2019 CFA level 3 qbank reading 30 alternative investments portfolio management questions

10/12/2018

Learning Management System

Question #1 of 87
Compared to stocks, direct equity investments in real estate have had:

A) higher volatility of returns.
B) lower volatility of returns.

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C) about the same volatility of returns.

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Question #2 of 87

Which of the following most likely represents the timeline of a private equity fund?

A) The commitment period of 2 years, the life of the fund reaching 5 years, an option to

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extend the fund 3 more years.

B) 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.

C) The commitment period of 5 years, the life of the fund reaching 7-10 years, an option to

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extend the fund 5 more years.

Question #3 of 87

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With respect to managed futures and real estate, legal issues and valuation methods are
special due diligence issues associated with:

A) real estate only.
B) managed futures only.
C) real estate and managed futures.

Question #4 of 87
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In alternative investments, distressed debt arbitrage seeks to earn a return from:

A) an improvement in the prospects of the rm only.
B) either the decline of the stock to zero or an improvement in the prospects of the rm.
C) the decline of the stock to zero only.

Question #5 of 87

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In the due diligence process of selecting an active manager of alternative investments,
"assessing the organization of the manager's rm" means assessing the:

B) stability of the rm and sta turnover.

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A) terms and structure of the investments the manager o ers.

Question #6 of 87

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C) documents (e.g., prospectuses of the investments the manager o ers).

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In the due diligence process of selecting an active manager of alternative investments,

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"assessing the investment process" means assessing the:

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A) stability of the organization and employee turnover.
B) special assets the manager o ers.

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C) competitive edge the manager o ers.

Question #7 of 87
Which of the following statements regarding how managed futures are typically structured is

least accurate?

A) Commodity trading advisors are responsible for actively buying and selling futures
contracts.

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B) Commodity trading advisors hire commodity pool operators to manage the pool of
futures contracts.
C) Commodity pool operators can act as commodity trading advisors who actively manage
a pool of futures contracts.

Question #8 of 87

venture capital investments will receive the promised dividend:

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Compared to common stockholders, investors who use convertible preferred stock to make

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A) only if common stockholders receive a dividend or a disbursement through liquidation.
B) before common stockholders receive a dividend or a disbursement through liquidation.

Question #9 of 87

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C) before common stockholders receive a dividend but not if there is a liquidation.

In distressed securities investing, a private equity fund that seeks to partner with the company

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in which the fund invests would most likely be called:

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A) an orphan equity fund.

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B) a high yield fund.

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C) a vulture fund.

Question #10 of 87
With respect to weighting schemes for hedge fund indices, the weighting schemes:

A) are always based upon assets under management.
B) can be either equally weighted or based upon assets under management.
C) are always equally weighted.

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Question #11 of 87
In making investments in private equity, diversi cation 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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Question #12 of 87

A hedge fund that takes positions in convertible bonds or convertible preferred stock and then
takes other positions in the underlying stock would be most accurately placed in the style

A) distressed securities.
B) equity market neutral.

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C) convertible arbitrage.

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category:

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Question #13 of 87

Special due diligence issues such as valuation, credit analysis, and nancial structure are most

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likely associated with investments:

A) in distressed securities.
B) made indirectly in real estate.
C) in managed futures.

Question #14 of 87
In distressed securities investing, the fact that there can be cyclical supply and demand for
these investments is associated with:
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A) market liquidity risk.
B) J-factor risk.
C) arbitrage risk.

Question #15 of 87
Hedge fund managers with good track records:

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A) generally continue to have good track records.
B) often demand higher incentive fees.

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Question #16 of 87

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C) usually lower their fees to increase the assets under management.

A hedge fund that focuses on earning returns from mergers, spin-o s, and takeovers would be

most accurately placed in which style category?

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C) Hedged equity.

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B) Merger arbitrage.

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A) Equity market neutral.

Question #17 of 87
In the structure of a hedge fund, which of the following is least accurate concerning a lock-up
period? A lock-up period:

A) establishes a cap on new investment.
B) establishes exit windows.
C) establishes a minimum investment period for each investment.

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Question #18 of 87
With respect to the role of alternative assets in a portfolio, it can be best described as exposure
to:

A) unique asset classes and/or special investment strategies.
B) special investment strategies.
C) unique asset classes only.

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Question #19 of 87

Direct investment in commodities has become easier for all investors because of the:

A) increased number of hedge funds in these markets.

B) increase in hedging activities of managers in rms that produce and/or deal in

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commodities.

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C) the increase in the number of commodity indices.

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Question #20 of 87

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Which stage of nancing generally supports further expansion of production and sales?

A) The second stage.

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B) The third stage.
C) The rst stage.

Question #21 of 87
For use in evaluating hedge funds, which of the following is NOT a shortcoming of the Sharpe
ratio?

A) It uses an arbitrary reference return.
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B) It is a stand-alone measure that ignores the diversi cation contributions of a hedge
fund to an overall portfolio.
C) It has had little success in predicting winners.

Question #22 of 87
Compared to indirect investments in commodities, direct investments o er:

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A) less exposure to commodity returns but lower carrying costs.
B) more exposure to commodity returns but higher carrying costs.

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Question #23 of 87

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C) less exposure to commodity returns and higher carrying costs.

Frank Campbell, CFA, has a client who wants to make a venture capital investment. Campbell is
considering recommending convertible preferred. Which of the following is most likely an
advantage of using convertible preferred stock in making an investment in venture capital?

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Convertible preferred stock:

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A) bene ts in the event of a company buyout.

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B) has dividends that can increase.

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C) ranks ahead of debt investors.

Question #24 of 87
With respect to information e ciency and potential for diversi cation, in comparing alternative
investments to exchange traded stocks, the markets for alternative investments are:

A) more informationally e cient and provide more opportunity for diversi cation.
B) less informationally e cient and provide less opportunity for diversi cation.
C) less informationally e cient and provide more opportunity for diversi cation.
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Question #25 of 87
William Jones, CFA, has a client who wants to invest in a hedge fund that has the strategy of
investing in equities and has among its goals the elimination of systematic risk. Jones has found
two funds that he thinks are well run: the Marius Fund that uses an equity market neutral
strategy and the Hera Fund that uses a hedged equity strategy. Given the client's stated
preferences, Jones should recommend:

A) the Hera Fund only.

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B) either fund.

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C) the Marius Fund only.

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Question #26 of 87

With respect to the terms "formative-stage companies" and "expansion-stage companies",
which are considered issuers of venture capital?

A) Formative-stage companies only.

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B) Both formative-stage companies and expansion-stage companies.

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C) Neither formative-stage companies nor expansion-stage companies.

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Question #27 of 87

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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Question #28 of 87
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) invest the client’s money because private equity has the desired properties.
B) not invest the money because private equity requires a longer holding period than
speci ed by the client.

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C) not invest the money because it represents too much of the client’s portfolio.

Question #29 of 87

Bernice Clark, CFA, is analyzing the portfolio of a private wealth client. In the process, Clark

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wants to address special issues that alternative investments raise for her client. The special
issues would:

A) not include measuring the ownership in the client’s corporate bond portfolio and not

include measuring the client’s ownership in closely held companies.

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B) not include measuring the ownership in the client’s corporate bond portfolio but would
include measuring the client’s ownership in closely held companies.

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C) include measuring the ownership in the client’s corporate bond portfolio and the client’s

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ownership in closely held companies.

Question #30 of 87
Diversi cation is one of the major issues that must be addressed when formulating a private
equity investment strategy. To be considered diversi ed, investors must be able to invest in 5
to 10 di erent investments. Which of the following statements regarding private equity is most
accurate?

A) Liquidity is usually not an issue with private equity due to its positive correlation with
equities.

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B) Smaller portfolios can achieve the necessary diversi cation by investing in private
equity funds.
C) The typical private equity investment is usually less than 7 years.

Question #31 of 87
In contrast to venture capital funds, buyout funds usually have:

B) less frequent losses and more upside potential.

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Question #32 of 87

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C) more frequent losses and more upside potential.

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A) less frequent losses and less upside potential.

As an investment, the commodity energy is:

A) nonstorable and a hedge against in ation.

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B) storable and a hedge against in ation.

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C) nonstorable but not a hedge against in ation.

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Question #33 of 87

When added to a portfolio of stocks and bonds, based upon historical performance, we can
expect distressed securities to contribute:

A) diversi cation but not enhanced return.
B) enhanced return but not diversi cation.
C) both enhanced return and diversi cation.

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Question #34 of 87
With respect to adding managed futures investing to a stock and bond portfolio:

A) a trend-following strategy will o er lower diversi cation than a contrarian strategy.
B) a trend-following strategy will o er more diversi cation than a contrarian strategy.
C) a trend-following strategy will o er diversi cation equal to that of a contrarian strategy.

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Question #35 of 87

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Commodities can be categorized into storable and nonstorable. Which category, if any, should
an analyst recommend as a hedge against in ation?

A) Both storable and nonstorable commodities.

C) Nonstorable commodities.

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Question #36 of 87

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B) Storable commodities.

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In contrast to venture capital funds, buyout funds usually have a:

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A) higher level of leverage and earlier and steadier cash ows.
B) lower level of leverage and earlier and steadier cash ows.

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C) higher level of leverage and later and more erratic cash ows.

Question #37 of 87
In the special issues that alternative investments raise for investment advisors of private wealth
clients, with respect to tax issues and suitability:

A) both are explicitly special issues to consider.
B) suitability is a special issue to consider but tax issues are not.
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C) tax issues are a special issue to consider but suitability is not.

Question #38 of 87
As an asset class, over the period from 1996 to 2015, commodities:

A) enhanced the return of an equally weighted stock and bond portfolio due to
commodities’ low correlation with stocks and bonds.
B) underperformed the return of an equally weighted stock and bond portfolio both on an

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absolute and risk adjusted basis.

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C) enhanced the risk adjusted return of an equally weighted stock and bond portfolio due

Question #39 of 87

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to commodities’ low correlation with stocks and bond.

Which of the following would be among the most common compensation structures for the

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manager of a hedge fund?

A) An assets-under-management fee of 1.5% and a lock-up fee of 20%.

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B) An assets-under-management fee of 1.5% and an incentive fee of 20% of the dollar

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return over the initial investment.
C) An assets-under-management fee of 20% and an incentive fee of 1.5% of the dollar

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return over the initial investment.

Question #40 of 87
The structure, explanation of performance data, and style and strategy are special due
diligence issues most associated with:

A) distressed securities.
B) hedge funds.
C) direct real estate investing.
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Question #41 of 87
With respect to due diligence costs and liquidity, in comparing alternative investments to
exchange traded stocks, the markets for alternative investments have:

A) more liquidity and higher due diligence costs.
B) less liquidity and lower due diligence costs.

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C) less liquidity and higher due diligence costs.

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Question #42 of 87

With respect to the operations of a hedge fund, a high water mark is designed to:

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A) prevent a manager from allowing the fund to become so large that it cannot be
managed e ciently and/or use its selected style e ectively.
B) put a cap on the assets-under-management fee.

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C) prevent a manager from being paid twice for the same gains of the fund.

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Question #43 of 87

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

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the manager is that:

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

Question #44 of 87
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When evaluating the performance of a hedge fund that uses leverage, the convention is to:

A) not attempt to evaluate the fund because the existence of leverage makes such an
assessment impossible.
B) treat an asset as if it were fully paid to e ectively “look through” the leverage.
C) use an optimization model to determine the weights on the book and debt values.

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Question #45 of 87
William Jones, CFA, has a client who wants to invest in a hedge fund. Jones might recommend a

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fund of funds instead of a single fund for all of the following reasons EXCEPT a fund of funds:

A) may serve as a better indicator of aggregate performance of hedge funds.
B) would be more liquid.

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Question #46 of 87

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C) would have a lower correlation with equity markets.

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investing EXCEPT:

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Direct equity real estate investing has the following disadvantages over indirect real estate

A) less control over the investment’s performance.

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B) political risk.

C) high commissions.

