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6、In distinguishing between strategy risks and structural risks that stem from a fund of hedge funds, which of the following would be considered strategy risk(s)?

  I. Trading liquidity risk.

 II. The extent and form of management oversight.

III. The risk of poor information reporting systems.

IV. The risk of high ownership concentration of hedge fund shares.

A) I, III and IV. 

B) II and III. 

C) II and IV. 

D) I only. 

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The correct answer is D

Hedge funds face structural risks that stem from a hedge fund’s operations. These risks include the potential for deterioration in a firm’s reputation, poor information reporting systems, inadequate management oversight, etc. Strategy risks derive from a hedge fund’s investment strategy. They include a fund’s exposure to price swings from different asset classes (market risk), the risk of non-performance by counterparties (credit risk), the risk of price impact from executing large trades (trading liquidity risk), and the risk of not being able to meet interim cash flows obligations before strategies are able to become profitable (funding liquidity risk).

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AIM 2: Explain how funds of hedge funds can be classified according to diversification characteristics.

1、A risk reducer hedge fund is characterized by:

A) low returns and low positive correlation with traditional asset classes.

B) high returns and high positive correlation with traditional asset classes. 

C) high returns and negative correlation with traditional asset classes. 

D) low returns and negative correlation with traditional asset classes.

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The correct answer is A

A risk reducer hedge fund is characterized by lower returns, and low correlations with traditional stock/bond asset classes. One example is a long/short equity fund.

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2 Fullen Capital Management recently started a convertible bond arbitrage hedge fund and is looking to market the fund to investors with traditional stock and bond portfolios. Based on the characteristics of similar funds, Fullen expects his hedge fund to have high returns and a relatively high correlation with a traditional stock and bond portfolio. In his marketing materials, Fullen would most accurately categorize the fund as a:

A) total diversifier.

B) return enhancer. 

C) risk reducer.

D) pure diversifier. 

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The correct answer is B

Hedge funds classified as return enhancers have high returns and high correlations with traditional stock and bond portfolios.

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3、Which of the following statements best describes the fund-of-funds (FOF) class of hedge funds? A fund of funds:

A) is an open-end mutual fund that primarily invests in other open-end funds.

B) allows smaller investors to access the hedge funds market.

C) is open to institutional investors for the purpose of seeking arbitrage situations in hedge fund pricing.

D) allows smaller investors to participate in the venture capital market.

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The correct answer is B

A FOF is a fund that invests in hedge funds. They are open to both individual and institutional investors.

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4、One of the main advantages to investing in a fund of funds (FOF) is that FOF provide:

A) lower management fees.

B) a proven track record.

C) higher expected returns.

D) improved diversification of assets.

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The correct answer is D

FOF will actually have higher management fees because the FOF will charge a fee in addition to the fee charged by the hedge fund manager. Hedge funds selected by the FOF may have a good track record, but it is no indication of future performance. FOF actually have lower expected returns because of increased diversification. FOF can diversify across many hedge funds strategies to decrease risk.