LOS i: Describe and explain the categories of risks and costs in private equity investing.

Q1. The most relevant market risk to a private equity investor is:

A)   short-term macro changes only.

B)   long-term macro changes only.

C)   both short-term and long-term macro changes.

Q2. Private equity values have declined significantly over the last year. Which of the following risk factors is the least likely reason for the decline?

A)   Investment-specific risk.

B)   Market risk.

C)   Tax risk.

Q3. Which of the following pairs correctly identifies the fees paid to agents for raising funds for the private equity firm, and the fees paid to the general partner (GP) for investment banking services, respectively?

                Fees to agents                 Fees to GP

A)    Transaction fees              Administrative costs

B)   Administrative costs         Placement fees

C)     Placement fees             Transaction fees

LOS i: Describe and explain the categories of risks and costs in private equity investing. fficeffice" />

Q1. The most relevant market risk to a private equity investor is:

A)   short-term macro changes only.

B)   long-term macro changes only.

C)   both short-term and long-term macro changes.

Correct answer is B)

Private equity investments are affected to a large degree by long-term macro- factors such as interest rate and exchange rate fluctuations and various market risks. Short-term macro-factors and short-term fluctuations are less relevant as the investor’s time horizon typically exceeds 10 years.

Q2. Private equity values have declined significantly over the last year. Which of the following risk factors is the least likely reason for the decline?

A)   Investment-specific risk.

B)   Market risk.

C)   Tax risk.

Correct answer is C)

Market risk is the risk of long-term changes in interest rates, exchange rates and economic risk. Certainly all of these have been factors in the less than spectacular private equity returns recently. Investment-specific risk is probably the most important source of risk in recent times, as many private equity investments suffered significant losses as a result of the subprime mortgage and real estate meltdown. Tax risk is the risk of tax changes over time, which has not been a significant factor in private equity valuations recently.

Q3. Which of the following pairs correctly identifies the fees paid to agents for raising funds for the private equity firm, and the fees paid to the general partner (GP) for investment banking services, respectively?

                Fees to agents                 Fees to GP

A)    Transaction fees              Administrative costs

B)   Administrative costs         Placement fees

C)     Placement fees             Transaction fees

Correct answer is C)

Placement fees are upfront fees paid to agents for raising funds for the private equity firm. These fees typically are in the 2% range or paid as trailers.

Transaction fees are paid to the GP for investment banking services in the event of a merger or acquisition. Transaction fees are usually split with the limited partners and deducted from management fees.

Administrative costs are various annual costs including custodian fees, fees to transfer agents and accounting costs.

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