AIMs: Describe the common characteristics attributed to hedge funds, and how they differentiate from standard mutual funds. Explain the investment strategies used by hedge funds to generate returns. Discuss how hedge funds grew in popularity and their sub-sequent slowdown in 2008.
Questions:
21.1. Which of the following LEAST applies to (is least characteristic of) the textbook definition of a hedge fund?
a. Low tracking error with respect to the S&P 500 (benchmark) index
b. Low correlation with the S&P 500 (benchmark) index
c. Highly liquid investments so that investors can retrieve their money especially in the first year or two
d. Low leverage and policy restriction against short positions
21.2. Hedge funds frequently create leverage to boost returns, which magnifies their risk. Which of the following is the LEAST effective at creating leverage?
a. Selling credit protection via a credit default swap (CDS)
b. Selling credit protection via a fully-funded credit-linked note (CLN)
c. Taking out a margin loan to buy $10 worth of securities for only $2 (assuming a 20% margin on the security)
d. Using a repossession agreement (repo), where the hedge fund agrees to sell a security to another party for a predetermined price and then buy the security back at a higher price on a specified date in the future
21.3. In 2008, the hedge fund industry experience an "unprecedented" slowdown. According to to Stowell, each of the following was a factor in the 2008 slowdown EXCEPT for:
a. Uncertainty caused counterparties, including prime brokers, to reevaluate the amount and terms of of credit they extended the hedge funds
b. Too many funds bought the same assets: As markets fell, many moved to sell the same assets, sending prices even lower
c. It became hard to value and exit illiquid investments in hard-to-trade assets; e.g., loans, real-estate holdings, and stakes in small, private companies
d. Although absolute performance was strong (positive double digits) for hedge funds in 2008, they performed much worse than the S&P 500
Answers:
Questions:
21.1. Which of the following LEAST applies to (is least characteristic of) the textbook definition of a hedge fund?
a. Low tracking error with respect to the S&P 500 (benchmark) index
b. Low correlation with the S&P 500 (benchmark) index
c. Highly liquid investments so that investors can retrieve their money especially in the first year or two
d. Low leverage and policy restriction against short positions
21.2. Hedge funds frequently create leverage to boost returns, which magnifies their risk. Which of the following is the LEAST effective at creating leverage?
a. Selling credit protection via a credit default swap (CDS)
b. Selling credit protection via a fully-funded credit-linked note (CLN)
c. Taking out a margin loan to buy $10 worth of securities for only $2 (assuming a 20% margin on the security)
d. Using a repossession agreement (repo), where the hedge fund agrees to sell a security to another party for a predetermined price and then buy the security back at a higher price on a specified date in the future
21.3. In 2008, the hedge fund industry experience an "unprecedented" slowdown. According to to Stowell, each of the following was a factor in the 2008 slowdown EXCEPT for:
a. Uncertainty caused counterparties, including prime brokers, to reevaluate the amount and terms of of credit they extended the hedge funds
b. Too many funds bought the same assets: As markets fell, many moved to sell the same assets, sending prices even lower
c. It became hard to value and exit illiquid investments in hard-to-trade assets; e.g., loans, real-estate holdings, and stakes in small, private companies
d. Although absolute performance was strong (positive double digits) for hedge funds in 2008, they performed much worse than the S&P 500
Answers:
