2.5. Topic 5: Private Equity. -...

Exam I. CAIA I. 2017.

Pag. 166/300 ©FINANCER TRAINING Alexey De La Loma CFA, CMT, CAIA, FRM, EFA, CFTe

2.5. Topic 5: Private Equity.

146

Mark the correct sentence in relation to the definition of the private equity term as defined in the CAIA

curriculum.

a) The CAIA curriculum includes also public securities.

b) The CAIA curriculum includes also securities that are not equity.

c) Both A and B are correct.

d) Neither B nor B are correct.

Chambers, Anson, Black, and Kazemi, Alternative Investments: CAIA Level I, 3rd edition (John Wiley & Sons, 2015), Chapter 22

147

Private equity is used in the CAIA curriculum as a generic term to encompass four distinct categories or

asset groups, which one of the following is not one of these categories?

a) Venture capital.

b) Buyouts.

c) Mezzanine financing.

d) Corporate debt.


148

According to the CAIA curriculum private equity investments can be divided into three main levels or

layers, which one of the following is not one of these levels?

a) Private equity firms.

b) Private equity funds.

c) Underlying business enterprises.

d) All of the above are true layers.


149

The year a particular private equity fund commences operations is known as its

a) Start-up year.

b) Vintage year.

c) Trigger year.

d) None of the above.


CAIA I. 2017. Exam I.

Alexey De La Loma ©FINANCER TRAINING Pag. 167/300 CFA, CMT, CAIA, FRM, EFA, CFTe

150


asset groups, which one of these categories focuses on equity claims of enterprises that are attempting to

emerge into large firms?

a) Venture capital.

b) Buyouts.

c) Mezzanine financing.

d) Corporate debt.


151

If we define the main stages in the life of corporations as: start-up, growth and mature, determine the

correct sentence that illustrates the difference between venture capital and buyouts.

a) Venture capital funds focus on the start-up stage, while buyouts focus on the growth stage.

b) Venture capital funds focus on the start-up stage, while buyouts focus on the mature stage.

c) Venture capital funds focus on the growth stage, while buyouts focus on the mature stage.



152

Which one of the following sentences regarding the main differences between venture capital and buyouts

is correct?

a) Venture capital funds are idea-driven while buyout funds are operations-driven.

b) In venture capital control of the company is generally not absolute, while in buyout funds this control

is usually absolute.

c) The target return, as measured by the IRR, is higher in venture capital than in buyouts.

d) All of the above.


153

Venture capitalists

a) Invest the capital of their clients in the underlying companies.

b) Invest their own capital in the underlying companies.

c) Both A and B.

d) Neither A nor B.


154

Venture capitalists usually invest in ___________ of the start-up company.

a) Warrants.

b) Convertible notes.

c) Convertible preferred stock.

d) Debentures.




155

Investing in a start-up company is similar to:

a) The purchase of a call option.

b) The sale of a call option.

c) The purchase of a put option.

d) The sale of a put option.


156

According to the CAIA curriculum there are two main types of debt securities in Private Equity:

a) Mezzanine debt and corporate bonds.

b) Mezzanine debt and distressed bonds.

c) Corporate bonds and government bonds.

d) Government bonds and distressed debt.


157

Mezzanine financing, by definition, defies generalization.

a) Some investors, such as commercial banks seek consistent cash flows and preservation of capital

b) Some investors, such as insurance companies seek potential capital appreciation.

c) Some investors, such as LBO firms seek consistent cash flows and preservation of capital.

d) Some investors, such as Mezzanine Limited Partnerships seek potential capital appreciation.


158

All these sentences are related to mezzanine financing. Mark the wrong sentence.

a) Typically, the total return sought by investors in mezzanine financing is in the range of 15% to 20%.

The largest piece of the total return is the coupon rate.

b) The expected rate of return of mezzanine debt is lower than LBO funds but higher than VC funds.

c) The expected rate of return of mezzanine debt is lower than both LBO and VC funds.

d) Mezzanine funds avoid the early negative returns associated with venture capital or leveraged buyout

funds (J-curve).


159

All these sentences are related to mezzanine financing. Mark the wrong sentence.

a) Mezzanine financing is an appropriate financing source for those companies that have a reliable cash

flow. This is in contrast to venture capital.

b) Mezzanine financing does not necessarily involve control of the company, in contrast to an LBO, and

is therefore much more passive than an LBO.

c) Mezzanine financing provides a lower risk profile to an investor than does senior debt.

d) All these sentences are correct.




160

Company A has a simple capital structure with a 70% bank loan and a 30% equity capital structure. Bank

debt is assumed to be cheap, and equity is assumed to be expensive. Unfortunately, a bank may be willing

to lend only up to 70% of the total capital structure of the company. the cost of bank debt is 5%, while the

cost of equity is 20%. Mezzanine debt is not available.

On the other side, company B has the same capital structure than A, but it can include mezzanine debt at a

cost of 10%. In company B, half of the equity capital is replaced with mezzanine debt at a coupon rate of

10%. This makes the equity riskier so the cost of capital increases by 25%.

a) WACC of company A is 9.50% while WACC of company B is 8.75%.

b) WACC of company A is 8.75% while WACC of company B is 9.50%.

c) WACC of company A is 13.00% while WACC of company B is 8.75%.

d) WACC of company A is 9.50% while WACC of company B is 13.00%.




2.6. Topic 6: Structured Products.

161

According to the CAIA curriculum, the primary motivation to the financial structured products is:

a) Risk.

b) Taxation.

c) Liquidity.



162

Which one of the following is not a clear example of a financial structured product?

a) Forwards.

b) Futures.

c) Options.



163

Which one of the following is not a clear example of a financial structured product?

a) CDSs.

b) CMOs.

c) CDOs.



164

CDOs are structures that partition the risk of a portfolio into ownership claims called_________.

a) Seniority divisions.

b) Segments.

c) Tranches.





165

A structured product exists because both the issuer of the structured product and the investor in the

structured product were driven by one or more economic motivations. Which one of the following is

considered as the primary role of structured products from the perspective of a financial economist?

a) Tax Minimization.

b) Market Completion.

c) Liquidity Enhancement.

d) Risk Management.


166

In the real world of uncertainty and asymmetric information, markets are highly incomplete. Incomplete

markets are understood in the context of ____________.

a) States of the World.

b) States of Nature.


d) Neither A nor B are correct.


167

Which one of the following risks tends to have somewhat symmetrical payoff distributions?

a) Credit Risk.

b) Default Risk

c) Equity Risk.

d) Idiosyncratic or Company-Specific Risk.


168

__________________ is dispersion in financial outcomes associated with the failure or potential failure of

a counterparty to fulfill its financial obligations. It generally leads to payoff distributions that are

substantially skewed to the left.

a) Credit Risk.

b) Default Risk.

c) Equity Risk.

d) Idiosyncratic or Company-Specific Risk.


169

Speaking broadly and according to the CAIA curriculum, credit models can be divided into two main

groups.

a) Reduced-form credit models, and reduced-structure credit models.

b) Reduced-structure credit models and structural models.

c) Structural models and reduced-form credit models.





170

According to the CAIA curriculum the expected credit loss of a credit exposure can be expressed

according to the next equation: PD · EAD · LGD. Which one of these three factors specifies the nominal

value of the position that is exposed to default at the time of default?

a) PD.

b) EAD.

c) LGD.



171

According to the CAIA curriculum the expected credit loss of a credit exposure can be expressed

according to the next equation: PD · EAD · LGD. Which one of these three factors specifies percentage of

the credit exposure that the lender ultimately receives through the bankruptcy process and all available

remedies?

a) PD.

b) EAD.

c) LGD.



172

Alpha Bank has extended a $100 million one-year loan at an interest rate of 14% to a client with a BBB

credit rating. Suppose that historical data indicate that the one-year probability of default for firms with a

BBB rating is 7% and that investors are typically able to recover 30% of the notional value of an

unsecured loan to such firms. Determine the expected credit loss and the loss if default actually occurs.

a) Expected credit loss = $7.59 million. Loss if actual default occurs = $30 million.

b) Expected credit loss = $7.59 million. Loss if actual default occurs = $70 million.

c) Expected credit loss = $5.59 million. Loss if actual default occurs = $30 million.

d) Expected credit loss = $5.59 million. Loss if actual default occurs = $70 million.


