mouse123

The fee structure of a hedge fund may lead to biases in performance data because:

A) hedge fund managers are not required to disclose information regarding fee structures.

B) hedge fund managers charge higher fees than managers of traditional funds.

C) fund managers have incentives to take big risks if past performance has been poor.

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Hedge fund managers have the potential to earn more than managers of traditional funds, but this does not bias performance data. Hedge fund managers typically receive a modest base fee (1%) and then a large incentive fee based upon performance. If past performance has been poor, then fund managers feel they have “nothing to lose” and may invest more aggressively.

mouse123

Hedge fund performance data suffers from serious biases that can be attributed to the fact that:

A) there is not a reliable index that tracks hedge fund performance.

B) hedge funds as an asset class have not been in existence long enough to have meaningful performance data.

C) fund managers tend to submit only favorable performance data.

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Hedge funds have been in existence since the early 1990’s, long enough to compile meaningful data. There are several reliable indexes designed to track hedge funds. One of the primary reasons why performance data has biases is that submission is strictly voluntary, so managers tend to only submit impressive performance information.

mouse123

Which of the following statements regarding survivorship bias in hedge funds is most accurate? Survivorship bias tends to:

A) overstate the performance and understate the volatility of hedge funds.

B) overstate both the performance and volatility of hedge funds.

C) understate the performance and overstate the volatility of hedge funds.

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Survivorship bias exists because only the successful hedge funds submit performance data, thus overstating performance when the index is considered to be representative of the entire hedge fund population. Likewise, stable funds tend to succeed, while more volatile funds tend to go out of business, causing the database to tend to understate volatility for hedge funds as an asset class.

mouse123

Survivorship bias is acute with hedge fund databases because hedge:

A) funds experience higher volatility of returns than traditional investments.

B) funds are more highly leveraged than other asset classes.

C) fund managers often do not have to comply with performance presentation standards.

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The main reason behind the survivorship bias problem in hedge fund reporting is that hedge funds are exempt from most SEC regulations, including performance presentation standards. This lack of standards leads to many inconsistencies in reporting that are not present in other asset classes.

mouse123

Only successful, ongoing hedge funds are included in hedge fund databases. The resulting inflation of reported hedge fund performance can be best described as:

A) survivorship bias.

B) asymmetrical returns.

C) self-selection bias.

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Asymmetrical returns refers to the option-like return profiles that result from some hedge fund strategies. Self-selection bias reflects the fact that submission of data by fund managers is voluntary, and they tend to submit only impressive results. Survivorship bias does result from the fact that only successful hedge funds with ongoing operations are included in databases, thus putting an upward bias on the returns of hedge funds as an asset class.

mouse123

Hedge funds are generally not required to publicly disclose their performance, however, some managers choose to make performance information available to the public. This information is then included in hedge fund indexes and some conclusions about the performance of hedge funds can be drawn. Which of the following statements regarding hedge fund performance is least accurate?

A) When measured by standard deviation, hedge funds are less risky than traditional equity investments.

B) In recent years, the Sharpe ratio for hedge funds has been higher than that of most equity investments.

C) The reported volatility of hedge fund returns may be higher than the actual volatility of returns.

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Many assets that are included in a hedge fund portfolio are not actively traded. Managers utilize estimates to report the market value and performance of their hedge funds. Using estimates rather than actual market transactions may result in smoothed pricing, thereby reducing reported volatility.

mouse123

Which of the following statements regarding closely held companies is NOT correct?

A) Closely held companies can be formed as corporations, partnerships, or sole proprietorships.

B) The valuation of closely held companies is straightforward because of the relatively small number of investors.

C) The equity shares of closely held companies are not publicly traded.

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Closely held companies can be structured as one of several legal forms. The shares of closely held companies by definition are not publicly traded and are highly illiquid. Although there may be a small number of investors, the valuation of closely held companies is difficult because shares are illiquid, and there is limited information available.

mouse123

Edward Cloever, CFA, is reviewing a colleague’s first draft of a research report on how the legal environment affects the valuation of closely held companies. Two statements in the report draw Cloever’s attention:
Statement 1: In situations that require a legal determination of a company’s value, market transactions provide a ready estimate for a publicly traded company, but no uniform definition exists for the value of a closely held company.
Statement 2: If two closely held companies are identical in their operations and profitability, but one is structured as a corporation and the other is structured as a partnership, the rational investor should be indifferent between the two companies.
Should Cloever agree or disagree with these two statements?

Statement 1

Statement 2

A) Agree Agree

B) Agree Disagree

C) Disagree Disagree

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Cloever should agree with Statement 1 but disagree with Statement 2. Because their equity shares do not trade in the open market, closely held companies do not have a readily available estimate of their value. Different legal jurisdictions have their own definitions of intrinsic value, fundamental value, and fair value that can become important if litigation arises. A closely held company’s legal structure as a corporation, partnership, or proprietorship affects the rights and responsibilities of the investors, and therefore affects the value of their investments. The investor must take the difference in legal structure into account when evaluating otherwise identical firms.

mouse123

Approaches commonly used in the valuation of closely held companies include all of the following EXCEPT the:

A) comparables approach.

B) fundamental value approach.

C) cost approach.

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The cost approach and the comparables approach are both used in the valuation of closely held companies. The fundamental value approach is a fictitious approach.

mouse123

Regarding closely held companies, the valuation adjustment, due to the lack of a public market for the shares, is called a:

A) marketability discount.

B) marketability premium.

C) minority discount.

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A minority discount would be applied to shares that represent a non-controlling minority interest in a company. Shares of closely held companies are not publicly traded, so the shares should be discounted an appropriate amount to reflect this lack of marketability.