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CFA Level 1 - Alternative Investments Exam Questions and Answers 2024( A+ GRADED 100% VERIFIED).
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CFA Level 1 - Alternative Investments Exam Questions and Answers 2024( A+ GRADED 100% VERIFIED).
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CFA Level 1 - Alternative InvestmentsAlternative investments - ANS Differ from traditional investments (publicly traded stocks, bonds,
cash) both in the types of assets and securities included in this asset class and in the structure
of the investment vehicles in which these assets are held. Includes assets such as real estate
and commodities, or special vehicles such as private equity funds, hedge funds, and ETFs,
giving managers flexibility to use derivatives and leverage, to make investments in illiquid
assets, and to take short positions.
Alternative investments generally have:
-High fees
-Large size of investments
-Low diversification within the portfolio
-high use of leverage
-restrictions on redemptions
Compared to traditional investments, alternative investments exhibit:
-Less liquidity of assets held
-More specialization by investment managers
-Low correlation with traditional investments
-Less regulation and transparency
-More problematic and less available historical return and volatility data
-Different legal issues and tax treatments
Integrating with traditional investments - ANS Risk/return profile of a traditional portfolio can be
improved by adding alternative investments, however there are challenges:
-Getting reliable measures of risk and return
-identifying appropriate allocation
-selecting portfolio managers
Higher returns can be explained by tax advantages for REIT, exploiting mispricings, return
premium for illiquidity, significant use of leverage
Keep in mind:
-returns are averages which may not be representative of returns for subperiods
-volatility and correlation may be understated since values are estimated
-hedge fund index bias upward (self-selection, backfill, survivorship)
-Differences in weightings and constituents in index construction can impact results
Categories of alternative investments - ANS Hedge funds
Private equity funds (LBOs, venture capital)
, Real estate (REIT)
Commodities
Infrastructure
Other
Self-selection bias - ANS Since disclosures of performance data to hedge fund indices is
voluntary, fund managers tend to reveal their performance only if it's impressive
Survivorship bias - ANS The upward bias of returns if data only for currently existing (surviving)
firms is included. Since surviving firms tend to be those that had better-than-average returns,
excluding the returns data for failed firms results in average returns that are biased upward.
Backfill bias - ANS Refers to bias introduced by including the previous performance data for
firms recently added to a benchmark index. Since firms that are newly added to an index must
be those that have survived and done better than average, including their returns for prior years
(w/out including the previous and current returns for funds that have not been added to the
index) tends to bias index returns upward.
Prime brokers - ANS Provide many services including custodial services, administrative
services, money lending, securities lending for short sales, and trading. The complex nature of
hedge fund transactions leads managers to trade through prime brokers.
Hedge funds - ANS Private investment vehicles that manage portfolios of securities and
derivatives positions using a variety of strategies to achieve positive absolute returns
irrespective of the performance of the broad market. Aggressive, not subject to as many
restrictions.
-Private investor partnership where the fund is the general partner and investors are limited
partners, GP receives a base fee (AUM) and an incentive fee (hurdle rate, high water mark
provision), LPs must be qualified investors with a lot of money and liquidity
-strategies = event-driven, relative value, macro, equity hedge
-less than perfect correlation with hedge fund returns and equity returns, giving rise to
diversification opportunities
-use of leverage - magnifies gains and losses
-liquidity is a major concern in valuation
-Due diligence for hedge funds = investment strategy, investment process, competitive
advantage, track record, size and longevity, management style, key-person risk, reputation,
investor relations, plans for growth, return calculation methodology, risk management
Hedge fund returns: absolute vs. relative basis - ANS Absolute = 10%
Relative = 5% above a specific benchmark return
Hedge Fund Lockup period - ANS A time after initial investment during which investor
withdrawals are not allowed.
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