FRM Part 1 | Test ID- 0003 | Topic – TVM + Mutual funds | Questions - 50

Answer Sheet
Question 1

Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in
Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In
order to determine how much of the money must be set aside and held for the trip, he should
use the 5% as a:

A) required rate of return.

B) opportunity cost.
C) discount rate.

The correct answer is: C).discount rate.

He needs to figure out how much the trip will cost in one year, and use the 5% as a discount
rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as
a discount rate.

Question 2

Wei Zhang has funds on deposit with Iron Range bank. The funds are currently earning 6%
interest. If he withdraws $15,000 to purchase an automobile, the 6% interest rate can be best
thought of as a(n):

A) financing cost.
B) discount rate.
C) opportunity cost.

The correct answer is: C).opportunity cost.

Since Wei will be foregoing interest on the withdrawn funds, the 6% interest can be best
characterized as an opportunity cost — the return he could earn by postponing his auto
purchase until the future.

Question 3

Vega research has been conducting investor polls for Third State Bank. They have found the
most investors are not willing to tie up their money in a 1-year (2-year) CD unless they receive
at least 1.0% (1.5%) more than they would on an ordinary savings account. If the savings
account rate is 3%, and the bank wants to raise funds with 2-year CDs, the yield must be at
least:
 A) 4.0%, and this represents a required rate of return.
B) 4.5%, and this represents a required rate of return.
C) 4.5%, and this represents a discount rate.

The correct answer is: B).4.5%, and this represents a required rate of return.

Since we are taking the view of the minimum amount required to induce investors to lend funds
to the bank, this is best described as a required rate of return. Based upon the numerical
information, the rate must be 4.5% (= 3.0 + 1.5).

Question 4

The real risk-free rate can be thought of as:

A) approximately the nominal risk-free rate reduced by the expected inflation rate.
B) exactly the nominal risk-free rate reduced by the expected inflation rate.
C) approximately the nominal risk-free rate plus the expected inflation rate.

The correct answer is: A).

The approximate relationship between nominal rates, real rates and expected inflation rates can
be written as:

Nominal risk-free rate = real risk-free rate + expected inflation rate.

Therefore we can rewrite this equation in terms of the real risk-free rate as:

Real risk-free rate = Nominal risk-free rate -expected inflation rate

The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal)

Question 5

Which one of the following statements best describes the components of the required interest
rate on a security?

The nominal risk-free rate, the expected inflation rate, the default risk premium, a
A) liquidity premium and a premium to reflect the risk associated with the maturity of the
security.
The real risk-free rate, the default risk premium, a liquidity premium and a premium
B)
to reflect the risk associated with the maturity of the security.
The real risk-free rate, the expected inflation rate, the default risk premium, a liquidity
C) premium and a premium to reflect the risk associated with the maturity of the
security.
The correct answer is: C).The real risk-free rate, the expected inflation rate, the default risk
premium, a liquidity premium and a premium to reflect the risk associated with the maturity of
the security.

The required interest rate on a security is made up of the nominal rate which is in turn made up
of the real risk-free rate plus the expected inflation rate. It should also contain a liquidity
premium as well as a premium related to the maturity of the security.

Question 6

T-bill yields can be thought of as:

A) nominal risk-free rates because they do not contain an inflation premium.

B) real risk-free rates because they contain an inflation premium.
C) nominal risk-free rates because they contain an inflation premium.

The correct answer is: C).nominal risk-free rates because they contain an inflation premium.

T-bills are government issued securities and are therefore considered to be default risk free.
More precisely, they are nominal risk-free rates rather than real risk-free rates since they
contain a premium for expected inflation.

Question 7

A major brokerage house is currently selling an investment product that offers an 8% rate of
return, compounded monthly. Based on this information, it follows that this investment has:

A) an effective annual rate of 8.00%.

B) a stated rate of 0.830%.
C) a periodic interest rate of 0.667%.

The correct answer is: C).a periodic interest rate of 0.667%.

Periodic rate = 8.0 / 12 = 0.667. Stated rate is 8.0% and effective rate is 8.30%.

Question 8

Which of the following is the most accurate statement about stated and effective annual interest
rates?

A) The stated annual interest rate is used to find the effective annual rate.
 B) The stated rate adjusts for the frequency of compounding.
So long as interest is compounded more than once a year, the stated annual rate will
C)
always be more than the effective rate.

