karoliukas

Jill Tillman, CFA, has a client who wishes to invest in private equity. The client’s total portfolio is $2 million. The client wants to invest $250,000 in private equity, wants to keep the money invested for 7-10 years, and does not need liquidity. Tillman should:

A) not invest the money because it represents too much of the client’s portfolio.

B) invest the client’s money because private equity has the desired properties.

C) not invest the money because private equity requires a longer holding period than specified by the client.

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Private equity has low liquidity. The allocation to this class should be 5% or less with a plan to keep the money invested for 7-10 years. Since the client only has $2 million, the $250,000 (12.5%) requested investment is too large.

karoliukas

Compared to direct investing in commodities, indirect investing is usually considered to be:

A) more convenient.

B) less convenient.

C) just as convenient, which is very convenient.

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This is generally true, but indirect investment via companies that deal in the commodity may provide limited exposure to the performance of the commodity.

karoliukas

Direct investment in commodities has become easier for all investors because of the:

A) increase in hedging activities of managers in firms that produce and/or deal in commodities.

B) the increase in the number of commodity indices.

C) increased number of hedge funds in these markets.

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There has been an increase in the number of indices making it easier for smaller investors to invest in commodities and take derivative positions in commodities.

karoliukas

Compared to indirect investments in commodities, direct investments offer:

A) more exposure to commodity returns but higher carrying costs.

B) less exposure to commodity returns and higher carrying costs.

C) less exposure to commodity returns but lower carrying costs.

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Often indirect investments via investing in a company producing the commodity provide lower exposure because the managers hedge the very exposure the investor seeks. Direct investments in commodities incur costs of storage called carrying costs.

karoliukas

Jill Beaman, CFA, notices that for wheat futures there is a downward-sloping term structure of futures prices. Beaman should recognize that this would be associated with:

A) normal backwardation and a positive roll return.

B) normal backwardation and a negative roll return.

C) contango and a positive roll return.

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Normal backwardation, when it exists, produces a downward-sloping term structure of futures prices. Such a condition predicts a positive roll return. If the term structure is positive, which is a result of contango, the roll return would be negative.

karoliukas

With respect to a commodity futures contract, the collateral return:

A) is the opportunity cost of storing the commodity.

B) is highly correlated with the spot rate.

C) represents the return on a fully hedged commodity position which should be approximately the risk-free rate.

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The collateral return or “collateral yield” is the result of the no-arbitrage assumption that if an investor is long a contract and invests an amount in T-bills that will be equal to the amount required to pay for the required purchase at the maturity of the futures contract. Such a fully-hedge position should earn the risk-free rate.

karoliukas

Jill Beaman, CFA, has recorded the components of the return on a commodity futures contract. The return on the futures contract is $17, the spot return is $9, and the roll return is $5. What is the collateral return?

A) $6.89.

B) $31.00.

C) $3.00.

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Total return = spot return + collateral return + roll return.
Collateral return = total return − spot return − roll return.

$3 = $17 − $9 − $5

karoliukas

Jake Billingsly, CFA, and Paula Sloop, CFA, are investigating alternative investments for their clients. They have both institutional and private wealth clients, and Billingsly and Sloop have investigated the special issues that alternative investments raise for investment advisers of private wealth clients. When compared to institutional clients, Billingsly says that decision risk is higher for private wealth clients, and Sloop says that tax issues are generally more complex for private wealth clients.
Billingsly and Sloop review the principal classes of alternative investments, and they compare the features of real estate, private equity, commodity investments, hedge funds, managed futures, buy-out funds, infrastructure funds, and distressed securities. Some of their clients have been interested in venture capital funds, but Billingsly and Sloop think that buy-out funds may be a better alternative. Compared to venture capital, Billingsly says that buy-out funds tend to have lower leverage. Compared to venture capital, Sloop says that buy-out funds tend to have steadier cash flows.
Some of the institutional clients have held venture capital investments for several years. Billingsly and Sloop anticipate some of these investments are approaching the exit stage. As they look over the investments held by the institutional clients, they anticipate that the institutions’ investments in venture capital will most likely realize their value through one of four ways: i) the entrepreneurs buying out the venture capital investment from the venture capitalists, ii) a merger with another company, iii) an acquisition by another company, or iv) an initial public offering when the company in which the venture capital is invested and goes public (IPO).
Commodities are another area of interest. Many of both the private wealth clients and the institutional investors have asked if commodities would be good hedges against inflation. To accommodate the demand for inflation hedges, Billingsly and Sloop arrange for the clients to take long positions in energy, livestock, industrial metals, and precious metals. They want to use futures contracts that have the potential for the highest roll yield with a buy-and-hold strategy. They specifically focus on the topics of backwardation and contango and plot the roll returns for historical commodity futures over their respective lives. Billingsly and Sloop notice that the returns generally change over the life of each commodity futures contract and take this into account in their investment plans.
Billingsly and Sloop look at different types of hedge funds. They analyze the different styles and the fees the managers charge. They notice that one of the most popular hedge fund strategies attempts to identify overvalued and undervalued equity securities. The strategy takes long and short positions, but the goal of the fund is not necessarily to be market neutral or industry neutral. They find that the fee structures generally have three components. There is also a feature called a high water mark, and they discuss the rationale for the high water mark.Billingsly makes a statement about the decision risk and Sloop makes a statement about tax issues of private wealth clients compared to institutional clients. With respect to these statements:

