CFS Alternative Investments 2 — Questions and Answers
Question 1: Real estate investment through a Real Estate Limited Partnership (RELP) primarily offers investors:
- Full personal liability for partnership debts
- Pass-through income and potential tax benefits with limited liability (Correct answer)
- Daily liquidity similar to publicly traded REITs
- FDIC protection on invested capital
Correct answer: Pass-through income and potential tax benefits with limited liability
RELPs allow investors to receive pass-through income and depreciation benefits while limiting personal liability to their invested capital amount.
Question 2: Commodity futures contracts are used in portfolio management primarily to:
- Guarantee a fixed return on investment
- Provide inflation hedging and diversification through non-correlated returns (Correct answer)
- Eliminate all downside risk in a portfolio
- Generate dividend income from physical assets
Correct answer: Provide inflation hedging and diversification through non-correlated returns
Commodities often move independently of stocks and bonds and historically provide a hedge against inflation, making them useful for diversification.
Question 3: A 'venture capital' fund most commonly invests in:
- Distressed public companies undergoing bankruptcy restructuring
- Early-stage or startup companies with high growth potential (Correct answer)
- Investment-grade corporate bonds for stable income
- Large-cap dividend-paying stocks
Correct answer: Early-stage or startup companies with high growth potential
Venture capital funds focus on providing capital to early-stage companies in exchange for equity, accepting high risk in pursuit of potentially high returns.
Question 4: Which of the following best describes a 'high-water mark' provision in a hedge fund?
- The maximum leverage ratio allowed by the fund's charter
- A threshold ensuring performance fees are only paid on new net profits above previous peak NAV (Correct answer)
- The minimum investment required to participate in the fund
- A cap on annual withdrawals by limited partners
Correct answer: A threshold ensuring performance fees are only paid on new net profits above previous peak NAV
A high-water mark ensures managers only collect performance fees when the fund exceeds its previous highest NAV, preventing double-charging for recovering lost ground.
Question 5: Managed futures funds primarily derive returns by:
- Holding physical commodities in warehouse storage
- Trading futures contracts across asset classes based on systematic trend-following or discretionary strategies (Correct answer)
- Investing in futures-linked ETFs on public exchanges only
- Providing loans to commodity producers
Correct answer: Trading futures contracts across asset classes based on systematic trend-following or discretionary strategies
Managed futures funds use systematic or discretionary approaches to trade futures contracts on commodities, currencies, interest rates, and equity indices.
Question 6: The J-curve effect in private equity refers to:
- A gradual increase in investor returns from day one of investment
- Early negative returns due to fees and capital deployment, followed by positive returns as investments mature (Correct answer)
- An upward-sloping relationship between risk and return in buyout funds
- The immediate distribution of income from leveraged buyouts
Correct answer: Early negative returns due to fees and capital deployment, followed by positive returns as investments mature
The J-curve describes the pattern where private equity funds show negative early returns due to management fees and unrealized investments, then generate positive returns as portfolio companies mature and are exited.
Question 7: Which of the following is a key risk unique to alternative investments compared to traditional mutual funds?
- Exposure to interest rate changes
- Illiquidity risk due to limited redemption opportunities (Correct answer)
- Sensitivity to market volatility
- Dividend reinvestment risk
Correct answer: Illiquidity risk due to limited redemption opportunities
Alternative investments often have restricted redemption windows, lock-up periods, and limited secondary markets, making illiquidity a primary risk not typically found in open-end mutual funds.
CFS Alternative Investments 2
Real estate investment through a Real Estate Limited Partnership (RELP) primarily offers investors: