Reading 34: Alternative Investm....olio Management－LOS t games, otherwise, returns, excess, market

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CFA Institute Area 8-11, 13: Asset Valuation
Session 11: Alternative Investments for Portfolio Management
Reading 34: Alternative Investments Portfolio Management
LOS t: Explain the market opportunities that may be exploited to earn excess returns in derivative markets that are otherwise zero-sum games.

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Which of the following statements concerning derivative portfolios is most accurate?

A) The gross long-term return on actively managed and levered derivative portfolios should be the risk-free rate because derivatives are zero-sum games.

B) The gross long-term return on passively managed and unlevered derivative portfolios should be the risk-free rate because derivatives are zero-sum games.

C) The gross long-term return on passively managed and levered derivative portfolios should be the risk-free rate because the market for derivatives is heavily regulated.

D) The gross long-term return on actively managed and unlevered derivative portfolios should be the risk-free rate because the market for derivatives is heavily regulated.

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Answer and Explanation

This is one of the realities of derivative investing. Thus the active manager must use active strategies and leverage to earn a premium above the risk-free rate.

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Actively managed derivative-based hedge funds try to earn excess returns by:

A) finding pricing relationships that are not in equilibrium only.

B) following momentum strategies only.

C) neither finding pricing relationships that are not in equilibrium nor by following momentum strategies.

D) finding pricing relationships that are not in equilibrium or by following momentum strategies.

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Answer and Explanation

Actively managed funds do try to earn excess returns by finding cases where pricing relationships are not in equilibrium or by following momentum strategies.

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Actively managed derivative-based hedge funds can:

A) only earn the risk-free rate over the long-term.

B) earn a risk premium by taking the opposite position to investors hedging cash portfolios.

C) only earn a zero rate of return over the long-term.

D) only earn a negative return over the long-term.

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Answer and Explanation

This is one of the sources of a risk premium along with using momentum and other strategies.