The correct answer is: A).

The effective annual rate, not the stated rate, adjusts for the frequency of compounding. The
nominal, stated, and stated annual rates are all the same thing.

Question 9

What is the effective annual rate if the stated rate is 12% compounded quarterly?

A) 57.35%.
B) 12.55%.
C) 12.00%.

The correct answer is: B).12.55%.

EAR = (1 + 0.12 / 4)4 -1 = 12.55%

Question 10

As the number of compounding periods increases, what is the effect on the annual percentage
rate (APR) and the effective annual rate (EAR)?

A) APR remains the same, EAR increases.

B) APR increases, EAR increases.
C) APR increases, EAR remains the same.

The correct answer is: A).

The APR remains the same since the APR is computed as (interest per period) × (number of
compounding periods in 1 year). As the frequency of compounding increases, the interest rate
per period decreases leaving the original APR unchanged. However, the EAR increases with
the frequency of compounding.

Question 11
A local bank advertises that it will pay interest at the rate of 4.5%, compounded monthly, on
regular savings accounts. What is the effective rate of interest that the bank is paying on these
accounts?

A) 4.65%.
B) 4.50%.
C) 4.59%.

The correct answer is: C).4.59%.

(1 + 0.045 / 12)12 − 1 = 1.0459 − 1 = 0.0459.

Question 12

Given: $1,000 investment, compounded monthly at 12% find the future value after one year.

A) $1,121.35.
B) $1,126.83.
C) $1,120.00.

The correct answer is: B).$1,126.83.

Divide the interest rate by the number of compound periods and multiply the number of years by
the number of compound periods. I = 12 / 12 = 1; N = (1)(12) = 12; PV = 1,000.

Question 13

If $1,000 is invested at the beginning of the year at an annual rate of 48%, compounded
quarterly, what would that investment be worth at the end of the year?

A) $1,048.
B) $4,798.
C) $1,574.

The correct answer is: C).$1,574.

N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = –1,000; CPT → FV = 1,573.52.

Question 14
Jamie Morgan needs to accumulate $2,000 in 18 months. If she can earn 6% at the bank,
compounded quarterly, how much must she deposit today?

A) $1,829.08.
B) $1,832.61.
C) $1,840.45.

The correct answer is: A).

Each quarter of a year is comprised of 3 months thus N = 18 / 3 = 6; I/Y = 6 / 4 = 1.5; PMT = 0;

FV = 2,000; CPT → PV = $1,829.08.

Question 15

Given: an 11% annual rate compounded quarterly for 2 years; compute the future value of
$8,000 today.

A) $9,939.
B) $8,962.
C) $9,857.

The correct answer is: A).

Divide the interest rate by the number of compound periods and multiply the number of years by
the number of compound periods. I = 11 / 4 = 2.75; N = (2)(4) = 8; PV = 8,000.

Question 16

What is the maximum price an investor should be willing to pay (today) for a 10 year annuity
that will generate $500 per quarter (such payments to be made at the end of each quarter),
given he wants to earn 12%, compounded quarterly?

A) $6,440.
B) $11,300.
C) $11,557.

The correct answer is: C).$11,557.

Using a financial calculator: N = 10 × 4 = 40; I/Y = 12 / 4 = 3; PMT = -500; FV = 0; CPT → PV =

11,557.
Question 17

If a $45,000 car loan is financed at 12% over 4 years, what is the monthly car payment?

A) $985.
B) $1,565.
C) $1,185.

The correct answer is: C).$1,185.

N = 4 × 12 = 48; I/Y = 12/12 = 1; PV = - 45,000; FV = 0; CPT → PMT = 1,185.02

Question 18

The value in 7 years of $500 invested today at an interest rate of 6% compounded monthly is
closest to:

A) $780.
B) $750.
C) $760.

The correct answer is: C).$760.

PV = -500; N = 7 × 12 = 84; I/Y = 6/12 = 0.5; compute FV = 760.18

Question 19

Given investors require an annual return of 12.5%, a perpetual bond (i.e., a bond with no
maturity/due date) that pays $87.50 a year in interest should be valued at:

A) $70.
B) $1,093.
C) $700.

The correct answer is: C).$700.

87.50 ÷ 0.125 = $700.

