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

A)   Margin borrowing.

B)   Using derivatives.

C)   Pursuing arbitrage opportunities.

D)   Borrowing external funds.

2.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)   liquidity risk.

C)   pricing risk.

D)   settlement risk.

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

A)   Margin borrowing.

B)   Using derivatives.

C)   Pursuing arbitrage opportunities.

D)   Borrowing external funds.

The correct answer was C)

Borrowing through a margin account, using derivatives, 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.

2.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)   liquidity risk.

C)   pricing risk.

D)   settlement risk.

The correct answer was C)

Counterparty risk is the exposure to the creditworthiness of the broker-dealers that hedge funds transact with. Liquidity risk is faced by hedge funds that trade in illiquid or thin markets, and it may decrease trading flexibility. 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.