LOS k: Explain the typical structure of a private equity fund, including the compensation to the fund's sponsor (general partner), and typical timelines.

Q1. Which of the following most likely represents the timeline of a private equity fund?

A)   The commitment period of 5 years, the life of the fund reaching 7-10 years, an option to extend the fund 5 more years.

B)   The commitment period of 2 years, the life of the fund reaching 5 years, an option to extend the fund 3 more years.

C)   The commitment period of 7-10 years, the life of the fund reaching 12-15 years, an option to extend the fund 5 more years.

Q2. Which of the following most likely represents the compensation to a sponsor of a private equity fund?

A)   A management fee of 2% and an incentive fee of 20%.

B)   A management fee of 10% and an incentive fee of 10%.

C)   A management fee of 2% and an incentive fee of 2%.

Q3. In the life of a private equity fund, capital calls represent the:

A)   request for more capital by the fund sponsor from the investors after the commitment period.

B)   request for more capital by the fund sponsor from the investors during the commitment period.

C)   request for more capital by the fund sponsor from the investors at the beginning of the fund prior to the commitment period.

Q4. If a hedge fund goal is the elimination of systematic risk, a problem for the fund in motivating the manager is that:

A)   it is impossible to gauge the degree to which systematic risk has been eliminated.

B)   the standard incentive fee only applies to assets under management and would not reward the elimination of systematic risk.

C)   the standard incentive fee only applies to raw earnings and would not reward the elimination of systematic risk.

Q5. Hedge fund managers with good track records:

A)   usually lower their fees to increase the assets under management.

B)   often demand higher incentive fees.

C)   generally continue to have good track records.

Q6. For hedge funds, the basic incentive fee for managers may not be adequate because:

A)   they are usually too low, e.g., 2% or less.

B)   a manager usually earns a minimum incentive fee regardless of the performance of the fund.

C)   a hedge fund manager may have several goals other than earning a high return, e.g., lowering downside risk.

LOS k: Explain the typical structure of a private equity fund, including the compensation to the fund's sponsor (general partner), and typical timelines. fficeffice" />

Q1. Which of the following most likely represents the timeline of a private equity fund?

A)   The commitment period of 5 years, the life of the fund reaching 7-10 years, an option to extend the fund 5 more years.

B)   The commitment period of 2 years, the life of the fund reaching 5 years, an option to extend the fund 3 more years.

C)   The commitment period of 7-10 years, the life of the fund reaching 12-15 years, an option to extend the fund 5 more years.

Correct answer is A)

The commitment period usually occurs during the first five years when the sponsor gives the capital calls. The expected life of these funds is 7-10 years, and there is often an option to extend the life up to 5 more years.

Q2. Which of the following most likely represents the compensation to a sponsor of a private equity fund?

A)   A management fee of 2% and an incentive fee of 20%.

B)   A management fee of 10% and an incentive fee of 10%.

C)   A management fee of 2% and an incentive fee of 2%.

Correct answer is A)

As a manager, the sponsor gets a management fee and incentive fee. The management fee is usually around 1.5%-2.5%, and is based upon the committed cash and not just the cash already invested. The percent may decline over time based upon the assumption that the sponsor’s work declines over time. The incentive fee is the share of the profits, usually around 20%, that is paid to the manager after the fund has returned the outside investors’ capital.

Q3. In the life of a private equity fund, capital calls represent the:

A)   request for more capital by the fund sponsor from the investors after the commitment period.

B)   request for more capital by the fund sponsor from the investors during the commitment period.

C)   request for more capital by the fund sponsor from the investors at the beginning of the fund prior to the commitment period.

Correct answer is B)

The timeline includes the sponsor getting commitments from the investors at the start of the fund and then giving “capital calls” over the first five years (typically) called the commitment period to bring in the promised cash.

Q4. If a hedge fund goal is the elimination of systematic risk, a problem for the fund in motivating the manager is that:

A)   it is impossible to gauge the degree to which systematic risk has been eliminated.

B)   the standard incentive fee only applies to assets under management and would not reward the elimination of systematic risk.

C)   the standard incentive fee only applies to raw earnings and would not reward the elimination of systematic risk.

Correct answer is C)

There is some controversy concerning fees because a manager may have or should have other goals than simply earning a gross return. For example, the manager may/should be providing limited downside risk and diversification. The basic incentive fee does not reward this service.

Q5. Hedge fund managers with good track records:

A)   usually lower their fees to increase the assets under management.

B)   often demand higher incentive fees.

C)   generally continue to have good track records.

Correct answer is B)

Managers with good track records often demand higher incentive fees. The concern for investors is whether the manager with a good historical record can continue to perform well enough to justify the higher fees.

Q6. For hedge funds, the basic incentive fee for managers may not be adequate because:

A)   they are usually too low, e.g., 2% or less.

B)   a manager usually earns a minimum incentive fee regardless of the performance of the fund.

C)   a hedge fund manager may have several goals other than earning a high return, e.g., lowering downside risk.

Correct answer is C)

The rationale for incentive fees is obvious: encourage the manger to earn higher profits. There is some controversy concerning fees because a manager may have or should have other goals than simply earning a gross return. For example, the manager may/should be providing limited downside risk and diversification. The basic incentive fee does not reward this service.

Q1. Which of the following most likely represents the timeline of a private equity fund?

A)   The commitment period of 5 years, the life of the fund reaching 7-10 years, an option to extend the fund 5 more years.

B)   The commitment period of 2 years, the life of the fund reaching 5 years, an option to extend the fund 3 more years.

C)   The commitment period of 7-10 years, the life of the fund reaching 12-15 years, an option to extend the fund 5 more years.

Q2. Which of the following most likely represents the compensation to a sponsor of a private equity fund?

A)   A management fee of 2% and an incentive fee of 20%.

B)   A management fee of 10% and an incentive fee of 10%.

C)   A management fee of 2% and an incentive fee of 2%.

Q3. In the life of a private equity fund, capital calls represent the:

A)   request for more capital by the fund sponsor from the investors after the commitment period.

B)   request for more capital by the fund sponsor from the investors during the commitment period.

C)   request for more capital by the fund sponsor from the investors at the beginning of the fund prior to the commitment period.

Q4. If a hedge fund goal is the elimination of systematic risk, a problem for the fund in motivating the manager is that:

A)   it is impossible to gauge the degree to which systematic risk has been eliminated.

B)   the standard incentive fee only applies to assets under management and would not reward the elimination of systematic risk.

C)   the standard incentive fee only applies to raw earnings and would not reward the elimination of systematic risk.

Q5. Hedge fund managers with good track records:

A)   usually lower their fees to increase the assets under management.

B)   often demand higher incentive fees.

C)   generally continue to have good track records.

Q6. For hedge funds, the basic incentive fee for managers may not be adequate because:

A)   they are usually too low, e.g., 2% or less.

B)   a manager usually earns a minimum incentive fee regardless of the performance of the fund.

C)   a hedge fund manager may have several goals other than earning a high return, e.g., lowering downside risk

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