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LOS b: Compare and contrast the use of market indices, hedge fund indices, and positive risk-free rates to evaluate hedge fund performance.

Which of the following would be the most appropriate benchmark to use for hedge fund evaluation?

The Merrill Lynch High Yield index may be the best individual market index for fixed income hedge funds and the Russell 3000 may be the individual market index for equity hedge funds. However, a combination of indexes may be the best market index, as it has been found that multifactor models do the best in explaining mutual fund returns. Of equity hedge funds, market neutral strategies should have a return that is closest to risk-free, but they are not completely risk-free. The risk-free rate is not an appropriate benchmark for fixed income hedge funds either because of their exposure to interest rate risk and the use of leverage.

Which of the following is most accurate in describing the problems of survivorship bias and backfill bias in the performance evaluation of hedge funds?

A)	Survivorship bias and backfill bias both result in upwardly biased hedge fund index returns.

B)	Survivorship bias and backfill bias both result in downwardly biased hedge fund index returns.

C)	Survivorship bias results in upwardly biased hedge fund index returns, but backfill bias results in downwardly biased hedge fund index returns.

The problem in survivorship bias is that only the returns for survivors will be reported and the index return will be biased upwards. Backfill bias results when a new hedge fund is added to an index and the fund's historical performance is added to the index's historical performance. The problem is that only funds that survived will have their performance added to the index, resulting in an upward bias in index returns.

Which of the following is least accurate regarding hedge fund performance evaluation?

A)	The S& 500 is the most appropriate index for a market neutral equtiy hedge fund.

B)	Serial correlation in hedge fund data results in artificially low standard deviations for hedge fund indicies.

C)	Although a hedge fund can lever up to 20 times its capital, the benchmark is not usually adjusted to reflect the amount of leverage a manager uses.

The S& 500 is often used for long only funds, but is not an appropriate index for hedge funds.

Which of the following hedge fund types is most likely to have a return that is closest to risk-free?

A)	An event driven hedge fund.

B)	A market neutral hedge fund.

C)	A long/short hedge fund.

Of the equity hedge funds, market neutral strategies should have a return that is closest to risk-free, however, they are not completely risk-free.