Chapter 26 Test Bank - Static

Student: ___________________________________________________________________________

Multiple Choice Questions

1. ______ are the dominant form of investing in securities markets for most individuals, but ______ have enjoyed a far greater growth
rate in the last decade.

A. Hedge Funds; hedge funds

B. Mutual funds; hedge funds
C. Hedge Funds; mutual funds
D. Mutual funds; mutual funds
E. None of the options are correct.

2. Like mutual funds, hedge funds

A. allow private investors to pool assets to be managed by a fund manager.

B. are commonly organized as private partnerships.
C. are subject to extensive SEC regulations.
D. are typically only open to wealthy or institutional investors.
E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

3. Unlike mutual funds, hedge funds

A. allow private investors to pool assets to be managed by a fund manager.

B. are commonly organized as private partnerships.
C. are subject to extensive SEC regulations.
D. are typically only open to wealthy or institutional investors.
E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

4. Alpha-seeking hedge funds typically ______ relative mispricing of specific securities and ______ broad market exposure.

A. bet on; bet on

B. hedge; hedge
C. hedge; bet on
D. bet on; hedge
E. None of the options are correct.

5. Hedge funds ______ engage in market timing ______ take extensive derivative positions.

A. cannot; and cannot

B. cannot; but can
C. can; and can
D. can; but cannot
E. None of the options are correct.

6. The risk profile of hedge funds ______, making performance evaluation ______.

A. can shift rapidly and substantially; challenging

B. can shift rapidly and substantially; straightforward
C. is stable; challenging
D. is stable; straightforward
E. None of the options are correct.

26-1
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7. Shares in hedge funds are priced

A. at NAV.
B. a significant premium to NAV.
C. a significant discount from NAV.
D. a significant premium to NAV or a significant discount from NAV.
E. None of the options are correct.

8. Hedge funds are typically set up as ______ and provide ______ information about portfolio composition and strategy to their
investors.

A. limited liability partnerships; minimal

B. limited liability partnerships; extensive
C. investment trusts; minimal
D. investment trusts; extensive

9. Hedge funds are ______ transparent than mutual funds because of ______ strict SEC regulation on hedge funds.

A. more; more
B. more; less
C. less; less
D. less; more

10. ______ must periodically provide the public with information on portfolio composition.

A. Hedge funds
B. Mutual funds
C. ADRs
D. Hedge funds and ADRs
E. Hedge funds and mutual funds

11. ______ are subject to the Securities Act of 1933 and the Investment Company Act of 1940 to protect unsophisticated investors.

A. Hedge funds
B. Mutual funds
C. ADRs
D. Hedge funds and ADRs
E. Mutual funds and ADRs

12. Hedge funds traditionally have ______ than 100 investors and ______ to the general public.

A. more; advertise
B. more; do not advertise
C. less; advertise
D. less; do not advertise

13. Hedge funds differ from mutual funds in terms of

A. transparency.
B. investors.
C. investment strategy.
D. liquidity.
E. All of the options are correct.

26-2
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14. Hedge funds may invest or engage in

A. distressed firms.
B. convertible bonds.
C. currency speculation.
D. merger arbitrage.
E. All of the options are correct.

15. Hedge funds are prohibited from investing or engaging in

A. distressed firms.
B. convertible bonds.
C. currency speculation.
D. merger arbitrage.
E. None of the options are correct.

16. Hedge funds often have ______ provisions as long as ______, which preclude redemption.

A. crackdown; 2 months
B. lock-up; 2 months
C. crackdown; several years
D. lock-up; several years
E. None of the options are correct.

17. Hedge fund strategies can be classified as

A. directional or nondirectional.
B. stock or bond.
C. arbitrage or speculation.
D. stock or bond and arbitrage or speculation.
E. directional or nondirectional and stock or bond.