Question 20
A certain investment product promises to pay $25,458 at the end of 9 years. If an investor feels
this investment should produce a rate of return of 14%, compounded annually, what’s the most
he should be willing to pay for it?

A) $9,426.
B) $7,618.
C) $7,829.

The correct answer is: C).$7,829.

N = 9; I/Y = 14; FV = -25,458; PMT = 0; CPT → PV = $7,828.54.

or: 25,458/1.149 = 7,828.54

Question 21

An investor deposits $4,000 in an account that pays 7.5%, compounded annually. How much
will this investment be worth after 12 years?

A) $9,527.
B) $5,850.
C) $9,358.

The correct answer is: A).

N = 12; I/Y = 7.5; PV = -4,000; PMT = 0; CPT → FV = $9,527.

Question 22

If an investor puts $5,724 per year, starting at the end of the first year, in an account earning 8%
and ends up accumulating $500,000, how many years did it take the investor?

A) 87 years.
B) 27 years.
C) 26 years.

The correct answer is: B).27 years.

I/Y = 8; PMT = -5,724; FV = 500,000; CPT → N = 27.

Remember, you must put the pmt in as a negative (cash out) and the FV in as a positive (cash
in) to compute either N or I/Y.
Question 23

If a person needs $20,000 in 5 years from now and interest rates are currently 6% how much do
they need to invest today if interest is compounded annually?

A) $14,945.
B) $14,683.
C) $15,301.

The correct answer is: A).

PV = FV / (1 + r)n = 20,000 / (1.06)5 = 20,000 / 1.33823 = $14,945

N = 5; I/Y = 6%; PMT = 0; FV = $20,000; CPT → PV = -$14,945.16

Question 24

Suppose you are going to deposit $1,000 at the start of this year, $1,500 at the start of next
year, and $2,000 at the start of the following year in an savings account. How much money will
you have at the end of three years if the rate of interest is 10% each year?

A) $4,000.00.
B) $5,346.00.
C) $5,750.00.

The correct answer is: B).$5,346.00.

Future value of $1,000 for 3 periods at 10% = 1,331

Future value of $1,500 for 2 periods at 10% = 1,815
Future value of $2,000 for 1 period at 10% = 2,200
Total = $5,346

N = 3; PV = -$1,000; I/Y = 10%; CPT → FV = $1,331

N = 2; PV = -$1,500; I/Y = 10%; CPT → FV = $1,815
N = 1; PV = -$2,000; I/Y = 10%; CPT → FV = $2,200

Question 25

An annuity will pay eight annual payments of $100, with the first payment to be received one
year from now. If the interest rate is 12% per year, what is the present value of this annuity?
 A) $1,229.97.
B) $556.38.
C) $496.76.

The correct answer is: C).$496.76.

N = 8; I/Y = 12%; PMT = -$100; FV = 0; CPT → PV = $496.76.

Question 26

An investor deposits $10,000 in a bank account paying 5% interest compounded annually.

Rounded to the nearest dollar, in 5 years the investor will have:

A) $12,763.
B) $12,500.
C) $10,210.

The correct answer is: A).

PV = 10,000; I/Y = 5; N = 5; CPT → FV = 12,763.

or: 10,000(1.05)5 = 12,763.

Question 27

An investor purchases a 10-year, $1,000 par value bond that pays annual coupons of $100. If
the market rate of interest is 12%, what is the current market value of the bond?

A) $1,124.
B) $887.
C) $950.

The correct answer is: B).$887.

Note that bond problems are just mixed annuity problems. You can solve bond problems directly
with your financial calculator using all five of the main TVM keys at once. For bond-types of
problems the bond’s price (PV) will be negative, while the coupon payment (PMT) and par value
(FV) will be positive. N = 10; I/Y = 12; FV = 1,000; PMT = 100; CPT → PV = –886.99.

Question 28
Lois Weaver wants to have $1.5 million in a retirement fund when she retires in 30 years. If
Weaver can earn a 9% rate of return on her investments, approximately how much money must
she invest at the end of each of the next 30 years in order to reach her goal?

A) $11,005.
B) $50,000.
C) $28,725.

The correct answer is: A).

Using a financial calculator: N = 30; I/Y = 9; FV = -1,500,000; PV = 0; CPT → PMT = 11,004.52.

Question 29

Which of the following statements about compounding and interest rates is least accurate?

A) Present values and discount rates move in opposite directions.