173

Mark the correct sentence.

a) Although the assumption of risk neutrality by investors is unrealistic, the risk-neutral approach is so

important to finance because we do not need to differentiate between systematic and idiosyncratic

risks.

b) Although the assumption of risk neutrality by investors is unrealistic, the risk-neutral approach is so

important to finance because we do not need to estimate the risk premium required to bear systematic

risk.

c) Although the assumption of risk neutrality by investors is unrealistic, the risk-neutral approach is so

important to finance because, under specific conditions, the prices obtained in a risk-neutral

framework can be theoretically proven to be the same as the prices that would exist in a world of risk-

averse invertors.

d) All of the above are correct.




174

In bond markets, a bond price is often described as being determined by its credit spread (s). If r is the

risk-free rate, and K is the face value of the bond at the end of the period, which one of the following

equation represents the current value of a one-period zero-coupon bond?

a) B(0,1) =K

1 − r − s

b) B(0,1) =K

1 + r + s

c) B(0,1) =K

1 + r − s

d) B(0,1) =K

1 − r + s


175

In which one off the following CDO structures is the entire risk of the portfolio gathered within a special

purpose vehicle, and then distributed to investors through various CDO securities or tranches?

a) Market Value CDO.

b) Arbitrage CDO.

c) Balance Sheet CDO.



176

The key to the use of the CDO structure in the case of credit risk is that a large portion of the financing of

the CDO can be in the form of senior tranches (little credit risk compared to the underlying collateral

portfolio). The high credit ratings given to senior tranches when the underlying collateral consists of non-

investment-grade bonds are based on:

a) The diversification inherent in the collateral portfolio.

b) The credit enhancements, such as a major bank providing additional safety features.


d) A senior tranche cannot be a grade investment if the collateral used to issue that tranche is a non-

investment-grade portfolio.


177

According to the CAIA curriculum, CDOs were born from two streams of asset-backed securities:

a) CLOs and CBOs

b) CMOs and CLOs.

c) CMOs, and CBOs.





178

In most CDOs, there is a three-period life cycle, the three stages are:

a) The tranching period, the revolving period, and the closing period.

b) The ramp-up period, the revolving period, and the amortization period.

c) The ramp-up period, the investment period, and the amortization period.

d) The tranching period, the investing period, and the closing period.


179

In most CDOs, there is a three-period life cycle. During the ________the CDO trust issues securities

(tranches) and uses the proceeds from the CDO note sale to acquire the initial collateral pool (the assets).

The CDO’s trust documents govern what type of assets may be purchased.

a) Amortization period.

b) Revolving period.

c) Ramp-up period.

d) Acquiring collateral period.


180

Most of the tranches of notes issued by the CDO structure receive a(n) _________ rating by a nationally

recognized statistical rating organization, and the equity tranche is usually acquired by the________

a) Investment-grade. Sponsor of the Trust.

b) Non-investment-grade. Sponsor of the Trust.

c) Investment-grade. Sponsor of the Trust.

d) Non-investment-grade. Sponsor of the Trust.


181

According to the CAIA curriculum, equity-linked structured products are distinguished from other

structured products, such as CDOs or MBOs by the following aspect:

a) They are tailored to meet the preferences of the investors and to generate fee revenue for the issuer.

b) They are not usually collateralized with risky assets.

c) They rarely serve as a pass-through or simple tranching of the risks of a long-only exposure to an

asset, such as a risky bond or a loan portfolio.





182

A wrapper is the legal vehicle within which an investment product is offered. According to BNP Paribas

Equities and Derivatives Handbook, there are six examples of structured product wrappers, which one of

the following is not one of these examples?

a) OTC contracts.

b) Life insurance policies.

c) Futures.



183

An investor in a 35% tax bracket on ordinary income invests in a product that earns a pre-tax return of

20%. Determine the after-tax return.

a) 12.04%.

b) 13.00%.

c) 15.94%.

d) 18.41%.


184

An investor in a 35% tax bracket on ordinary income invests in a product that earns a pre-tax return of

20%. Determine the after-tax return if 70 percent of the income is distributed as a capital gain that is taxed

at 40% of the ordinary income tax rate.

a) 12.04%.

b) 13.00%.

c) 15.94%.

d) 18.41%.