18. A hedge fund pursuing a ______ strategy is betting one sector of the economy will outperform other sectors.

A. directional
B. nondirectional
C. stock or bond
D. arbitrage or speculation
E. None of the options are correct.

19. A hedge fund pursuing a ______ strategy is attempting to exploit temporary misalignments in relative pricing.

A. directional
B. nondirectional
C. stock or bond
D. arbitrage or speculation
E. None of the options are correct.

26-3
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20. A hedge fund pursuing a ______ strategy is trying to exploit relative mispricing within a market but is hedged to avoid taking a
stance on the direction of the broad market.

A. directional
B. nondirectional
C. market neutral
D. arbitrage or speculation
E. nondirectional and market neutral

21. An example of a ______ strategy is the mispricing of a futures contract that must be corrected by contract expiration.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

22. A hedge fund attempting to profit from a change in the spread between mortgages and Treasuries is using a ______ strategy.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

23. If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a relative
value strategy would

A. short sell the Treasury bonds and short sell the mortgage-backed securities.
B. short sell the Treasury bonds and buy the mortgage-backed securities.
C. buy the Treasury bonds and buy the mortgage-backed securities.
D. buy the Treasury bonds and short sell the mortgage-backed securities.
E. None of the options are correct.

24. Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical
duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A. market neutral position.

B. conservative position.
C. bullish position.
D. bearish position.

25. A bet on particular mispricing across two or more securities with extraneous sources of risk, such as general market exposure
hedged away, is a

A. pure play.
B. relative play.
C. long shot.
D. sure thing.
E. relative play and sure thing.

26-4
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26. Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical
duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A. market neutral position.

B. conservative position.
C. bullish position.
D. bearish position.

27. If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a hedge fund pursuing a relative
value strategy would

A. short sell the Treasury bonds and short sell the mortgage-backed securities.
B. short sell the Treasury bonds and buy the mortgage-backed securities.
C. buy the Treasury bonds and buy the mortgage-backed securities.
D. buy the Treasury bonds and short sell the mortgage-backed securities.

28. Statistical arbitrage is a version of a ______ strategy.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

29. ______ uses quantitative techniques, and often automated trading systems, to seek out many temporary misalignments among
securities.

A. Covered interest arbitrage

B. Locational arbitrage
C. Triangular arbitrage
D. Statistical arbitrage
E. All arbitrage

30. Assume that you manage a $3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month.
Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next
30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 14
C. buying 1
D. buying 14
E. selling 6

31. Assume that you manage a $1.3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month.
Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next
30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 6
C. buying 1
D. buying 6
E. selling 4

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32. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.25 and an alpha of 2% per month. Also,
assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,300. If you expect the market to fall within the next 30
days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 8
C. buying 1
D. buying 8
E. selling 6

33. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.3 and an alpha of 2% per month. Also,
assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,500. If you expect the market to fall within the next 30
days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 7
C. buying 1
D. buying 7
E. selling 11

34. Market neutral bets can result in ______ volatility because hedge funds use ______.

A. very low; hedging techniques to eliminate risk

B. low; risk management techniques to reduce risk
C. considerable; risk management techniques to reduce risk
D. considerable; considerable leverage

35. ______ bias arises because hedge funds only report returns to database publishers if they want to.

A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. None of the options are correct.

36. ______ bias arises when the returns of unsuccessful funds are left out of the sample.

A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. None of the options are correct.

37. Performance evaluation of hedge funds is complicated by

A. liquidity premiums.
B. survivorship bias.
C. unreliable market valuations of infrequently-traded assets.
D. merger arbitrage.
E. All of the options are correct.

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38. The previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees is known as a

A. benchmark.
B. water stain.
C. water mark.
D. high water mark.
E. low water mark.

39. The typical hedge fund fee structure is

A. a management fee of 1% to 2%.

B. an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance.
C. a 12-b1 fee of 1%.
D. a management fee of 1% to 2% and an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark
performance.
E. a management fee of 1% to 2% and a 12-b1 fee of 1%.

40. Hedge fund incentive fees are essentially

A. put options on the portfolio with a strike price equal to the current portfolio value.
B. put options on the portfolio with a strike price equal to the expected future portfolio value.
C. call options on the portfolio with a strike price equal to the expected future portfolio value.
D. call options on the portfolio with a strike price equal to the current portfolio value times one plus the benchmark return.
E. straddles.

41. Regarding hedge fund incentive fees, hedge fund managers ______ if the portfolio return is very large and ______ if the portfolio
return is negative.

A. get nothing; get nothing

B. refund the fee; get the fee
C. get the fee; lose nothing except the incentive fee
D. get the fee; lose the management fee
E. None of the options are correct.

42. Hedge funds often employ ______ that require investors to provide ________ notice of their desire to redeem funds.

A. redemption notices; several weeks to several months

B. redemption notices; several hours to several days
C. redemption notices; several days to several weeks
D. lock-up; several years
E. lock-up; several hours

43. Pairs trading is associated with

A. triangular arbitrage.
B. statistical arbitrage.
C. data mining.
D. triangular arbitrage and data mining.
E. statistical arbitrage and data mining.

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44. ________ refers to sorting through huge amounts of historical data to uncover systematic patterns in returns that can be exploited
by traders.

A. Data mining
B. Pairs trading
C. Alpha transfer
D. Beta shifting

45. Hedge fund performance may reflect significant compensation for ________ risk.

A. liquidity
B. systematic
C. unsystematic
D. default
E. unsystematic and default

46. A ________ is an investment fraud in which a manager collects funds from clients, claims to invest those funds on their behalf,
and reports extremely favorable investment returns, but in fact uses the funds for his or her own use.

A. Ponzi scheme
B. bonsai scheme
C. statistical arbitrage scheme
D. pairs trading scheme
E. None of the options are correct.

47. Sadka (2010) shows that exposure to unexpected declines in ________ is an important determinant of average hedge fund returns,
and that the spreads in average returns across funds with the highest and lowest ________ may be as much as 6% annually.

A. market risk; systematic risk

B. market liquidity; liquidity risk
C. unsystematic risk; unique risk
D. default risk; default risk

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 Chapter 26 Test Bank - Static Key

Multiple Choice Questions

1. ______ are the dominant form of investing in securities markets for most individuals, but ______ have enjoyed a far greater growth
rate in the last decade.

A. Hedge Funds; hedge funds

B. Mutual funds; hedge funds
C. Hedge Funds; mutual funds
D. Mutual funds; mutual funds
E. None of the options are correct.

Mutual funds are the dominant form of investing in securities markets for most individuals, and hedge funds have enjoyed a far greater
growth rate in the last decade.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Gradable: automatic
Topic: Hedge funds versus mutual funds

2. Like mutual funds, hedge funds

A. allow private investors to pool assets to be managed by a fund manager.

B. are commonly organized as private partnerships.
C. are subject to extensive SEC regulations.
D. are typically only open to wealthy or institutional investors.
E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

Like mutual funds, hedge funds allow private investors to pool assets to be managed by a fund manager.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Gradable: automatic
Topic: Hedge funds versus mutual funds

3. Unlike mutual funds, hedge funds

A. allow private investors to pool assets to be managed by a fund manager.

B. are commonly organized as private partnerships.
C. are subject to extensive SEC regulations.
D. are typically only open to wealthy or institutional investors.
E. are commonly organized as private partnerships and are typically only open to wealthy or institutional investors.

Unlike mutual funds, hedge funds are commonly organized as private partnerships and are typically only open to wealthy or
institutional investors.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Gradable: automatic
Topic: Hedge funds versus mutual funds

26-9
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4. Alpha-seeking hedge funds typically ______ relative mispricing of specific securities and ______ broad market exposure.