On monthly compounded loans, the effective annual rate (EAR) will exceed the
B)
annual percentage rate (APR).
All else equal, the longer the term of a loan, the lower will be the total interest you
C)
pay.

The correct answer is: C).All else equal, the longer the term of a loan, the lower will be the
total interest you pay.

Since the proportion of each payment going toward the principal decreases as the original loan
maturity increases, the total dollars interest paid over the life of the loan also increases.

Question 30

Nikki Ali and Donald Ankard borrowed $15,000 to help finance their wedding and reception. The
annual payment loan carries a term of seven years and an 11% interest rate. Respectively, the
amount of the first payment that is interest and the amount of the second payment that is
principal are approximately:

A) $1,468; $1,702.
B) $1,650; $1,468.
C) $1,650; $1,702.

The correct answer is: C).$1,650; $1,702.

Step 1: Calculate the annual payment.

Using a financial calculator (remember to clear your registers): PV = 15,000; FV = 0; I/Y = 11; N
= 7; PMT = $3,183

Step 2: Calculate the portion of the first payment that is interest.

Interest1 = Principal × Interest rate = (15,000 × 0.11) = 1,650

Step 3: Calculate the portion of the second payment that is principal.

Principal1 = Payment − Interest1 = 3,183 − 1,650 = 1,533 (interest calculation is from Step 2)

Interest2 = Principal remaining × Interest rate = [(15,000 − 1.533) × 0.11] = 1,481

Principal2 = Payment − Interest1 = 3,183 − 1,481 = 1,702

Question 31

The First State Bank is willing to lend $100,000 for 4 years at a 12% rate of interest, with the
loan to be repaid in equal semi-annual payments. Given the payments are to be made at the
end of each 6-month period, how much will each loan payment be?

A) $25,450.
B) $32,925.
C) $16,104.

The correct answer is: C).$16,104.

N = 4 × 2 = 8; I/Y = 12/2 = 6; PV = -100,000; FV = 0; CPT → PMT = 16,103.59.

Question 32

An individual borrows $200,000 to buy a house with a 30-year mortgage requiring payments to
be made at the end of each month. The interest rate is 8%, compounded monthly. What is the
monthly mortgage payment?

A) $2,142.39.
B) $1,467.53.
C) $1,480.46.

The correct answer is: B).$1,467.53.

With PV = 200,000; N = 30 × 12 = 360; I/Y = 8/12; CPT → PMT = $1,467.53.

Question 33

Elise Corrs, hedge fund manager and avid downhill skier, was recently granted permission to
take a 4 month sabbatical. During the sabbatical, (scheduled to start in 11 months), Corrs will
ski at approximately 12 resorts located in the Austrian, Italian, and Swiss Alps. Corrs estimates
that she will need $6,000 at the beginning of each month for expenses that month. (She has
already financed her initial travel and equipment costs.) Her financial planner estimates that she
will earn an annual rate of 8.5% during her savings period and an annual rate of return during
her sabbatical of 9.5%. How much does she need to put in her savings account at the end of
each month for the next 11 months to ensure the cash flow she needs over her sabbatical?
Each month, Corrs should save approximately:

A) $2,065.
B) $2,070.
C) $2,080.

The correct answer is: C).$2,080.

This is a two-step problem. First, we need to calculate the present value of the amount she
needs over her sabbatical. (This amount will be in the form of an annuity due since she requires
the payment at the beginning of the month.) Then, we will use future value formulas to
determine how much she needs to save each month.

Step 1:Â Calculate present value of amount required during the sabbatical

Using a financial calculator: Set to BEGIN Mode, then N = 4; I/Y = 9.5 / 12 = 0.79167; PMT =
6,000; FV = 0; CPT → PV = -23,719.

Step 2:Â Calculate amount to save each month

Using a financial calculator: Make sure it is set to END mode, then N = 11; I/Y = 8.5 / 12.0 =
0.70833; PV = 0; FV = 23,719; CPT → PMT= -2,081, or approximately $2,080.

Question 34

How much should an investor have in a retirement account on his 65th birthday if he wishes to
withdraw $40,000 on that birthday and each of the following 14 birthdays, assuming his
retirement account is expected to earn 14.5%?

A) $234,422.
B) $272,977.
C) $274,422.

The correct answer is: C).$274,422.

