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Practice Problems 397

PRACTICE PROBLEMS
1. Which of the following is least likely to be considered an alternative investment?
A. Real estate

B. Commodities

C. Long-only equity funds

2. An investor is seeking an investment that can take long and short positions, may
use multi-strategies, and historically exhibits low correlation with a traditional
investment portfolio. The investor’s goals will be best satisfied with an investment
in:
A. real estate.

B. a hedge fund.

C. a private equity fund.

3. Relative to traditional investments, alternative investments are least likely to be

characterized by:
A. high levels of transparency.

B. limited historical return data.

C. significant restrictions on redemptions.

4. Alternative investment funds are typically managed:

A. actively.

B. to generate positive beta return.

C. assuming that markets are efficient.

5. Compared with traditional investments, alternative investments are more likely

to have:
A. greater use of leverage.

B. long-only positions in liquid assets.

C. more transparent and reliable risk and return data.

6. The potential benefits of allocating a portion of a portfolio to alternative invest-

ments include:
A. ease of manager selection.

B. improvement in the portfolio’s risk–return relationship.

C. accessible and reliable measures of risk and return.

7. From the perspective of the investor, the most active approach to investing in
alternative investments is:
A. co-investing.
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398 Learning Module 1 Categories, Characteristics, and Compensation Structures of Alternative Investments

B. fund investing.

C. direct investing.

8. In comparison to other alternative investment approaches, co-investing is most

likely:
A. more expensive.

B. subject to adverse selection bias.

C. the most flexible approach for the investor.

9. Relative to co-investing, direct investing due diligence is most likely:

A. harder to control.

B. more independent.

C. equally thorough.

10. The investment method that typically requires the most thorough due diligence
from an investor is:
A. fund investing.

B. co-investing.

C. direct investing.

11. An alternative investment fund’s hurdle rate is a:

A. rate unrelated to a catch-up clause.

B. tool to protect clients from paying twice for the same performance.

C. minimum rate of return the GP must exceed in order to earn a performance

fee.

12. An investor in a private equity fund is concerned that the general partner can re-
ceive incentive fees in excess of the agreed-on incentive fees by making distribu-
tions over time based on profits earned rather than making distributions only at
exit from investments of the fund. Which of the following is most likely to protect
the investor from the general partner receiving excess fees?
A. high hurdle rate

B. clawback provision

C. lower capital commitment

13. Until the committed capital is fully drawn down and invested, the management
fee for a private equity fund is based on:
A. invested capital.

B. committed capital.

C. assets under management.

14. The distribution method by which profits generated by a fund are allocated be-
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Practice Problems 399

tween LPs and the GP is called:

A. a waterfall.

B. an 80/20 split.

C. a fair division.

15. An American waterfall distributes performance fees on a(n) ___________ basis

and is more advantageous to the ___________.
A. deal-by-deal; LPs

B. aggregate fund; LPs

C. deal-by-deal; GP
 © CFA Institute. For candidate use only. Not for distribution.
422 Learning Module 2 Performance Calculation and Appraisal of Alternative Investments

PRACTICE PROBLEMS
1. The Sharpe ratio is a less-than-ideal performance measure for alternative invest-
ments because:
A. it uses a semi-deviation measure of volatility.

B. returns of alternative assets are not normally distributed.

C. alternative assets exhibit low correlation with traditional asset classes.

2. Which of the following statements regarding private equity performance calcula-

tions is true?
A. The money multiple calculation relies on the amount and timing of cash
flows.

B. The IRR calculation involves the assumption of two rates.

C. Because private equity funds have low volatility, accounting conventions

allow them to use a lagged mark-to-market process.

3. Which of the following statements is not true of mark-to-model valuations?

A. Return volatility may be understated.

B. Returns may be smooth and overstated.

C. A calibrated model will produce a reliable liquidation value.

4. An analyst wanting to assess the downside risk of an alternative investment is

least likely to use the investment’s:
A. Sortino ratio.