A. bet on; bet on

B. hedge; hedge
C. hedge; bet on
D. bet on; hedge
E. None of the options are correct.

Alpha seeking hedge funds typically bet on relative mispricing of specific securities and hedge broad market exposure.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

5. Hedge funds ______ engage in market timing ______ take extensive derivative positions.

A. cannot; and cannot

B. cannot; but can
C. can; and can
D. can; but cannot
E. None of the options are correct.

Hedge funds can engage in market timing and can take extensive derivative positions.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

6. The risk profile of hedge funds ______, making performance evaluation ______.

A. can shift rapidly and substantially; challenging

B. can shift rapidly and substantially; straightforward
C. is stable; challenging
D. is stable; straightforward
E. None of the options are correct.

The risk profile of hedge funds can shift rapidly and substantially, making performance evaluation challenging.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

26-10
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7. Shares in hedge funds are priced

A. at NAV.
B. a significant premium to NAV.
C. a significant discount from NAV.
D. a significant premium to NAV or a significant discount from NAV.
E. None of the options are correct.

Shares in hedge funds are priced at NAV.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Basic
Gradable: automatic
Topic: Hedge fund characteristics and objectives

8. Hedge funds are typically set up as ______ and provide ______ information about portfolio composition and strategy to their
investors.

A. limited liability partnerships; minimal

B. limited liability partnerships; extensive
C. investment trusts; minimal
D. investment trusts; extensive

Hedge funds are typically set up as limited liability partnerships and provide minimal information about portfolio composition and
strategy to their investors.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

9. Hedge funds are ______ transparent than mutual funds because of ______ strict SEC regulation on hedge funds.

A. more; more
B. more; less
C. less; less
D. less; more

Hedge funds are less transparent than mutual funds because of less strict SEC regulation on hedge funds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

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10. ______ must periodically provide the public with information on portfolio composition.

A. Hedge funds
B. Mutual funds
C. ADRs
D. Hedge funds and ADRs
E. Hedge funds and mutual funds

Mutual funds must periodically provide the public with information on portfolio composition.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge funds versus mutual funds

11. ______ are subject to the Securities Act of 1933 and the Investment Company Act of 1940 to protect unsophisticated investors.

A. Hedge funds
B. Mutual funds
C. ADRs
D. Hedge funds and ADRs
E. Mutual funds and ADRs

Mutual funds are subject to the Securities Act of 1933 and the Investment Company Act of 1940 to protect unsophisticated investors.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge funds versus mutual funds

12. Hedge funds traditionally have ______ than 100 investors and ______ to the general public.

A. more; advertise
B. more; do not advertise
C. less; advertise
D. less; do not advertise

Hedge funds traditionally have less than 100 investors and do not advertise to the general public.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

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13. Hedge funds differ from mutual funds in terms of

A. transparency.
B. investors.
C. investment strategy.
D. liquidity.
E. All of the options are correct.

Funds differ from mutual funds in terms of transparency, investors, investment strategy, and liquidity.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge funds versus mutual funds

14. Hedge funds may invest or engage in

A. distressed firms.
B. convertible bonds.
C. currency speculation.
D. merger arbitrage.
E. All of the options are correct.

Hedge funds may invest or engage in distressed firms, convertible bonds, currency speculation, and merger arbitrage.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

15. Hedge funds are prohibited from investing or engaging in

A. distressed firms.
B. convertible bonds.
C. currency speculation.
D. merger arbitrage.
E. None of the options are correct.

Hedge funds may invest or engage in distressed firms, convertible bonds, currency speculation, and merger arbitrage.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

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16. Hedge funds often have ______ provisions as long as ______, which preclude redemption.

A. crackdown; 2 months
B. lock-up; 2 months
C. crackdown; several years
D. lock-up; several years
E. None of the options are correct.

Hedge funds often have lock-up provisions as long as several years, which preclude redemption.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

17. Hedge fund strategies can be classified as

A. directional or nondirectional.
B. stock or bond.
C. arbitrage or speculation.
D. stock or bond and arbitrage or speculation.
E. directional or nondirectional and stock or bond.

