AIM 1: Explain and distinguish between the strategies followed by “Capital Decimation Partners” and “Capital Multiplication Partners.”

1、The Capital Decimation Partners hypothetical strategy is most similar to which of the following?

A) Buying insurance.

B) Selling insurance.

C) A perfect market-timing strategy.

D) A protective put option strategy.

The correct answer is B

Capital Decimation Partners, CDP, strategy of writing out-of-the money puts is most similar to selling insurance. A perfect market-timing strategy is consistent with the CMP strategy. The CMP strategy is a protective put strategy that involves a long position a put option on the underlying asset, and the underlying asset (S& 500), which is the same as buying insurance.

2、The Capital Multiplication Partners hypothetical strategy is least similar to which of the following:

A) Buying insurance.

B) Selling insurance.

C) A perfect market-timing strategy.

D) A dynamic asset allocation strategy.

The correct answer is B

Capital Multiplication Partners, CMP, is a hypothetical perfect market strategy that is also a dynamic asset-allocation strategy. The CMP strategy has been proven to be the same as holding a long position in the S& 500 and a put option on the S& 500 with the strike price equal to the Treasury bill rate. Buying a put when owning the underlying asset is equivalent to buying insurance. The CDP strategy of writing out-of-the money puts is the most similar with selling insurance.

3、Which of the following is a perfect market-timing strategy?

I.           Capital Decimation Partners.

II.         Capital Multiplication Partners.

A) I only.

B) Both I and II.

C) Neither I nor II.

D) II only.

The correct answer is D

Capital Multiplication Partners, CMP, is a hypothetical perfect market strategy of always investing in the asset that generates the highest return each month.

4、Which of the following best describes the Capital Multiplication Partners strategy?

A) Writing out-of-the-money puts.

B) A covered call strategy.

C) A perfect market-timing strategy.

D) Selling insurance.

The correct answer is C

A perfect market-timing strategy is consistent with the CMP strategy. The CMP strategy is a protective put strategy that involves a long position, a put option on the underlying asset, and the underlying asset (S& 500), which is the same as buying insurance.

AIM 2: Compare the relative performance of various hedge fund strategies.

1、The Sharpe ratio for hedge funds is overstated:

A) if the standard deviation of the hedge fund is overstated.

B) during periods when the risk-free rate is low.

C) if the hedge fund is liquid.

D) if a hedge fund returns have high positive serial correlation.

The correct answer is D

High values of positive autocorrelation is an indication of illiquidity exposure, which would create low values for the standard deviation and therefore overstate the Sharpe ratio.

2、Which of the following hedge fund styles has experienced high measures for the Sharpe ratio and serial correlation?

A) Convertible Arbitrage.

B) Long/Short Equity Hedge.

C) Dedicated Short Bias.

D) Managed Futures.

The correct answer is A

The Convertible Arbitrage funds have the highest relative performance using the Sharpe measure; however, funds with this style also have high positive serial correlation.

3、Based on historical relative performance measures for hedge fund strategies, which of the following funds are characterized as having low relative performance?

I.           Convertible Arbitrage.

II.         Dedicated Short Bias.

III.        Fixed Income Arbitrage.

IV.      Event Driven.

A) I only.

B) II only.

C) I and II.

D) I, III and IV.

The correct answer is B

The Dedicated Short Bias and the Managed Futures hedge fund styles have the lowest Sharpe ratios.

AIM 3: Analyze the sources of hedge fund return variance when the performance is assessed in a multifactor model.

1、Each source of return variance for a hedge fund should yield which of the following?

A) Risk factor.

B) Sharpe Ratio.

C) A linear clone.

The correct answer is D

There exist multiple sources of risk, and each source of risk should generate a risk premium including a risk-based alpha.

AIM 4: Explain the relative performance of various hedge fund strategies based on factor analysis.

1、Which of the following hedge fund style categories has experienced the highest mean value for manager-specific alpha?

A) Convertible Arbitrage.

B) Fund of Funds.

C) Equity Market Neutral.

D) Emerging Markets.

The correct answer is D

The Emerging Markets style category has the highest intercept (i.e., manager-specific alpha) of 1.41, compared to the second highest, which is the Event Driven at 0.93, and the lowest, which is Managed Futures at 0.42.

2、An Equity Market Neutral style hedge fund is most likely to have a factor exposure to the market with which of the following values?

A) ?1.0.

B) 0.5.

C) 0.0.

D) 1.0.

The correct answer is C

The Equity Market Neutral strategy style funds’ coefficient on the S& 500 risk factor is expected to be close to zero.

3、Hedge funds with the Emerging Markets style are most likely to be exposed to which of the following:

I.           long stocks.

II.         long U.S. Dollar.

III.        short stocks.

IV.      short U.S. Dollar.

A) II and III.

B) I and IV.

C) IV only.

D) II only.

The correct answer is B

Emerging Markets style funds’ primary exposures are: long stocks, short U.S. Dollar, long credit spread, and long commodities.

