AIM 1: Discuss the challenges of benchmarking alpha returns.

1、In benchmarking hedge fund performance, returns due to managerial skill are best measured as the return in excess of the:

A) risk-free return.

B) return to a global market portfolio.

C) return to a comprehensive index of hedge funds.

D) risk-free return and relevant risk premia.

The correct answer is D

The key to benchmarking returns is to identify the proper alpha. This requires subtracting the risk-free return and any risk premia attributable to risks to which the hedge fund is exposed.

2、While traditional assets have benchmarks such as the S& 500, hedge funds do not have such a clear-cut criterion for performance measurement. Where do hedge funds derive the bulk of their returns?

A) Risk premia.

B) Overall economic conditions.

C) Combination of alpha and beta.

D) Alternative risk.

The correct answer is A

Hedge funds do derive the majority of their returns from risk premia. Thus these returns are largely dependent on the behavior of global capital markets.

AIM 2: Identify the attributes of a good hedge fund index and discuss the problems with existing hedge fund indexes.

1、Which of the following statements does NOT describe existing hedge fund indices?

A) Index construction criteria sometimes include subjective asset weighting schemes. 

B) Indices are often difficult to replicate. 

C) Methodologies are often not transparent. 

D) The criteria used to assemble indices are highly uniform.

The correct answer is D

The criteria used to assemble indices vary widely. The use of subjective criteria in index construction often results in a lack of transparency and indices that are difficult to replicate.

2、Which of the following performance biases are likely when a fund is deleted from a hedge fund index and replaced with another fund?

I.           Backfilling bias.

II.         Survivorship bias.

III.        Time-period bias.

A) I and III.

B) I and II.

C) II and III.

D) I, II and III.

The correct answer is B

Backfilling refers to the practice of inserting the past performance of a new fund into the index, distorting the performance history of the index. Survivorship bias occurs when an unsuccessful fund is dropped from an index, causing the index to be more representative of funds with positive performance. Time-period bias occurs when the time period over which the index has been calculated is not representative of performance in a variety of market conditions.

3、Which of the following is NOT an attribute of a good hedge fund index?

A) Based on reliable, verifiable information.

B) Transparent methodology.

C) Representative of the top performing funds in the asset class.

D) Easily replicated by a third party.

The correct answer is C

The asset class should be completely covered, with all managers and strategies represented in the index.