Hedge fund strategies can be classified as directional and nondirectional.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

18. A hedge fund pursuing a ______ strategy is betting one sector of the economy will outperform other sectors.

A. directional
B. nondirectional
C. stock or bond
D. arbitrage or speculation
E. None of the options are correct.

A hedge fund pursuing a directional strategy is betting one sector of the economy will outperform other sectors.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

26-14
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19. A hedge fund pursuing a ______ strategy is attempting to exploit temporary misalignments in relative pricing.

A. directional
B. nondirectional
C. stock or bond
D. arbitrage or speculation
E. None of the options are correct.

A hedge fund pursuing a nondirectional strategy is attempting to exploit temporary misalignments in relative pricing.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

20. A hedge fund pursuing a ______ strategy is trying to exploit relative mispricing within a market but is hedged to avoid taking a
stance on the direction of the broad market.

A. directional
B. nondirectional
C. market neutral
D. arbitrage or speculation
E. nondirectional and market neutral

A hedge fund pursuing a market neutral strategy is trying to exploit relative mispricing within a market, but is hedged to avoid taking
a stance on the direction of the broad market.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

21. An example of a ______ strategy is the mispricing of a futures contract that must be corrected by contract expiration.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

An example of a convergence strategy is the mispricing of a futures contract that must be corrected by contract expiration.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

26-15
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22. A hedge fund attempting to profit from a change in the spread between mortgages and Treasuries is using a ______ strategy.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

A hedge fund attempting to profit from a change in the spread between mortgages and Treasuries is using a relative value strategy.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

23. If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a relative
value strategy would

A. short sell the Treasury bonds and short sell the mortgage-backed securities.
B. short sell the Treasury bonds and buy the mortgage-backed securities.
C. buy the Treasury bonds and buy the mortgage-backed securities.
D. buy the Treasury bonds and short sell the mortgage-backed securities.
E. None of the options are correct.

If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a nondirectional
strategy would short sell the Treasury bonds and buy the mortgage-backed securities.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

24. Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical
duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A. market neutral position.

B. conservative position.
C. bullish position.
D. bearish position.

A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a market neutral position.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

26-16
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25. A bet on particular mispricing across two or more securities with extraneous sources of risk, such as general market exposure
hedged away, is a

A. pure play.
B. relative play.
C. long shot.
D. sure thing.
E. relative play and sure thing.

A bet on particular mispricing across two or more securities, with extraneous sources of risk such as general market exposure hedged
away, is a pure play.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

26. Assume newly-issued 30-year on-the-run bonds sell at higher yields (lower prices) than 29½-year bonds with a nearly identical
duration. A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a

A. market neutral position.

B. conservative position.
C. bullish position.
D. bearish position.

A hedge fund that sells 29½-year bonds and buys 30-year bonds is taking a market neutral position.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

27. If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a hedge fund pursuing a relative
value strategy would

A. short sell the Treasury bonds and short sell the mortgage-backed securities.
B. short sell the Treasury bonds and buy the mortgage-backed securities.
C. buy the Treasury bonds and buy the mortgage-backed securities.
D. buy the Treasury bonds and short sell the mortgage-backed securities.

If the yield on mortgage-backed securities was abnormally low compared to Treasury bonds, a hedge fund pursuing a non-directional
strategy would buy the Treasury and short sell the mortgage-backed securities.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

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28. Statistical arbitrage is a version of a ______ strategy.

A. market neutral
B. directional
C. relative value
D. divergence
E. convergence

Statistical arbitrage is a version of a market neutral strategy.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund strategies

29. ______ uses quantitative techniques, and often automated trading systems, to seek out many temporary misalignments among
securities.