B. value at risk (VaR).

C. standard deviation of returns.

5. The following performance data are provided for an alternative investment.

Average Annual Compounded Return
1 Year 3 Years 5 Years Since Inception
5.3% 6.2% 4.7% 4.4%

Assume the maximum drawdown risk is steady at 10.2% over each time period.
Assume the average drawdown risk is steady at 6.8% over each time period.
Using the data provided, calculate the Calmar ratio the way it is typically calcu-
lated. The Calmar ratio is the closest to:
A. 0.46.

B. 0.61.

C. 0.65.

6. United Capital is a hedge fund with USD250 million of initial capital. United
charges a 2% management fee based on assets under management at year end
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Practice Problems 423

and a 20% incentive fee based on returns in excess of an 8% hurdle rate. In its
first year, United appreciates 16%. Assume management fees are calculated using
end-of-period valuation. The investor’s net return assuming the performance fee
is calculated net of the management fee is closest to:
A. 11.58%.

B. 12.54%.

C. 12.80%.

7. Capricorn Fund of Funds invests GBP100 million in each of Alpha Hedge Fund
and ABC Hedge Fund. Capricorn Fund of Funds has a “1 and 10” fee structure.
Management fees and incentive fees are calculated independently at the end of
each year. After one year, net of their respective management and incentive fees,
Capricorn’s investment in Alpha is valued at GBP80 million and Capricorn’s in-
vestment in ABC is valued at GBP140 million. The annual return to an investor in
Capricorn Fund of Funds, net of fees assessed at the fund-of-funds level, is closest
to:
A. 7.9%.

B. 8.0%.

C. 8.1%.

8. The following information applies to Rotunda Advisers, a hedge fund:

■ USD288 million in AUM as of prior year end
■ 2% management fee (based on year-end AUM)
■ 20% incentive fee calculated:

● net of management fee

● using a 5% soft hurdle rate
● using a high-water mark (high-water mark is USD357 million)
■ Current-year fund gross return is 25%.
The total fee earned by Rotunda in the current year is closest to:
A. USD7.20 million.

B. USD20.16 million.

C. USD21.60 million.

9. A hedge fund has the following fee structure:

Annual management fee based on year-end AUM 2%

Incentive fee 20%
Hurdle rate before incentive fee collection starts 4%
Current high-water mark USD610 million

The fund has a value of USD583.1 million at the beginning of the year. After one
year, it has a value of USD642 million before fees. The net percentage return to an
investor for this year is closest to:
A. 6.72%.
 © CFA Institute. For candidate use only. Not for distribution.
424 Learning Module 2 Performance Calculation and Appraisal of Alternative Investments

B. 6.80%.

C. 7.64%.
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Practice Problems 489

PRACTICE PROBLEMS
1. A collateralized loan obligation specialist is most likely to:
A. sell its debt at a single interest rate.

B. cater to niche borrowers in specific situations.

C. rely on diverse risk profiles to complete deals.

2. Private capital is:

A. accurately described by the generic term “private equity.”

B. a source of diversification benefits from both debt and equity.

C. predisposed to invest in both the debt and equity of a client’s firm.

3. The first stage of financing at which a venture capital fund most likely invests is
the:
A. seed stage.

B. mezzanine stage.

C. angel investing stage.

4. A private equity fund desiring to realize an immediate and complete cash exit
from a portfolio company is most likely to pursue:
A. an IPO.