This is an annuity due so set your calculator to the BGN mode. N = 15; I/Y = 14.5; PMT =
–40,000; FV = 0; CPT → PV = 274,422.50. Switch back to END mode.

Question 35

Steve Hall wants to give his son a new car for his graduation. If the cost of the car is $15,000
and Hall finances 80% of the value of the car for 36 months at 8% annual interest, his monthly
payments will be:

A) $413.
B) $289.
C) $376.

The correct answer is: C).$376.

PV = 0.8 × 15,000 = -12,000; N = 36; I = 8/12 = 0.667; CPT → PMT = 376.

Question 36

John is getting a $25,000 loan, with an 8% annual interest rate to be paid in 48 equal monthly
installments. If the first payment is due at the end of the first month, the principal and interest
values for the first payment are closest to:

Principal Interest
A) Â $443.65Â Â $166.67
B) Â $410.32 $200.00
C) Â $443.65Â Â $200.00

The correct answer is: A).

Calculate the payment first:

N = 48; I/Y = 8/12 = 0.667; PV = 25,000; FV = 0; CPT PMT = 610.32.

Interest = 0.006667 — 25,000 = $166.67; Principal = 610.32 -166.67 = $443.65 .

37.
Robert Jobs, FRM, has historically invested in multiple stocks. After incurring significant losses
on his investments, he decides to liquidate most of his holdings in favor of a mutual fund. Which
of the following best explains why a mutual fund might be better than multiple investments
spread out across several industries?
A. Mutual funds are considered immune from the effects of financial crises
B. Mutual funds are more profitable than individual investments in the long-run
C. Mutual funds allow investors to diversify risks in a way multiple stock investments cannot
D. Mutual funds are easier to manage compared to multiple stock investments
The correct answer is: C).

Mutual funds are very attractive to small investors because of the diversification opportunities
that they offer. It may be difficult to hold enough stocks to shake off all specific risks. And even
though a small investor might be able to create a well-diversified portfolio, transaction costs can
be somewhat overwhelming. A mutual fund provides an avenue where small investors can pool
their resources and realize the fruits of diversification at a low cost.

38.
An investor joins a mutual fund and buys shares at $200 each. In the course of trading, the
fund leads to a capital gain of $15 per share in the first year and a capital loss of $20 per share
in the second year. If the investor decided to sell the shares dunring the second year, what
would be the purchase price for the purpose of calculating the capital gain/loss on the
transaction during the second year?
A. $200
B. $215
C. $195
D. $205
The correct answer is: B).

The investor has to declare a capital gain of $15 in the first year and a capital loss of $20 in the
second year. To avoid double counting, the purchase price must be adjusted to take into
account the capital gains or losses that have already accrued to the investor. By selling the
shares in the second year, only the $15 capital gain has accrued, and thus the purchase price
would be (200 + 15) = $215.

Note: If the investor were to sell during the third year, both the capital gain of $15 and the capital
loss of $20 would have accrued, giving an adjusted purchase price of (200 + 15 – 20) = $195

39.
. Funds that are designed to track a particular equity index such as the S&P 500 are known as:
A. Open-end funds
B. Closed-end funds
C. Index funds
D. Hedge funds
The correct answer is: C).

Index funds are used to track the performance of particular equity indexes, such as the S&P 500
or the FTSE 100. To achieve this, all the shares in the chosen index are bought in amounts
reflective of their weight. That means if XYZ stock has 2% weight in a particular index, 2% of the
tracking portfolio for the index would be invested in XYZ stock.

40.
Michael Bauer wishes to buy shares in a Front-end loaded mutual fund. He is likely to:
A. Pay a front-end purchase fee at the time of purchase
B. Pay a back-end purchase fee at the time of purchase
C. Pay a front-end fee whenever he decides to sell his shares
D. Pay a back-end purchase fee when he decides to sell the shares
The correct answer is: A).

To meet management expenses, sales commissions, administrative costs and other costs,
mutual funds charge a fee for every share sold. Those that charge a fee at the onset are called
front-end loaded mutual funds. Those that charge a fee when an investor decides to sell his
holdings are called back-end loaded mutual funds.

41.
Describe the meaning of hurdle rate in regard to hedge funds.
A. The minimum rate of return necessary for fund managers to be paid
B. The minimum rate of return necessary for the incentive fee to be applicable
C. The maximum minimum rate of return necessary for the incentive fee to be applicable
D. The minimum rate of return required to be earned by hedge funds as per the guidelines of
the SEC
The correct answer is: B).