A. Covered interest arbitrage

B. Locational arbitrage
C. Triangular arbitrage
D. Statistical arbitrage
E. All arbitrage

Statistical arbitrage uses quantitative techniques and often automated trading systems to seek out many temporary misalignments
among securities.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Arbitrage and its limits

30. Assume that you manage a $3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month.
Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next
30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 14
C. buying 1
D. buying 14
E. selling 6

The hedge ratio is [$3M/(1220 × 250)] × 1.45 = 14.26. Thus, you would need to sell 14 contracts.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Gradable: automatic
Topic: Hedge fund strategies

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31. Assume that you manage a $1.3 million portfolio that pays no dividends and has a beta of 1.45 and an alpha of 1.5% per month.
Also, assume that the risk-free rate is 0.025% (per month) and the S&P 500 is at 1,220. If you expect the market to fall within the next
30 days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 6
C. buying 1
D. buying 6
E. selling 4

The hedge ratio is [$1.3M/(1220 × 250)] × 1.45 = 6.18. Thus, you would need to sell 6 contracts.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Gradable: automatic
Topic: Hedge fund strategies

32. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.25 and an alpha of 2% per month. Also,
assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,300. If you expect the market to fall within the next 30
days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 8
C. buying 1
D. buying 8
E. selling 6

The hedge ratio is [$2M/(1300 × 250)] × 1.25 = 7.69. Thus, you would need to sell 8 contracts.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Gradable: automatic
Topic: Hedge fund strategies

33. Assume that you manage a $2 million portfolio that pays no dividends and has a beta of 1.3 and an alpha of 2% per month. Also,
assume that the risk-free rate is 0.05% (per month) and the S&P 500 is at 1,500. If you expect the market to fall within the next 30
days, you can hedge your portfolio by ______ S&P 500 futures contracts (the futures contract has a multiplier of $250).

A. selling 1
B. selling 7
C. buying 1
D. buying 7
E. selling 11

The hedge ratio is [$2M/(1500 × 250)] × 1.3 = 6.93. Thus, you would need to sell 7 contracts.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Gradable: automatic
Topic: Hedge fund strategies

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34. Market neutral bets can result in ______ volatility because hedge funds use ______.

A. very low; hedging techniques to eliminate risk

B. low; risk management techniques to reduce risk
C. considerable; risk management techniques to reduce risk
D. considerable; considerable leverage

Market neutral bets can result in considerable volatility because hedge funds use considerable leverage.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

35. ______ bias arises because hedge funds only report returns to database publishers if they want to.

A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. None of the options are correct.

Backfill bias arises because hedge funds only report returns to database publishers if they want to.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

36. ______ bias arises when the returns of unsuccessful funds are left out of the sample.

A. Survivorship
B. Backfill
C. Omission
D. Incubation
E. None of the options are correct.

Survivorship bias arises when the returns of unsuccessful funds are left out of the sample.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

37. Performance evaluation of hedge funds is complicated by

A. liquidity premiums.
B. survivorship bias.
C. unreliable market valuations of infrequently-traded assets.
D. merger arbitrage.
E. All of the options are correct.

Performance evaluation of hedge funds is complicated by liquidity premiums, survivorship bias, unreliable market valuations of
infrequently traded assets, and unstable risk attributes.

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 AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

38. The previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees is known as a

A. benchmark.
B. water stain.
C. water mark.
D. high water mark.
E. low water mark.

The previous value of a portfolio that must be reattained before a hedge fund can charge incentive fees is known as a high water mark.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund fees

39. The typical hedge fund fee structure is

A. a management fee of 1% to 2%.

B. an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark performance.
C. a 12-b1 fee of 1%.
D. a management fee of 1% to 2% and an annual incentive fee equal to 20% of investment profits beyond a stipulated benchmark
performance.
E. a management fee of 1% to 2% and a 12-b1 fee of 1%.

The typical hedge fund fee structure is a management fee of 1% to 2% and annual incentive fee equal to 20% of investment profits
beyond a stipulated benchmark performance.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund fees

40. Hedge fund incentive fees are essentially

A. put options on the portfolio with a strike price equal to the current portfolio value.
B. put options on the portfolio with a strike price equal to the expected future portfolio value.
C. call options on the portfolio with a strike price equal to the expected future portfolio value.
D. call options on the portfolio with a strike price equal to the current portfolio value times one plus the benchmark return.
E. straddles.