185

Consider an investor with a current and anticipated tax rate of 40% who anticipates withdrawing funds in

30 years. If the investor places money into a wrapper that offers tax deferment, how much will the after-

tax annual rate of return improve through use of the wrapper if the pre-tax rate is 10% and the time

horizon is30 years?

a) 9.28%.

b) 8.78%.

c) 8.28%.

d) 7.78%.




2.7. Topic 7: Risk Management and Portfolio Management.

186

From the following list of fund collapses, which one came from an extremely concentrated bet in the

energy markets?

a) Long-Term Capital Management (LTCM).

b) Amaranth Advisors.

c) Carlyle Capital Corporation (CCC).



187

From the following list of fund collapses, which one was not headquartered in Greenwich, Connecticut?






188

From the following list of fund collapses, which one quickly accumulated large losses that led to a margin

call from its prime broker in August 1998 when the Russian government defaulted on the payment of its

outstanding bonds?






189

From the following list of fund collapses, which one was more related to AAA-rated mortgage bonds

issued by Freddie Mac and Fannie Mae?








190

From the following list of fund collapses, which one had two Nobel laureates in economics in its board of

directors?






191

Which one of the following investment strategies is typically disclosed in the various documents provided

to investors prior to their decision to invest in the investment vehicle?

a) Actual Investment Strategy.

b) Stated Investment Strategy.

c) Permitted Investment Strategy.



192

In the financial area of investment strategies and processes, the change through time of a fund’s

investment strategy based on purposeful decisions by the fund manager in an attempt to improve risk-

adjusted performance, is known as:

a) Strategy convergence.

b) Strategy deviations

c) Style drift.

d) Style deviations.


193

Feffer and Kundro studied more than 100 HF liquidations over a 20-year period and attributed _______ of

all fund failures to operational risk.

a) 50%.

b) 45%.

c) 40%.

d) 35%.


194

According to the CAIA curriculum, due diligence consists of seven parts of phases, which one of the

following is not one of these parts?

a) Legal Review.

b) Audit Review.

c) Reference Review.

d) Administrative Review.




195

The two primary information-based explanations for superior investment performance in competitive

markets based on information are:

a) Information gathering and information filtering.

b) Information advantage and information filtering.

c) Information gathering and information advantage.



196

There are several ways that hedge funds can add value. According to the CAIA curriculum, the most

common argument for the source of superior returns is:

a) Offering attractive risk premiums for bearing risks like illiquidity.

b) Exploiting tax advantages.

c) Using available information to identify mispriced assets.



197

A(n) _______________ is a provision that allows investors to withdraw their asset from the fund,

immediately and without penalty, when the identified key personnel are no longer making investment

decisions for the fund.

a) Status Quo Clause.

b) Key Risk-to-Return Clause.

c) Key Contract Clause.

d) correct.


198

Smart beta strategies:

a) Use a market-capitalization weighting scheme.

b) Are objectively linked to one or more characteristics of the underlying assets. These characteristics are

exclusively fundamental

c) Tend to be relatively broad and involve relatively stable portfolio weights.





199

While smart beta strategies are typically focused on adjusting portfolio weights rather than on selection

and omitting securities, there is no bright line that distinguishes smart beta strategies from active alpha-

based strategies. Generally, smart beta strategies have portfolio weights that:

a) Differ moderately from market-capitalization weights.

b) Maintain broad portfolios rather than highly concentrated portfolios.

c) Are based on fixed rules using measurable security characteristics.



200

Investment management using the concepts of alpha and beta is based on an assumption that risk and

abnormal return can be estimated with sufficient reliability to facilitate meaningful decisions. Alpha and

beta are unobservable and are usually estimated using:

a) Historical data.

b) Montecarlo simulation.

c) Quantitative forward models.





141

D

The primary disadvantage of a fund of funds is a second layer of fees imposed by the fund of funds

manager.


142

B

At the end of 2014, Hedge Fund Research estimated that the industry was composed of 8,377 single hedge

funds and 1,724 FoFs. Whereas the number of single-manager hedge funds continues to grow, there has

been consolidation in the funds of funds sector, as there were 2,462 FoFs at the end of 2007.