A) both Billingsly and Sloop are incorrect.

B) Billingsly is correct and Sloop is incorrect.

C) both Billingsly and Sloop are correct.

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When compared to institutional clients, decision risk is higher for private wealth clients, and tax issues are generally more complex for private wealth clients. (Study Session 13, LOS 31.c)

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Billingsly and Sloop compare buy-out funds to venture capital. With respect to the statements they make:

A) Billingsly is correct and Sloop is incorrect.

B) Billingsly is incorrect and Sloop is correct.

C) both Billingsly and Sloop are correct.

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Buy-out funds tend to use more leverage, so Billingsly is wrong, but Sloop is correct in that the cash flows are steadier. (Study Session 13, LOS 31.d)

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Of the ways that Billingsly and Sloop estimate that firms invested in venture capital might exit and realize the value of their investment, the one that is not among the usual methods of exit is:

A) entrepreneurs buying out the venture capital investment from the venture capitalists.

B) an IPO.

C) a merger with another company.

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Mergers, acquisitions and IPOs are the usual methods. Entrepreneurs buying out investors is not a likely method of exit for the venture capitalist. (Study Session 13, LOS 31.h)

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With a futures buy-and-hold strategy, a positive roll yield would be associated with a commodity yield curve that exhibits:

A) backwardation, and the return decreases as it approaches maturity.

B) contango, and the return increases as it approaches maturity.

C) backwardation, and the return increases as it approaches maturity.

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A roll yield from a buy and hold strategy is only possible when there is backwardation. The return increases as the contract approaches maturity. (Study Session 13, LOS 31.n)

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The hedge fund style that Billingsly and Sloop find to be the most popular, and that they describe, would most likely be categorized as:

A) hedged equity.

B) convertible arbitrage.

C) merger arbitrage.

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Identifying overvalued and undervalued securities without focusing on making the fund market or industry neutral is called the hedge equity style. (Study Session 13, LOS 31.p)

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The rationale for the high water mark is to:

A) make sure managers get paid when the value of the fund increases steadily.

B) prevent managers from getting overpaid when the value of the fund increases steadily.

C) prevent managers from getting overpaid when the value of the fund oscillates.

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The high water mark prevents a manager from getting paid twice for the positive increase in the fund’s value. If a fund goes from $10 million in value to $11 million in value, the managers should get paid an incentive fee on the $1 million move. If the $11 million is set as a high water mark, the manager will not be paid an incentive fee if the fund declines below $11 million and then rises back to that value. (Study Session 13, LOS 31.q)

karoliukas

Which of the following commodities is least likely to have returns that are positively correlated with inflation?

A) Corn.

B) Energy.

C) Industrial metals.

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Nonstorable agricultural commodities returns have returns that are negatively correlated to inflation. Storable commodities like energy and metals have returns that are positively correlated with inflation.

karoliukas

As an investment, the commodity energy is:

A) nonstorable and a hedge against inflation.

B) storable and a hedge against inflation.

C) nonstorable but not a hedge against inflation.

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Commodities that are not agricultural products tend to be storable and hedges against inflation. Energy is both storable and its return has been correlated with inflation.