The hurdle rate is the minimum rate of return that a hedge fund should earn before incentive
fees can be deducted from the net profit, after deducting management fees.

42.
The following statements regarding open-end mutual funds are correct, EXCEPT:
A. The funds offer investors professional management
B. The funds offer investors a guaranteed rate of return
C. Shares are redeemed at net asset value
D. Investors are free to sell their holdings at will
The correct answer is: B).

Mutual funds do not offer a guaranteed rate of return. Rather, the return is in large part hinged
on investment performance.

43.
Consider the following statements regarding closed-end mutual funds:

I. Funds are redeemed at their NAVs

II. Shares at times trade at a premium to the NAV
III. Shares at times trade at a discount from the NAV
IV. The funds offer investors professional management

Which of the statements above is/are correct?

A. Only I is correct
B. Only I and II are correct
C. II, III, and IV only
D. All of the statements are correct
The correct answer is: C).

Shares of closed-end mutual funds are redeemed at their prevailing market values, not at their
NAVs.

Shares of closed-end mutual funds are redeemed at their prevailing market values, not at their
NAVs. All other statements are correct. Shares at times trade at a discount or at a premium
from the NAV, and these funds offer investors professional management.

44.
Proud Mutual Fund had year-end assets worth $335 million and liabilities of $68 million. Given
that there were a total of 100,000 shares outstanding, compute the NAV.
A. 120
B. 2600
C. 1500
D. 2670
The correct answer is: D).

NAV = (335,000,000 - 68,000,000)/100,000 = $2,670

45.
Brighter Market Portfolio had end-year liabilities amounting to $43 million and assets worth $279
million. Given that the fund's NAV was $20, how many shares must have been held in the fund?
A. 5000 shares
B. 11,000,000 shares
C. 11,800,000 shares
D. 10,000,000 shares
The correct answer is: C).

(279,000,000 - 43,000,000)/20 = 11,800,000 shares

46.
When most actively managed mutual funds are compared to a market index such as the S&P
500, they:
A. Beat the market return in most years
B. Underperform the market
C. Generally do not outperform the market
D. Exceed the return earned on index funds
The correct answer is: C).

A large majority of mutual funds may do very well when compared to market indexes, but
generally do not outperform the market. A good explanation usually has much to do with higher
transaction costs in mutual funds.

47.
Transaction costs and management expenses of money market mutual funds may include:
A. Back-end loads
B. Front-end loads
C. 12b-1 charges
D. All the above
The correct answer is: D).

Ownership of a money market mutual fund can include all of the listed expenses.

48.
Which of the following statements is correct regarding hedge funds?
A. Hedge funds are subject to the Investment Company Act of 1940 as well as the Securities
Act of 1933
B. Hedge funds outline their investment agenda in their prospectus
C. Hedge funds must be set up as partnerships and do not have to provide detailed investment
strategies to investors
D. A majority of hedge funds commit to the use of leverage and short-selling, and have a wide
investment latitude including land, derivatives, stocks, currencies, real estate, etc.
The correct answer is: D).

Unlike mutual funds, hedge funds are not subject to regulation by the Securities and Exchange
Commission. They attempt to earn a return from the use of short-selling, leverage, and do not
have to produce prospectuses. In fact, a majority are very secretive of their investment
strategies.

49.
Which of the following financial institutions must provide to all investors the information
regarding portfolio composition?
A. Mutual funds
B. Hedge funds
C. Both mutual funds and hedge funds
D. None of the above
The correct answer is: A).

Although hedge funds do not have to provide details about their investment compositions,
mutual funds are under stricter regulation and must keep investors abreast of strategies and
portfolio composition.
50.
Which of the following best describes the long/short equity hedge fund strategy?
A. Taking a long position in undervalued stocks and a short position in overvalued stocks
B. Taking a long position in overvalued stocks and a long position in undervalued stocks
C. Taking a long position in both overvalued and undervalued stocks
D. Taking a long position in overvalued stocks
The correct answer is: A).

The long/short equity strategy entails taking a long position in stocks that are undervalued and
another short position in overvalued stocks. If stocks in both classes are picked well, the
strategy gives good returns in both bull and bear markets.