Alternative Investments - Alternative Investments Section 1

• A. Hedge funds – These are classic examples of alternative investments. They use complex strategies like short selling, leverage, and derivatives.

• B. Real estate – Real estate is also a well-known alternative investment, especially when held through direct ownership or private funds.

• C. Long-only stock funds – These are traditional investments. They invest in publicly traded stocks without using leverage or short selling, and they typically offer high liquidity and transparency.

 Correct Answer: C. Long-only stock funds

→ This is incorrect. Beta measures systematic risk, i.e., the risk related to market movements as a whole, not unsystematic (diversifiable) risk.

Owing to existing inefficiencies, a positive return can be earned through exploitation and after adjustment of beta risk. This is defined as an alpha return.
→ This is correct. Alpha is the excess return earned over the expected return predicted by beta, representing a manager’s skill or an inefficiency exploited in the market.

Alpha returns are correlated with beta returns and are presumably the result of managers’ special skills in capturing non-systematic opportunities.
→ This is incorrect. Alpha is meant to be uncorrelated with beta returns, as it represents performance independent of market movements (non-systematic skill-based returns).

• A. Incentive fee – This is typically based on realized profits or performance. It’s a reward for the fund manager when returns exceed a benchmark or hurdle rate.

• B. Management fee – This is usually a fixed percentage of assets under management (AUM) and is charged regardless of performance. It is not based on realized profits, making it the correct answer.

• C. Performance fee – Like the incentive fee, this is also based on fund performance, often tied to realized gains or exceeding certain benchmarks.

Correct Answer: B. Management fee

• A. Incorrect to say it's "wrong" – Hedge funds are known for being aggressively managed and investing across various asset classes (equities, derivatives, currencies, etc.).

• B. Incorrect to say it's "wrong" – Hedge funds often do require a lock-up period, during which investors cannot withdraw their money. This is common and true.

• C. Correct – Hedge funds are not available to the general public. They are typically restricted to accredited or institutional investors due to their complexity, risk, and lack of regulation. While they do require hefty investments, the statement is misleading because the key part that makes it incorrect is saying they are "available to the public."

• Correct Answer: C. It is an investment opportunity available to the public and requires hefty investment.