AIP AIP Alternative Investments & Derivatives 1 — Questions and Answers
Question 1: Which of the following best describes a hedge fund's use of leverage?
- Leverage allows hedge funds to borrow capital to amplify potential returns (Correct answer)
- Leverage is prohibited in hedge fund strategies
- Leverage is used solely to reduce portfolio volatility
- Leverage refers to diversifying across multiple asset classes
Correct answer: Leverage allows hedge funds to borrow capital to amplify potential returns
Hedge funds use leverage by borrowing capital to increase their position size, which can amplify both gains and losses.
Question 2: A call option gives the buyer the right to:
- Sell the underlying asset at the strike price before expiration
- Purchase the underlying asset at the strike price before expiration (Correct answer)
- Receive dividends from the underlying stock
- Short sell the underlying asset at market price
Correct answer: Purchase the underlying asset at the strike price before expiration
A call option grants the holder the right, but not the obligation, to buy the underlying asset at the predetermined strike price before or on expiration.
Question 3: What is a primary characteristic of private equity investments?
- High liquidity and daily market pricing
- Government-guaranteed principal protection
- Long lock-up periods and limited liquidity (Correct answer)
- Mandatory public disclosure of holdings
Correct answer: Long lock-up periods and limited liquidity
Private equity investments typically require investors to commit capital for extended periods, often 7–10 years, with limited ability to exit early.
Question 4: In futures trading, 'marking to market' refers to:
- Calculating the total market capitalization of a futures exchange
- Daily settlement of gains and losses in a futures account (Correct answer)
- Setting the initial margin requirement for a new contract
- Publishing futures prices on public exchanges
Correct answer: Daily settlement of gains and losses in a futures account
Marking to market means futures positions are revalued daily, with gains credited and losses debited from the trader's margin account each trading day.
Question 5: A swap agreement in which one party pays a fixed interest rate and receives a floating rate is called a:
- Currency swap
- Equity swap
- Plain vanilla interest rate swap (Correct answer)
- Credit default swap
Correct answer: Plain vanilla interest rate swap
A plain vanilla interest rate swap involves one counterparty paying a fixed rate while receiving a variable (floating) rate, typically tied to LIBOR or SOFR.
Question 6: Which statement about real estate investment trusts (REITs) is correct?
- REITs must distribute at least 90% of taxable income to shareholders (Correct answer)
- REITs are exempt from all federal taxation regardless of distribution
- REITs invest exclusively in residential properties
- REITs are not permitted to use debt financing
Correct answer: REITs must distribute at least 90% of taxable income to shareholders
To qualify for special tax treatment, REITs are required by law to distribute at least 90% of their taxable income to shareholders as dividends.
AIP AIP Alternative Investments & Derivatives 1
Which of the following best describes a hedge fund's use of leverage?