Question #47 of 87
In distressed securities investing, the strategy that focuses on trying to nd opportunities
where the prospects will improve is called:

A) long-only value investing. Its returns depend on the fact that not all investors can invest
in distressed securities.
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B) long-only value investing. Its returns depend on the fact that the market for distressed
securities is e cient.
C) a momentum strategy. The goal is to nd a rm that has “improvement momentum.”

Question #48 of 87
The convertibilty feature in convertible preferred stock is important because it means that
preferred stockholders:

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A) can block a possible buyout.

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B) can convert their claims to equal those of later investors in the company.

Question #49 of 87

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C) can bene t from a buyout favorable to common stockholders.

Which of the following commodities is least likely to have returns that are positively correlated

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with in ation?

B) Energy.

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A) Corn.

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C) Industrial metals.

Question #50 of 87
With respect to buyers of venture capital, which group represents the rst group to invest in
the company after the initial entrepreneurs and their friends and family?

A) Venture capitalists.
B) Strategic partners.
C) Angel investors.

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Question #51 of 87
Lee Benson, CFA, is considering purchasing stock in a company that produces oil. With respect
to asset class and subgroup, as an alternative investment, this choice would be most accurately
categorized as:

A) an indirect investment in commodities.
B) an indirect investment in real estate.

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C) a direct investment in commodities.

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Question #52 of 87

Which of the following most likely represents the compensation to a sponsor of a private equity
fund?

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A) A management fee of 2% and an incentive fee of 20%.
B) A management fee of 2% and an incentive fee of 2%.

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C) A management fee of 10% and an incentive fee of 10%.

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Question #53 of 87

Ben Leesom, CFA, thinks distressed securities are appropriate for one of his clients and would
like to include them in his client's portfolio. If liquidity is a concern for the client, which

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alternative investment, either private equity or a hedge fund, would be more appropriate?

A) An investment with a hedge fund structure over a private equity structure.
B) Either one since both have approximately the same liquidity.
C) An investment with a private equity structure over a hedge fund structure.

Question #54 of 87

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In distressed securities investing, the type of risk that is from the human element associated
with decisions determined in a court of law is called:

A) decision risk.
B) J-factor risk.
C) event risk.

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Question #55 of 87

A) just as convenient, which is very convenient.
B) less convenient.

Question #56 of 87

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C) more convenient.

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Compared to direct investing in commodities, indirect investing is usually considered to be:

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Which of the following statements regarding what a managed futures trading strategy is called

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and how it is described is least accurate?

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A) Unsystematic – the commodity trading advisor tracks speci c commodity futures
contracts and uses trading rules to signal when to buy and sell the contract.
B) Discretionary – the commodity trading advisor uses their own discretion to buy futures

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contracts they feel are over or undervalued.
C) Systematic – the commodity trading advisor trades according to market trends and may
even use a contrarian strategy which trades against the market trend.

Question #57 of 87
When evaluating hedge funds, special issues that complicate the process would include the
fact(s) that:

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A) many hedge funds are absolute return vehicles for which no benchmark exists, and
they can use long/short strategies while most benchmarks are long only in nature.
B) benchmarks are designed to be both long and short in nature, but most hedge funds
are long only.
C) benchmarks are absolute return in nature and do not address other goals such as the
elimination of systematic risk.

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Question #58 of 87
With respect to the seed and start-up point in the early stage of venture capital, which of the

A) In neither the seed nor start-up point.

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two represents a point where the company has already started generating revenue?

B) Not at the start-up point, but revenue has begun at the seed point.

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Question #59 of 87

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C) Not at the seed point, but revenue has begun at the start-up point.

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investing EXCEPT:

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Direct equity real estate investing has all of the following advantages over indirect real estate

A) the ability to manage geographic diversi cation.

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B) tax deductible expenses.
C) lower information costs.

Question #60 of 87
With respect to hedge fund indices, back- ll bias refers to:

A) the increased in ow of investments to a given fund in an index right after the style of
the index has performed well.

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B) modifying the historical series of the index by replacing the historical returns of recently
dropped funds with the historical returns of new funds added to the index.
C) a hedge fund manager lling in historical values of his/her hedge fund’s performance
when the fund has been selected to be included in an index.