143

A

For hedge fund investing, due diligence is the process of monitoring and reviewing the management and

operations of a hedge fund manager. This is perhaps one of the most important functions and value-added

features of an FoF manager to consider when deciding between a direct and a delegated hedge fund

investment program.


144

C

According to the CAIA curriculum, the median minimum investment for a single hedge fund is $500,000.


145

A

Because of their offshore registration, many hedge funds and FoFs may be tax inefficient for certain

investors in certain countries. For example, in Germany, most FoFs invest in hedge funds that fail to meet

the extensive notification and disclosure duties requested by the German authorities. As a result, their

gains are subjected to heavy taxation penalties, which ultimately affect the investor.


146

C

Private equity is defined broadly in the CAIA curriculum, to such extent that some securities that are not

equity and some securities that are not equity and some securities that are publicly traded are included in

the category.




147

D


asset groups:

Venture capital (VC).

Buyouts.

Mezzanine financing.

Distressed debt.


148

D

All three sentences are true levels or layers in private equity investments.


149

B

The year a particular private equity fund commences operations is known as its vintage year.


150

A

There are two major types of private equity investments that involve ownership in equity claims: venture

capital and buyouts. Venture capital focuses on equity claims of enterprises that are attempting to emerge

in large firms, whereas buyouts focus on large enterprises that are attempting to transform into being more

profitable.


151

B

Venture capital and buyouts focus on opposite ends of the life of a company. Whereas VC funds target

nascent, start-up companies, buyouts target more established and mature companies.


152

D

All of these sentences regarding the main differences between venture capital funds and buyout funds are

correct.


153

C

Venture capitalists provide financing for start-up companies using their own capital and the capital of their

investors.




154

C

Venture capitalists usually invest in the convertible preferred stock of the start-up company because these

securities are senior to common stock in terms of dividends, voting rights, and liquidation preferences.

Furthermore, venture capitalists have the option to convert their shares to common stock when exiting via

an initial public offering (IPO).


155

A

Investing in a start-up company is similar to the purchase of a call option. If the company fails, the venture

capitalist losses the option premium (the capital invested).


156

B

In the CAIA curriculum we can find two main types of debt related to private equity: mezzanine debt and

distressed debt. These debt instruments can be referred to as private equity due to their equity-like risks.


157

D

Some investors, such as insurance companies, view mezzanine financing as a traditional form of debt, with

consistent cash flows and preservation of capital, while other investors, such as LBO funds, Mezzanine

limited partnerships or commercial banks seek potential capital appreciation.


158

B

In terms of returns, mezzanine financing is below both LBOs and VC because the risk profile is lower.


159

C

Mezzanine financing provides a higher risk profile to an investor than does senior debt because of its

unsecured status, lower credit priority, and equity kicker.


160

A

WACCCompany A = 0.3 ∙ 20% + 0.7 ∙ 5% = 9.50%

WACCCompany B = 0.15 ∙ 20% ∙ 1.25 + 0.15 ∙ 10% + 0.7 ∙ 5% = 8.75%




161

A

Although risk is the primary motivation to the structured products, structuring may be used to differentiate

ownership on attributes other than risk, such as taxation, and liquidity.


162

D

Structured products provide substantially altered risk (or other characteristic) exposures to different

investors. However, forwards, futures, and options would not be commonly described as a structured

product because these derivatives do not provide a substantially altered exposure to the fundamental

characteristics of the underlying asset.


163

A

Although simple credit derivatives, such as credit default swaps (CDSs), are not usually referred to as

structured products, they often serve similar roles. CDSs allow for the cost-effective transfer of default

risk.


164

C

CDOs are structures that partition the risk of a portfolio into ownership claims called tranches, which

different in seniority. More senior tranches tend to be the first to receive cash flows and the last to bear

losses. The tranching of CDOs performs a function quite similar to the capital structure of an operating

corporation.


165

B

A structured product exists because both the issuer of the structured product and the investor in the

structured product were driven by one or more economic motivations. The primary direct motivation of

the issuer is usually to earn fees. The motivation to the buyer could be risk management, tax minimization,

liquidity enhancement, or some other goal. From the perspective of a financial economist, the primary role

of structured products is usually market completion.


