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Define investment - Investment is deferred consumption List the four major types of real assets other than land and other types of real estate. - Natural resources, commodities, infrastructure, and intellectual property. List the three major types of alternative investments other than real assets in the CAIA curriculum. - Hedge funds, Private Equity, and Structured Products Name the five structures that differentiate traditional and alternative investments
- Regulatory Structures, Securities Structures, Trading Structures, Compensation Structures, and Institutional Structures. Which of the five structures that differentiate traditional and alternative investments relates to the taxation of an instrument? - Regulatory Structures Name the four return characteristics that differentiate traditional and alternative investments. - Diversification, Illiquidity, Inefficiency, and Nonnormality. Name four major methods of analysis that distinguish the analysis of alternative investments from the analysis of traditional investments. - Return Computation
Methods, Statistical Methods, Valuation Methods, Portfolio Management Methods. Describe an incomplete market. - An incomplete market refers to the lack of investment opportunities that causes market participants to be unable to implement an investment strategy that satisfies their exact preferences such as risk preferences. Define active management. - Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return. What distinguishes use of the term pure arbitrage from the more general usage of the term arbitrage? - Pure arbitrage is risk free, while arbitrage, as a more general term is not risk free. Pure arbitrage is an attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets. Whereas, arbitrage is used to represent efforts to earn superior returns even when risk is present because the long and short positions are not identical assets or are not held over the same time period. What is the term for a private management advisory firm that serves a group of related and ultra-high net worth investors? - Family office
Which of the following participants is LEAST LIKELY to be classified as an outside service provider to a fund: Arbitrageurs, accountants, auditors, or attorneys? - Arbitrageurs List four major legal documents necessary for establishing and managing a hedge fund? - Private-placement memorandum, partnership agreement, subscription agreement, management company operating agreement What is systemic risk? - Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants. What is the acronym for fund vehicles that are regulated and allow retail access of hedge-fund-like investment pools in the European Union? - UCITS In terms of financial regulation, what is the FCA? - Financial Conduct Authority - the primary regulator of financial services in the UK.
What is progressive taxation of income? - Progressive taxation places higher percentage taxation on individuals and corporations with higher incomes. What is the general term denoting compound interest when the interest is not continuously compounding? - Discrete compounding What is the primary challenge that causes difficulty in calculating the return performance of a forward contract or other position that requires no net investment? How is that challenge addressed? - If the forward contract has a starting value of zero, it would cause division by zero. One solution to the problem of computing return for derivatives is to base the return on notional principal. Another is to include collateral. Consider a position in a single forward contract. What distinguishes a fully collateralized position in this forward contract from a partially collateralized position? - A fully collateralized position is paired with a quantity of capital equal in value to the notional principal of the contract whereas a partially collateralized position is paired with a collateral lower in value than the notional value.
combined to form a portfolio, the IRR of the portfolio can vary substantially from an average of the IRRs of the two investments. Is an IRR a dollar-weighted return or a time-weighted return? Why? - The IRR is the primary way of computing a dollar-weighted return. In which scenario will a clawback lead to payments? - A clawback clause, clawback provision or clawback option is designed to return incentive fees to LPs when early profits are followed by subsequent losses. What is the difference between a hard hurdle rate and a soft hurdle rate? - A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate. A soft hurdle rate allows fund managers to earn an incentive fee on all profits, given that the hurdle rate has been achieved. "http://hedgefundlawblog.com/hedge-fund- hurdle-rate.html" Name the assets that are often characterized as traditional by some and as alternatives by others of the following categories: hedge funds, private equity, and real assets. - Hedge Funds - liquid alternative mutual funds Private Equity - close-end funds with illiquid holdings
Real Assets - public real estate and public equities of corporations with performance dominated by stable positions in real assets. Approximately when did average-quality corporate bonds and international equities become commonly viewed as institutional-quality investments in the United States? - Between 1950 to 1980 Name the four major methods of analysis that distinguish the analysis of alternative investments from the analysis of traditional investments. - Return Computation Methods, Statistical Methods, Valuation Methods, Portfolio Management Methods. Define active management. - Active management refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return. In a large financial services organization, what is the name used to denote the people an processes that play a supportive role in the maintenance of accounts and information systems as well as in the clearance and settlement of trades? - Back office operations
What is a qualified majority? - More than 75% of LPs voting to make a decision (e.g., the decision to extend the investment period or the fund's distribution. Is the New York Stock Exchange a secondary or third market? - Secondary market What are the three constraints against achieving alternative investment benefits through liquid products? - 1) Leverage: there is a 300% asset coverage rule that requires a mutual fund to have assets totaling at least three times the total borrowings of the fund, thus limiting borrowing to 33% of assets. UCITS restrictions are even tighter.
- Regulatory constraints on concentration
- Illiquidity constraints What is the general term denoting compound interest when the interest is not continuously compounded? - Discrete compounding An IRR is estimated for a fund based on an initial investment when the fund was created, several annual distributions and an estimate of the fund's value prior to its termination. What type of IRR is this? - Since Inception IRR
An analyst computes the IRR of one alternative to be 20% and another to be 30%. When the analyst combines the cash flows of the two alternatives into a single investment, must the IRR of the combination be greater than 20% and less than 30%? - No. THe answer is not immediately apparent because the IRR of a portfolio of two investments is not generally equal to a value-weighted average of the IRRs of the constituent investments. If the cash flows from two investments are combined to form a portfolio, the IRR of the portfolio can vary substantially from an average of the IRRs of the two investments. Is an IRR a dollar-weighted return or a time-weighted return? Why? - The IRR is the primary method of computing a dollar weighted return. What is the primary cause of the shape of teh J-curve of interim private equity fund returns? - It is caused by a combination of early expense recognition, early loss recognition, and deferred gain recognition. In which scenario will a clawback clause lead to payments? - A clawback clause, clawback provision or clawback option is designed to return incentive fees to LPs when early profits are followed by subsequent losses.
Using statistical termniology, what does the volatility of a return mean? - Volatility is often used synonymously with standard deviation in investments. The covariance between the returns of two financial assets is equal to the product of the standard deviations of the returns of the two assets. What is the primary statistical terminology for this relationship? - The covariance will equal the product of the standard deviations when correlation coefficient is equal to one. What is the value of the beta of the following three investments: a fund that tracks the overall market index, a riskless asset, and a bet at a casino table? - +1, 0, 0 (assuming the casino bet is a traditional bet not based on market outcomes) In the case of a financial asset with returns that have zero autocorrelation, what is the relationship between the variance of the assets daily returns and the variance of the asset's monthly returns? - The variance of the monthly returns are T times the variance of the daily returns where T is the number of trading days in the month. In the case of a financial asset with returns that have autocorrelation approaching +1, what is the relationship between the standard deviation of the asset's monthly returns and the standard deviation of the asset's annual return? - In the perfectly
correlated case the standard deviation of a multiperiod return is proportional to T. In the case the annual vol is 12 times the monthly vol. What is the general statistical issue addressed when the GARCH method is used in a time series analysis of returns? - The tendency of an asset's variance to change through time. Jane studies past prices and volume of trading in major public equities and establishes equity market neutral positions based on her forecasts of prices. Jane consistently outperforms market indices of comparable risk. Does the performance indicate that the equity market is informationally inefficient at the semistrong level? - The underlyin equity market is informationally inefficient at both the weak level and the semi-strong level since an inefficiency at a "lower" level indicates inefficiency at a "higher" level because the underlying information sets are cumulative moving from weak to strong. List two major factors that drive informational market efficiency through facilitating better investment analysis. - 1) Assets will also tend to trade at prices closer to their informationally efficient values when there is easier access to better information.
What makes a binomial tree a recombining tree? - A binomial tree with an upward movement followed by a downward movement that recombines with a pathway with a downward movement and an upward movement. A recombining binomial tree has n+l possible final outcomes for an n period tree, rather than 2^n outcomes. What is the term used to describe a framework for specifying the return or price of an asset based on its risk, as well as future cash flows and payoffs? - Asset pricing model. What is the market portfolio and what is a market-weight? - 1) The market portfolio is a hypothetical portfolio containing all tradable assets in the world.
- The market weight of an asset is the proportion of the total value of that asset to the total value of all asset in the market portfolio. What is an ex post excess return? - A realized return (an observed historical return) expressed as an excess return by subtracting the riskless return from the asset's total return.
What two spot interest rates imply the value of a six-month forward contract from a six-month Treasury bill? - The current six-month and 12-month spot rates are needed to find the six-month forward contract for a six-month Treasury bill. What is the relationship between a forward interest rate and its expected value at settlement under the unbiased expectations hypothesis and the liquidity premium hypothesis? - Under the unbiased expectations hypothesis, forward bond prices (whether implied by spot rates or observed in the forward price of forward contracts) are unbiased predictors of subsequent spot or cash market prices. What are the carrying costs (and benefits) of physical inventory such as a commodity? - The carrying costs of physical inventory include interest (r) and storage (c), the benefit of physical inventory is the convenient yield. Which is more likely to be more liquid, a forward contract or a futures contract? - A futures contract is more likely to be more liquid. What does it mean when a future is marked-to-market? - When a future is marked-to-market, it means that the side of a futures contract that benefits from a price change receives cash from the other side of the contract (and vice versa) throughout the contract's life.
What are the two main differences between the formula for variance and the formula for semivariance? - The semivariance uses a formula otherwise identical to the variance formula except that it only includes the negative deviations in the numerator and a smaller number of observations in the denominator. What are the main differences between the formula for semistandard deviation and target semistandard deviation? - Target semivariance is similar to semivariance except that target semivariance substitutes the investors' target rate of return in place of the asset's mean return. Define tracking error and average tracking error? - 1) Tracking error indicates the dispersion of the returns of an investment relative to a benchmark return, where a benchmark return is the contemporaneous realized return on an index or peer group of comparable risk.
- Average tracking errors imply refers to the average difference between an investment's return relative to its benchmark. In other words, it is the numerator of the information ratio. What is the difference bewteen value at risk and conditional value-at-risk? - 1) Value at risk (VaR or VAR) is the loss figure associated with a particular percentile
of a cumulative loss funtion. In other words, VaR is the maximum loss over a specified time period within a specified probability.
- Conditiona value-at-risk (CVaR), also known as expected tail loss, is the expected loss of the investor given that the VaR has been equaled or exceeded. CVaR will exceed VaR (if the overall maximum potential loss exceeds VaR). Name the two primary approaches for estimating the voaltility used in computing value-at-risk. - 1) Estimate the standard deviation (volatility) as being equal to the asset's historical standard deviation of returns.
- Estimate volatility based on the implied volatilities from option prices. What are the steps invovled in directly estimate VaR from historical data rather than through a parametric technique? - 1) Collect the perecentage price changes
- Rank the gains/losses from the highest to the lowest
- Select the outcome (loss) reflecting the quantile specified by the VaR (e.g., for a VaR based on 95% confidence pick the observation with a loss larger than 95% of the other outcomes). When is Monte Carlo analysis most appropriate as an estimation technique? - It is best used in difficult problems where it is not practical to find expected values and standard deviations using mathematical solutions.