Question #61 of 87

A) equally di cult with VC funds as it is with buyout funds.

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B) more di cult with VC funds than with buyout funds.

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With respect to venture capital (VC) funds and buyout funds, measuring returns accurately is:

Question #62 of 87

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C) less di cult with VC funds than with buyout funds.

Real estate has the National Council of Real Estate Investment Fiduciaries (NCREIF) Property

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Index as its principal benchmark. Which of the following is most accurate?

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A) The volatility of the index has a downward bias.
B) The average return of the index has an upward bias.

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C) The volatility of the index has an upward bias.

Question #63 of 87
With respect to hedge fund indices, survivorship bias:

A) can be as high as 3% to 5% and is probably high for event-driven strategies and lower
for hedged-equity strategies.
B) can be as high as 1.5% to 3% and is probably low for event-driven strategies and higher
for hedged-equity strategies.

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C) can be as high as 1.5% to 3% and is probably high for event-driven strategies and lower
for hedged-equity strategies.

Question #64 of 87
Assessing what a manager's competitive edge is over other managers in a speci c market falls
under which of the following due diligence checkpoints? Assessing the:

A) service providers.

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Question #65 of 87

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C) investment process.

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B) market opportunity o ered.

With respect to hedge fund investing, the net return to an investor in a fund of funds would be
lower than that earned from an individual hedge fund because of:

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A) the extra layer of fees only.

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B) no reason; fund of funds earn returns that are equal to those of individual hedge funds.

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C) both the extra layer of fees and the higher liquidity o ered.

Question #66 of 87
With respect to commodities and managed futures, which have investable indices?

A) Commodities but not managed futures.
B) Both commodities and managed futures.
C) Neither commodities nor managed futures.

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Question #67 of 87
Which of the following is an example of an issuer of venture capital?

A) Large, successful corporations.
B) Formative-stage companies.
C) Venture capitalists.

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Question #68 of 87

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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 rst
ve years of the fund.

B) is additional money requested by the sponsor as mezzanine nancing after the

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commitment period.

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

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Hollis, Ignitowski, Jacobs, and Kelso are four analysts working in a windowless basement o ce

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at Madison Partners, a money manager specializing in alternative investments. They have an
ongoing debate over which alternative-investment vehicle is best. As is often the case in long-

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running feuds, each frequently refers back to a favorite argument.
Hollis: "I like receiving convertible preferred stock for my venture-capital investments because

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my claim is usually senior to those of investors who get in later."
Ignitowski: "Agricultural commodity investments are better, because they provide an in ation
hedge and have traditionally delivered better returns than bonds."
Jacobs: "Private-equity limited partnerships not only limit the potential losses of initial
investors, but also avoid double taxation."
Kelso: "A fund of funds has less survivorship bias than an index, and it rarely falls prey to style
drift."
Opinions about investment classes aside, the four Madison analysts are tasked with performing
due diligence on hedge funds. Hedge funds are notoriously di cult to analyze, and the analysts
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divide up the task, with each focusing on a certain aspect of the due diligence.
Hollis considers the hedge fund's strategy, looking at the investment style as well as the
individual investments to assess whether the fund is likely to outperform not only the market,
but other hedge funds. In this analysis, he also considers the fund's nancial policies and
market risk pro le, using downside deviation rather than standard deviation. Hollis also
considers the age of the fund. He prefers funds that have been around for awhile because
experienced management gives the funds an edge. Lastly, Hollis' duties also include reviewing
the funds' structure, examining who manages, audits, or regulates the fund.
Ignitowski focuses on performance data. Because hedge funds are not well regulated, they

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have a lot of freedom regarding how they present performance data. Ignitowski drills down into
the performance of individual holdings to assess whether the stated returns are accurate. He

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then recalculates cumulative performance data using weekly returns, adjusting when possible
for in ows and out ows. Ignitowski prefers larger funds since they have historically
outperformed smaller funds.

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Jacobs tackles the administrative details, starting with an analysis of the fund's fee structure. He
researches legal issues, including pending lawsuits, regulatory actions, and lock-up provisions.
Jacobs' review also addresses personnel issues, including the amount of sta , turnover rates,
and, when possible, rates of compensation.