166

C

In the real world of uncertainty and asymmetric information, markets are highly incomplete. Incomplete

markets are understood in the context of “states of the world” or “states of nature.”




167

C

In contrast to credit risk, which tends to have payoff distributions that are substantially skewed to the left

(the upside performance of a traditional position exposed to credit risk is limited to the recovery of the

original investment plus the promised yield, whereas the downside performance could lead to the loss of

the entire investment), equity-related risk tends to have somewhat symmetrical payoff distributions.


168

A

Credit risk is dispersion in financial outcomes associated with the failure or potential failure of a

counterparty to fulfill its financial obligations. It generally leads to payoff distributions that are

substantially skewed to the left.


169

C

Speaking broadly, credit models can be divided into two groups: structural models and reduced-form

models. Structural credit models describe credit risk in terms of the risks of the underlying assets and the

financial structures that have claims to the underlying assets. Reduced-form credit models, in contrast, do

not attempt to look at the structural reasons for default risk. Therefore, reduced-form credit models do not

rely extensively on asset volatility or underlying structural details, such as the degree of leverage, to

analyze credit risk.


170

B

In general, the expected credit loss of a credit exposure can be determined by three factors:

PD (Probability of Default).

EAD (Exposure at Default).

LGD (Loss Given Default).


171

D

The converse of LGD is the economic proceeds given default – that is, the recovery rate, which is the

percentage of the credit exposure that the lender ultimately receives through the bankruptcy process and

all available remedies.




172

D

PD = 7%

EAD = $100 ∙ (1 + 0.14) = $114 million

RR = 30%

LGD = 1 − 0.30 = 70%

Expected Credit Loss = 0.07 ∙ $114 ∙ 0.70 = $5.586 million

Loss if defatul actually occurs = 0.70 ∙ $100 = $70 million


173

D

All these three sentences are correct so no explanation is needed.


174

B

In bond markets, a bond price is often described as being determined by its credit spread (s). If r is the

risk-free rate, K is the face value of the bond at the end of the period, the current value of a one-period

zero-coupon bond is represented by the following equation:

B(0,1) =K

1 + r + s


175

D

All of these CDO structures shares the feature that the entire risk of the portfolio is gathered within a

special purpose vehicle, and then distributed to investors through various CDO securities or tranches.


176

C

The key to the use of the CDO structure in the case of credit risk is that a large portion of the financing of

the CDO can be in the form of senior tranches (little credit risk compared to the underlying collateral

portfolio). The high credit ratings given to senior tranches when the underlying collateral consists of non-

investment-grade bonds are based on three primary justifications: (1) the senior position, (2) the

diversification inherent in the collateral portfolio, and (3) credit enhancements, such as a major bank

providing additional safety features.




177

A

Originally, CDOs focused on bonds and were called collateralized bond obligations (CBOs). Following

the heels of CBOs, banks began to realize that they had assets on their balance sheets (e.g. leverage loans)

that could be repackaged into a collateral pool and sold to investors. Hence, collateralized loan obligations

(CLOs) were born in the early 1990s. From these two streams of asset-backed securities, CDOs were born.


178

B

In most CDOs, there is a three-period life cycle: the three stages are the ramp-up period, the revolving

period, and the amortization period.


179

C

In most CDOs, there is a three-period life cycle. During the ramp-up period, the CDO trust issues

securities (tranches) and uses the proceeds from the CDO note sale to acquire the initial collateral pool

(the assets). The CDO’s trust documents govern what type of assets may be purchased.


180

A

Typically, most of the tranches of notes issued by the CDO structure receive an investment-grade rating by

a nationally recognized statistical rating organization, with the exception of highly subordinated fixed-

income tranches to receive any cash flows from the CDO collateral and the first tranche on the hook for

any defaults or lost value of the CDO collateral. Often, the sponsor of the trust holds the equity tranche.


181

D

According to the CAIA curriculum, equity-linked structured products are distinguished from other

structured products, such as CDOs or MBOs by one or more of the following three aspects: (1) they are

tailored to meet the preferences of the investors and to generate fee revenue for the issuer, (2) they are not

usually collateralized with risky assets, and (3) they rarely serve as a pass-through or simple tranching of

the risks of a long-only exposure to an asset, such as a risky bond or a loan portfolio.