B. a trade sale.

C. a recapitalization.

5. Angel investing capital is typically provided in which stage of financing?

A. Later stage

B. Formative stage

C. Mezzanine stage

6. Private equity funds are most likely to use:

A. merger arbitrage strategies.

B. leveraged buyouts.

C. market-neutral strategies.

7. The majority of real estate property may be classified as either:

A. debt or equity.

B. commercial or residential.

C. direct ownership or indirect ownership.

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490 Learning Module 3 Private Capital, Real Estate, Infrastructure, Natural Resources, and Hedge Funds

8. Which of the following relates to a benefit when owning real estate directly?
A. Taxes

B. Capital requirements

C. Portfolio concentration

9. Which of the following statements regarding mortgage-backed securities is true?

A. Insurance companies prefer the first-loss tranche.

B. When interest rates rise, prepayments will likely accelerate.

C. When interest rates fall, the low-risk senior tranche will amortize more
quickly.

10. Which of the following statements regarding REITs is true?

A. According to GAAP, equity REITs are exempt from reporting earnings per
share.

B. Though equity REIT correlations with other asset classes are typically mod-
erate, they are highest during steep market downturns.

C. The REIT corporation pays taxes on income, and the REIT shareholder pays
taxes on the REIT’s dividend distribution of after-tax earnings.

11. What is the most significant drawback of a repeat sales index to measure returns
to real estate?
A. Sample selection bias

B. Understatement of volatility

C. Reliance on subjective appraisals

12. As the loan-to-value ratio increases for a real estate investment, risk most likely
increases for:
A. debt investors only.

B. equity investors only.

C. both debt and equity investors.

13. Compared with direct investment in infrastructure, publicly traded infrastructure

securities are characterized by:
A. higher concentration risk.

B. more transparent governance.

C. greater control over the infrastructure assets.

14. Which of the following forms of infrastructure investment is the most liquid?
A. An unlisted infrastructure mutual fund

B. A direct investment in a greenfield project

C. An exchange-traded MLP
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Practice Problems 491

15. An investor chooses to invest in a brownfield, rather than a greenfield, infrastruc-

ture project. The investor is most likely motivated by:
A. growth opportunities.

B. predictable cash flows.

C. higher expected returns.

16. The privatization of an existing hospital is best described as:

A. a greenfield investment.

B. a brownfield investment.

C. an economic infrastructure investment.

17. Risks in infrastructure investing are most likely greatest when the project in-
volves:
A. construction of infrastructure assets.

B. investment in existing infrastructure assets.

C. investing in assets that will be leased back to a government.

18. A primary risk to investing in timber is most likely its:

A. high correlation with other asset classes.

B. dependence on an international competitive context.

C. return volatility compounded by financial market exposure.

19. A significant characteristic of farmland distinguishing it from timberland is its:

A. commodity price-driven returns.

B. less flexibility in timing of harvest.

C. value as an offset to other human activities.

20. Which of the following statements about commodity investing is invalid?

A. Few commodity investors trade actual physical commodities.

B. Commodity producers and consumers both hedge and speculate.

C. Commodity indexes are based on the price of physical commodities.

21. An investor seeks a current income stream as a component of total return and
desires an investment that historically has low correlation with other asset class-
es. The investment most likely to achieve the investor’s goals is:
A. timberland.

B. collectibles.

C. commodities.

22. If a commodity’s forward curve is upward sloping and there is little or no conve-
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492 Learning Module 3 Private Capital, Real Estate, Infrastructure, Natural Resources, and Hedge Funds

nience yield, the market is said to be in:

A. backwardation.

B. contango.

C. equilibrium.

23. Which approach is most commonly used by equity hedge strategies?

A. Top down

B. Bottom up

C. Market timing

24. An investor may prefer a single hedge fund to a fund of funds if she seeks:
A. due diligence expertise.

B. better redemption terms.

C. a less complex fee structure.

25. Hedge funds are similar to private equity funds in that both:
A. are typically structured as partnerships.

B. assess management fees based on assets under management.

C. do not earn an incentive fee until the initial investment is repaid.

26. Both event-driven and macro hedge fund strategies use:

A. long–short positions.

B. a top-down approach.

C. long-term market cycles.

27. Hedge fund losses are most likely to be magnified by a:

A. margin call.

B. lockup period.

C. redemption notice period.

28. An equity hedge fund following a fundamental growth strategy uses fundamental
analysis to identify companies that are most likely to:
A. be undervalued.

B. be either undervalued or overvalued.

C. experience high growth and capital appreciation.