karoliukas

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.

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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.

karoliukas

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%.

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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.

karoliukas

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.

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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.

karoliukas

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

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

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

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

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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.

karoliukas

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.

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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.

karoliukas

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

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

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

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

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The rationale for incentive fees is obvious: encourage the manager 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.

karoliukas

An investor in private equity needs to prepare for capital calls, which:

A) equal the funds promised at the initiation of the fund and usually occur during the first five years of the fund.

B) is additional money requested by the sponsor as mezzanine financing after the commitment period.

C) occurs at the beginning of the life of the fund before the commitment period.

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This is the definition of capital calls. The investors in private equity usually make commitments at the initiation of the fund. During the first five years, or so, the sponsor gives the capital calls to the investors to get the promised funds.

karoliukas

In making investments in private equity, diversification is:

A) possible by holding a number of positions, but usually only for investors with portfolios over $100 million.

B) possible by holding a number of positions, and the size of the portfolio is not an issue.

C) not possible to any investor.

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Diversification through number of positions can be a problem since commitments are usually large. Usually investors with portfolios well over $100 million can invest in the necessary 5-10 investments needed for diversification.

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.