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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.



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.

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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.



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.

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In distressed securities investing, a private equity fund that seeks to partner with the company in which the fund invests would most likely be called:
A)
a vulture fund.
B)
a high yield fund.
C)
an orphan equity fund.



A “vulture fund” is a private equity fund that uses an “active” approach where the fund or investor acquires positions in the company, and the investment gives some measure of control. The investor can then influence and assist the company and then acquire more ownership in the process of any reorganization. By providing services and obtaining a strategic position, the investors create their own opportunity.

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In distressed securities investing, the strategy that focuses on trying to find opportunities where the prospects will improve is called:
A)
a momentum strategy. The goal is to find a firm that has “improvement momentum.”
B)
long-only value investing. Its returns depend on the fact that not all investors can invest in distressed securities.
C)
long-only value investing. Its returns depend on the fact that the market for distressed securities is efficient.



This is the basic principal of long-only value investing in distressed securities.

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In alternative investments, distressed debt arbitrage seeks to earn a return from:
A)
an improvement in the prospects of the firm only.
B)
either the decline of the stock to zero or an improvement in the prospects of the firm.
C)
the decline of the stock to zero only.



Distressed debt arbitrage is the purchasing of a company’s distressed debt while selling the equities short. The investment can earn a return in two ways: 1) if the equity declines or goes to zero the investor gains from the short position but may continue to gain from the long bond position, 2) if the company’s prospects improve, because of the seniority of bond claims, the returns to bond holders should be greater than that of equity holders. The possibility of returns from two events provides a good market opportunity.

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In distressed securities investing, event risk is:
A)
a source of diversification only.
B)
a source of return only.
C)
a source of both return and diversification.



Event risk refers to the fact that the return on a particular investment within this class typically depends on a particular event for a company, and that can provide good diversification.

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In distressed securities investing, the fact that there can be cyclical supply and demand for these investments is associated with:
A)
arbitrage risk.
B)
J-factor risk.
C)
market liquidity risk.



Market liquidity risk refers to the low liquidity and the fact that there can be cyclical supply and demand for these investments.

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In distressed securities investing, the type of risk that is from the human element associated with decisions determined in a court of law is called:
A)
event risk.
B)
decision risk.
C)
J-factor risk.



In J-factor risk, the “J factor” refers to the role that courts and judges can play in the return, and this involves an unpredictable human element.

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Which of the following statements regarding the performance of managed futures is most accurate?
A)
Publicly traded managed futures have performed well on both a stand-alone and portfolio basis.
B)
Privately managed futures have not performed as well as publicly traded funds.
C)
Managed futures have exhibited a positive correlation to equities and bonds during up markets and a negative correlation during falling markets.



The primary benefit to managed futures is the significant diversification potential (i.e., improved Sharpe ratios). For example, some research has even shown that managed futures have exhibited positive correlation to equities and bonds during up markets and negative correlations during falling markets, although the performance seems to be related to specific strategies and time periods. In particular, private funds seem to add value whereas publicly traded funds have performed poorly both stand-alone and in portfolios.

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Which of the following statements regarding how managed futures are typically structured is least accurate?
A)
Commodity pool operators can act as commodity trading advisors who actively manage a pool of futures contracts.
B)
Commodity trading advisors are responsible for actively buying and selling futures contracts.
C)
Commodity trading advisors hire commodity pool operators to manage the pool of futures contracts.



Managed futures programs are typically run by Commodity Pool Operators (CPOs). CPOs can themselves be commodity trading advisors (CTAs) or will hire CTAs to actually manage all or part of the pool. In the United States, both must be registered with the U.S. Commodity Futures Trading Commission and the National Futures Association. Some CTAs may choose to work independently outside of a public or private CPO structure.

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