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Alternative Investments - Alternative Investments Section 2

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21. SHM Capital is a hedge fund with $200 million of initial investment capital. They charge a 3 percent management fee based on assets under management at year-end and a 15 percent incentive fee. In its first year, SHM Capital has a 28 percent return. Assume management fees are calculated using end-of-period valuation. In the second year, the fund value declines to $225 million. In the third year, the fund value increases to $250 million. If the incentive and management fees are calculated independently, and also includes the use of a high watermark, the geometric mean annual return over the three-year period is closest to:

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22. An investor is contemplating investing $1000 million in either Giyani Hedge Fund or Beta Fund of Funds. Beta has a “1.25 and 15” fee structure and invests 15 percent of its assets under management in Giyani. Giyani has a standard “3 and 25” fee structure with no hurdle rate. Management fees are calculated on an annual basis on assets under management at the beginning of the year. Management fees and incentive fees are calculated independently. Giyani has a 30 percent return for the year before management and incentive fees. If an investor invests directly in Giyani Hedge Fund, her return is closest to:

  • Option : B
  • Explanation : Profit of Giyani Hedge Fund before fees = 1000million ∗ 0.3 = $300million.
    Management fee = $1000million ∗ 0.03 = $30million.
    Incentive fee = $300million ∗ 0.25 = $75million.
    Return to the investor =frac {300-30-75}{1000} = 19.5%
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23. An investor is contemplating investing $1000 million in either Giyani Hedge Fund or Beta Fund of Funds. Beta has a “1.25 and 15” fee structure and invests 15 percent of its assets under management in Giyani. Giyani has a standard “3 and 25” fee structure with no hurdle rate. Management fees are calculated on an annual basis on assets under management at the beginning of the year. Management fees and incentive fees are calculated independently. Giyani has a 30 percent return for the year before management and incentive fees. An investor invests in Beta Fund of Funds. The other investments in the Beta portfolio generate the same return before management fees as Giyani Hedge Funds and have the same fee structure as Giyani. Investor’s return is closest to:

  • Option : A
  • Explanation : Return earned by Beta = 1000million ∗ 0.195 = $195million.
    Management fee = $1000million ∗ .0125 = $12.5million.
    Incentive fee = $195million ∗ 0.15 = $29.25million.
    Return to the investor = frac{195 – 12.5 – 29.25}{1000} = 15.33%.
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24. An investor is contemplating investing $1000 million in either Giyani Hedge Fund or Beta Fund of Funds. Beta has a “1.25 and 15” fee structure and invests 15 percent of its assets under management in Giyani. Giyani has a standard “3 and 25” fee structure with no hurdle rate. Management fees are calculated on an annual basis on assets under management at the beginning of the year. Management fees and incentive fees are calculated independently. Giyani has a 30 percent return for the year before management and incentive fees. An investor would choose to invest in Beta Funds of Funds instead of Giyani Hedge funds because of:

  • Option : A
  • Explanation : Funds of funds presumably have some expertise in conducting due diligence on hedge funds and may be able to negotiate more favorable redemption terms than an individual investor in a single hedge fund.
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25. If a quoted market price is available for an emerging market fixed income security, the use of liquidity discounts or “haircuts” is actually:

  • Option : B
  • Explanation : If a quoted market price is available for an emerging markets fixed income security, the use of liquidity discounts or “haircuts” is actually inconsistent with valuation guidance under most generally accepted accounting standards. However, many practitioners believe that liquidity discounts are necessary to reflect fair value.
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Alternative Investments Section 2