182

C

Both OTC contracts and life insurance policies are examples of structure product wrappers that can be

found in the Equities and Derivatives Handbook elaborated by BNP Paribas.




183

B

r∗ = 20%(1 − 0.35) = 13%


184

C

r∗ = 20% ∙ (1 − 0.35) ∙30

100+ 20% ∙ (1 − 0.35 ∙ 0.40) ∙

70

100= 15.94%


185

C

(1 + r∗)N = 1 + [(1 + r)N − 1][1 − T]

(1 + r∗)N = 1 + [(1 + 0.10)30 − 1][1 − 0.40]

(1 + r∗)N = 10.87

r∗ = 10.871/30 − 1 = 8.28%


186

B

Amaranth’s fall from glory came from an extremely concentrated bet in the energy markets. Although

Amaranth was technically a multistrategy hedge fund with positions across multiple asset classes, by 2006

it had developed a large portion of its risk capital to natural gas trading.


187

C

Both Amaranth Advisors and Long-Term Capital Management had their headquarters in Greenwich,

Connecticut.


188

A

As a result of the Russian bond default, there was a sudden and drastic liquidity crisis that caused spreads

to widen across a broad range of markets rather than contract, as LTCM’s models had predicted. The

fund’s positions quickly accumulated large losses that led to a margin call from its prime broker.


189

C

Carlyle Capital Corporation followed a simple strategy: it borrowed money at low short-term interest rate

and invested this money in long-term AAA-rated mortgage bonds issued by Freedie Mac and Fannie Mae.




190

A

LTCM was founded in 1994 by several executives from Salomon Brothers Inc., and its board included two

Nobel Prize winners (Myron Scholes and Robert C. Merton).


191

B

The investment mandate and its stated investment strategy are typically disclosed in the various documents

provided to investors prior to their decision to invest in the investment vehicle.


192

C

Style drift or strategy drift is the change through time of a fund’s investment strategy based on purposeful

decisions by the fund manager in an attempt to improve risk-adjusted performance.


193

A

Feffer and Kundro studied more than 100 HF liquidations over a 20-year period and attributed half of all

fund failures to operational risk. The International Association for Quantitative Finance defines

operational risk as “losses caused by problems with people, processes, technology, or external events.”

Feffer and Kundro argue that structural problems with hedge funds contributed to substantial investor

losses and that these problems could have been prevented by following a comprehensive due diligence

process.


194

B

According to the CAIA curriculum, due diligence consists of seven parts of phases:

Structural Review.

Strategic Review.

Administrative Review.

Performance Review.

Portfolio Risk Review.

Legal Review.

Reference Review.


195

A

The two primary information-based explanations for superior investment performance in competitive

markets based on information: information gathering and information filtering.




196

C

There are several ways that hedge funds can add value, such as offering attractive risk premiums for

bearing risks like illiquidity and exploiting tax advantages. According to the CAIA curriculum, the most

common argument for the source of superior returns is using available information to identify mispriced

assets.


197

D

A key personnel clause is a provision that allows investors to withdraw their asset from the fund,

immediately and without penalty, when the identified key personnel are no longer making investment

decisions for the fund.


198

C

Passively index strategies use a market-capitalization weighting scheme

Smart beta strategies utilize portfolio weights that are objectively linked to one or more measurable

characteristics of the underlying assets. Characteristics used to determine equity portfolio weights can be

based on any fundamental or technical attribute.


199

D

While smart beta strategies are typically focused on adjusting portfolio weights rather than on selection

and omitting securities, there is no bright line that distinguishes smart beta strategies from active alpha-

based strategies. Generally, smart beta strategies have portfolio weights that:

1) Seek to capture an attractive systematic risk premium.

2) Are based on fixed rules using measurable security characteristics.

3) Differ moderately from market-capitalization weights.

4) Maintain broad portfolios rather than highly concentrated portfolios.


200

A

Investment management using the concepts of alpha and beta is based on an assumption that risk and

abnormal return can be estimated with sufficient reliability to facilitate meaningful decisions. Alpha and

beta are unobservable and are usually estimated using historical data.


2.5. Topic 5: Private Equity. -...

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