Hedge fund incentive fees are essentially call options on the portfolio with a strike price equal to the current portfolio value times one
plus the benchmark return.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund fees

26-21
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41. Regarding hedge fund incentive fees, hedge fund managers ______ if the portfolio return is very large and ______ if the portfolio
return is negative.

A. get nothing; get nothing

B. refund the fee; get the fee
C. get the fee; lose nothing except the incentive fee
D. get the fee; lose the management fee
E. None of the options are correct.

Regarding hedge fund incentive fees, hedge fund managers get the fee if the portfolio return is very large and lose nothing except the
incentive fee if the portfolio return is negative.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund fees

42. Hedge funds often employ ______ that require investors to provide ________ notice of their desire to redeem funds.

A. redemption notices; several weeks to several months

B. redemption notices; several hours to several days
C. redemption notices; several days to several weeks
D. lock-up; several years
E. lock-up; several hours

Hedge funds often employ redemption notices that require investors to provide notice of several weeks to several months notice of
their desire to redeem funds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund characteristics and objectives

43. Pairs trading is associated with

A. triangular arbitrage.
B. statistical arbitrage.
C. data mining.
D. triangular arbitrage and data mining.
E. statistical arbitrage and data mining.

Pairs trading is associated with statistical arbitrage and is based on data mining.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

26-22
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44. ________ refers to sorting through huge amounts of historical data to uncover systematic patterns in returns that can be exploited
by traders.

A. Data mining
B. Pairs trading
C. Alpha transfer
D. Beta shifting

Data mining refers to sorting through huge amounts of historical data to uncover systematic patterns in returns that can be exploited by
traders.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

45. Hedge fund performance may reflect significant compensation for ________ risk.

A. liquidity
B. systematic
C. unsystematic
D. default
E. unsystematic and default

Hedge fund performance may reflect significant compensation for liquidity risk.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

46. A ________ is an investment fraud in which a manager collects funds from clients, claims to invest those funds on their behalf,
and reports extremely favorable investment returns, but in fact uses the funds for his or her own use.

A. Ponzi scheme
B. bonsai scheme
C. statistical arbitrage scheme
D. pairs trading scheme
E. None of the options are correct.

A Ponzi scheme is an investment fraud in which a manager collects funds from clients, claims to invest those funds on their behalf,
reports extremely favorable investment returns, but in fact uses the funds for his or her own use.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Ethics and corporate governance

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47. Sadka (2010) shows that exposure to unexpected declines in ________ is an important determinant of average hedge fund returns,
and that the spreads in average returns across funds with the highest and lowest ________ may be as much as 6% annually.

A. market risk; systematic risk

B. market liquidity; liquidity risk
C. unsystematic risk; unique risk
D. default risk; default risk

Sadka (2010) shows that exposure to unexpected declines in market liquidity is an important determinant of average hedge fund
returns and that the spreads in average returns across funds with the highest and lowest liquidity risk may be as much as 6% annually.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Gradable: automatic
Topic: Hedge fund analysis and performance

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 Chapter 26 Test Bank - Static Summary

Category # of Questions
AACSB: Knowledge Application 4
AACSB: Reflective Thinking 43
Accessibility: Keyboard Navigation 47
Blooms: Apply 4
Blooms: Remember 37
Blooms: Understand 6
Difficulty: 1 Basic 4
Difficulty: 2 Intermediate 39
Difficulty: 3 Challenge 4
Gradable: automatic 47
Topic: Arbitrage and its limits 1
Topic: Ethics and corporate governance 1
Topic: Hedge fund analysis and performance 9
Topic: Hedge fund characteristics and objectives 8
Topic: Hedge fund fees 4
Topic: Hedge fund strategies 18
Topic: Hedge funds versus mutual funds 6

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