LOS s: Critique the conventions and special issues involved in hedge fund performance evaluation, including the use of hedge fund indices and the Sharpe ratio.

Q1. When evaluating hedge funds, special issues that complicate the process would include the fact(s) that:

A)   benchmarks are absolute return in nature and do not address other goals such as the elimination of systematic risk.

B)   benchmarks are designed to be both long and short in nature, but most hedge funds are long only.

C)   many hedge funds are absolute return vehicles for which no benchmark exists, and they can use long/short strategies while most benchmarks are long only in nature.

Q2. When evaluating the performance of a hedge fund that uses leverage, the convention is to:

A)   not attempt to evaluate the fund because the existence of leverage makes such an assessment impossible.

B)   use an optimization model to determine the weights on the book and debt values.

C)   treat an asset as if it were fully paid to effectively “look through” the leverage.

LOS s: Critique the conventions and special issues involved in hedge fund performance evaluation, including the use of hedge fund indices and the Sharpe ratio. fficeffice" />

Q1. When evaluating hedge funds, special issues that complicate the process would include the fact(s) that:

A)   benchmarks are absolute return in nature and do not address other goals such as the elimination of systematic risk.

B)   benchmarks are designed to be both long and short in nature, but most hedge funds are long only.

C)   many hedge funds are absolute return vehicles for which no benchmark exists, and they can use long/short strategies while most benchmarks are long only in nature.

Correct answer is C)

These are two problems in defining and creating benchmarks. One method for addressing problems in defining and creating benchmarks is the use of single and multi-factor models. Thus, factor models do not pose a complication but offer a solution.

Q2. When evaluating the performance of a hedge fund that uses leverage, the convention is to:

A)   not attempt to evaluate the fund because the existence of leverage makes such an assessment impossible.

B)   use an optimization model to determine the weights on the book and debt values.

C)   treat an asset as if it were fully paid to effectively “look through” the leverage.

Correct answer is C)

The conventions for dealing with leverage is to treat an asset as if it were fully paid to effectively “look through” the leverage. When derivatives are included, the same principle of deleveraging is applied.

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

Thx!