Kelso calls investors in the hedge fund for references. He asks about investors' knowledge of

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the managers' investment styles and whether they deviate from the stated style.

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After the four analysts compile their analysis of hedge funds, their due diligence is forwarded

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upstairs to the investment director, Francine Finster. She does not see the analysts' e-mail on
this particular day because she is in conference with Dan Braden, a dot-com millionaire who
retired at 35 with just one goal: becoming a billionaire. Braden considers his portfolio of

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traditional investments – 60 percent large-cap stocks, 20 percent small-cap stocks, and 20
percent bonds -- well-diversi ed for his age and level of wealth, but his knowledge of
alternative investments is not extensive, and he is consulting Madison Partners for help with
that portion of his portfolio.
Braden has high hopes for his portfolio. He wants Finster to nd him an asset class that when
added to a portfolio of stocks and bonds will result in better returns and a higher average

return-to-volatility ratio, while at the same time bringing an additional diversi cation bene t to
the portfolio. Finster promises to look at some indexes and do some research into historical
returns of various asset classes in an attempt to nd this investment, but doubts she can nd
anything that will meet Braden's criteria.
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Looking ahead, Finster expects Braden to be a fairly di cult customer, demanding very high
returns and creative strategies. She decides that he might like the idea of a swap. Finster
prefers interest-rate and commodity swaps but has not been involved in either type of
transaction for a number of months. To refresh her memory, she wrote down some bullet
points comparing the two types of swaps:
The value of an interest-rate swap will change over time if market rates change, but will
not change over time if market rates stay the same, even if prices change.
The value of a commodity swap will change over time regardless of whether market rates
or prices change.
Both interest-rate and commodity swaps have a value of zero initially.

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In the event of a change in market rates, the value of both an interest-rate swap and a

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commodity swap will change.

Question #69 of 87

A) commodity futures.
B) a venture-capital fund.

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The alternative investment Finster added to the Braden portfolio is least likely to be:

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C) a direct real estate investment.

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Question #70 of 87

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Which of the Madison analysts does NOT ignore hedge-fund conventions?

A) Ignitowski, with his opinions about fund size.
B) Hollis, with his measure of fund risk.

C) Hollis, with his opinions about fund age.

Question #71 of 87
Based on historical data from 1996 to 2015, Finster can most likely meet Braden's lofty goals by
investing in:
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A) nothing, because no asset class meets those requirements.
B) venture capital.
C) managed futures.

Question #72 of 87
Which of Finster's notes about swaps is least accurate?

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A) The value of a commodity swap will change over time regardless of whether market
rates or prices change.

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B) The value of an interest-rate swap will change over time if market rates change, but will
not change over time if market rates stay the same, even if prices change.

Question #73 of 87

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c

C) Both interest-rate and commodity swaps have a value of zero initially.

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The Madison due diligence for hedge funds is detailed, but not comprehensive. Which

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traditional aspect of due diligence is neglected?

A) Assessment of the fund's suitability for particular investors.

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B) Analysis of the fund's research expenditures.

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C) Consideration of the fund's use of leverage.

Question #74 of 87
Which of the Madison Partners made the most accurate statement about alternative

investments?

A) Hollis.
B) Ignitowski.
C) Jacobs.
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Question #75 of 87
Style drift and survivorship bias are often mentioned in the analysis of hedge fund
performance. Which of the following statements is most accurate? Fund of funds can serve as
better indicators of aggregate hedge fund performance than hedge fund indices because they
tend to have a lower level of:

A) style drift only.
B) both survivorship bias and style drift.

Question #76 of 87

A) a source of return only.

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c

In distressed securities investing, event risk is:

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C) survivorship bias only.

B) a source of both return and diversi cation.

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C) a source of diversi cation only.

Question #77 of 87

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

A) they are usually too low, e.g., 2% or less.
B) a manager usually earns a minimum incentive fee regardless of the performance of the
fund.
C) a hedge fund manager may have several goals other than earning a high return, e.g.,

lowering downside risk.

Question #78 of 87
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