, thereby reducing reported volatility.