4、Which of the following hedge fund style categories has experienced the highest on average contribution from the manager-specific alpha to the category’s mean return?

A) Emerging Markets.

B) Dedicated Short Bias.

C) Convertible Arbitrage.

D) Equity Market Neutral.

The correct answer is B

The managers of the Dedicated Short Bias style category are shown to contribute the most to the expected rate of returns (225.6% contribution by manger-specific alpha).

5、Which of the following hedge fund style categories has experienced the lowest on average contribution from the manager-specific alpha to the category’s mean return?

A) Convertible Arbitrage.

B) Emerging Markets.

C) Dedicated Short Bias.

D) Equity Market Neutral.

The correct answer is A

The Convertible Arbitrage style managers on average have a negative contribution to expected return (?33.3%).

6、Which of the following hedge fund style categories has over 75% of the total return for the style category that contributed to the manager-specific alpha?

I.           Dedicated Short Bias.

II.         Convertible Arbitrage.

III.        Multistrategy.

IV.      Emerging Market.

V.        Equity Neutral.

A) I, II, III, IV and V.

B) I, III, IV and V.

C) I, IV and V.

D) II and III.

The correct answer is B

The Convertible Arbitrage style manager’s on average have a negative contribution to expected return (?33.3%). All of the following have contributions to expected returns that are greater than 70%: Dedicated Short Bias (225.6%), Equity Market Neutral (80.8%), Event Driven (79.0%), Multi-Strategy (78.9%), Emerging Markets (78.3%), Fixed Income Arbitrage (71.1%), Fund of Funds (71.1%) and Long/Short Equity Hedge (70.5%).

7、Which of the following hedge fund style categories is most likely to experience a factor risk associated with bonds?

A) Convertible Arbitrage.

B) Emerging Markets.

C) Fund of Funds.

D) Long/Short Equity Hedge.

The correct answer is A

Convertible Arbitrage style funds’ returns have three main factors:

1、   long credit spread.

2、   long bonds.

3、   long volatility.

Convertible Arbitrage funds, along with Managed Futures, have a large portion of their respective total returns contributed from the bond risk-factor, 34.9% and 53.8%, respectively.

8、Which of the following funds is most likely to have the highest leverage factor?

A) Managed Futures.

B) Fund of Funds.

C) Event Driven.

D) Convertible Arbitrage.

The correct answer is A

The highest renormalization factor is reported for the Managed Futures style at 2.76, and the lowest renormalization factor is 1.62 for the Fund of Funds style.

9、Linear clones perform best for which of the following hedge fund strategy categories?

A) Managed Futures.

B) Event Driven.

C) Emerging Markets.

D) Fixed Income Arbitrage.

The correct answer is A

The results indicate that the Managed Futures and Global Macro linear clones out perform the actual fund for both the fixed-weight and rolling-window construction.

AIM 5: Distinguish between “fixed-weight” and “rolling-window clones,” explain their construction and compare the differences between these strategies.

1、Linear clones of hedge fund categories using a five-factor model:

A) have higher values for the first-order auto correlation than the hedge funds they replicate.

B) outperform the all hedge funds categories they attempt to replicate.

C) cannot be actively traded.

D) have more liquidity than the hedge funds they replicate.

The correct answer is D

All of the linear clones have low values for autocorrelations, confirming that the clones are more liquid.

2、Which of the following best describes the impact of leverage on the linear clones that replicate hedge fund styles?

I.           Linear clones are not practical because the leverage values were too high to be practical.

II.         Linear clones can replicate the returns of hedge funds they represent by using futures contracts.

III.        The high amounts of leverage required to replicate the hedge fund returns makes the linear clones not practical.

A) I only.

B) III only.

C) II only.

D) I and III.

The correct answer is C

The impact of leverage is evaluated by using a renormalization factor. An analysis of the values for the renormalization factors indicates that leverage can be replicated using futures contracts. Therefore, the implied leverage in the clones is practical.

3、Linear clones created using the fixed-weighted method would be most appropriate for which of the following investors?

I.           Active investor implementing a dynamic asset-allocation policy.

II.         Passive investor with little expertise in trading.

A) I only.

B) Both I and II.

C) II only.

D) Neither I nor II.

The correct answer is C

More active investors engaging in dynamic asset-allocation will prefer the rolling-window method, and the more passive investors will prefer the fixed-weight approach.

4、Which of the following most accurately describes the liquidity of linear clones of hedge funds and the hedge funds that they are replicating?

I.           Positive first-order autocorrelation is an indicator of illiquidity risk.

II.         Hedge fund linear clones are less liquid than the hedge funds that they replicate.

III.        Larger p-values for the Ljung-Box Q-statistic indicate more statistically significant autocorrelation.

IV.      Larger p-values for the Ljung-Box Q-statistic indicate less statistically significant autocorrelation.

A) I and IV.

B) I, II and III.

C) II and III.

D) I and III.

The correct answer is A

Positive first-order autocorrelation indicates an illiquidity, and the larger p-values indicate less significant measures of autocorrelation (illiquidity).

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