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CAIA® Level I Study Guide
Chartered Alternative Investment Analyst Association®
Introduction to the Level I Program.................................................................................... 1 Foundations of the CAIA Curriculum ................................................................................ 1 Preparing for the Level I Examination................................................................................ 2 Level I Examination Topic Weights ................................................................................... 3 Errata Sheet ......................................................................................................................... 3 Calculator Policy................................................................................................................. 3 Level I Sample Questions ................................................................................................... 4 The Level II Examination and Completion of the Program ............................................... 4 CAIA Level I Outline ......................................................................................................... 5 Topic 1: Professional Standards and Ethics .................................................................... 8 Topic 2: Alpha Drivers and Beta Drivers ..................................................................... 12 Topic 3: Real Estate ...................................................................................................... 17 Topic 4: Hedge Funds ................................................................................................... 21 Topic 5: Commodities and Managed Futures ............................................................... 34 Topic 6: Private Equity ................................................................................................. 40 Topic 7: Credit Derivatives ........................................................................................... 46 Sample Questions Answer Key ........................................................................................ 52 Action Words .................................................................................................................... 53
Introduction to the Level I Program
Congratulations on becoming a Chartered Alternative Investment AnalystSM candidate, and welcome to the Level I examination program. The CAIA® program, organized by the CAIA Association® and co-founded by the Alternative Investment Management Association (AIMA) and the Center for International Securities and Derivatives Markets (CISDM), is designed to be the only globally recognized professional designation in the area of alternative investments, the fastest growing segment of the investment industry. The CAIA curriculum provides breadth and depth by first placing emphasis on understanding alternative asset classes and then by building applications in manager selection, risk management, and asset allocation. The CAIA program asks candidates to work through the curriculum to identify and describe various asset classes, risk-return characteristics of each asset class, the role of each class in a diversified portfolio, the role of active management in investment processes, the manager selection method, and risk management. The business school faculty and industry practitioners who have helped create our program bring years of experience in the financial services industry. Consequently, our curriculum is consistent with recent advances in the financial industry and reflects findings of applied academic research in the area of investment management. Passing the Level I examination is an important accomplishment and will require a significant amount of preparation. All candidates will need to study and become familiar with the CAIA Level I curriculum material in order to build confidence and be successful on examination day. Our study guides are organized to facilitate quick learning and easy retention. Each topic is structured around keywords and learning objectives with action words that help candidates concentrate on what is most important for the examination. For these reasons, we believe that the CAIA Association has built a rigorous program with high standards while also maintaining an awareness of the value of candidates’ time.
Foundations of the CAIA Curriculum
Candidates for the CAIA exam are assumed to have an understanding of the central concepts of quantitative analysis and finance. This includes awareness of the instruments that trade in traditional markets, models used to value these instruments, and the tools and methods used to analyze data. These concepts are typically covered in dedicated undergraduate courses or MBA level investment and business statistic courses. At the beginning of each topic, specific references to relevant Foundations of the CAIA Curriculum materials are listed.
March 2012 Level I Study Guide
While most college investment and business statistic textbooks could serve as resources for learning the content included in the Foundations of the CAIA Curriculum. The action words used within the learning objectives help candidates determine what they need to learn from the relevant passages and what type of questions they may expect to see on the examination. For further information about Foundations of the CAIA Curriculum. DeFusco. the CAIA Association recommends the following two books: • Investments. For example. ISBN: 978-0-470-44702-4. Chartered Alternative Investment Analyst Association. 2010. 9th Edition. Bodie. 2 Copyright (C) 2011. McGraw Hill Publishers. McLeavey. please visit www. and A. ISBN-13: 978-0073530703. Pinto. whether or not they are stated explicitly in a learning objective. 2009. Virginia: CFA Institute. as they form the basis for the examination questions. Kane. and concepts included in the Foundations of the CAIA Curriculum incorporated into Level I examination questions. Wiley Publishers. Note that actual examination questions are not limited in scope to the exact action word used within the learning objectives. explain. Quantitative Investment Analysis. the action word "understand" could result in an examination question that asks candidates to define. skills. The reading materials for the Level I curriculum are: • Standards of Practice Handbook. A candidate who is able to meet all learning objectives in this study guide should be well-prepared for the examination. a candidate may be asked to evaluate the output of a regression analysis or calculate the value of a bond (both are concepts included in Foundations of the CAIA Curriculum) as part of a response to a broader examination question. . CAIA Level I: An Introduction to Core Topics in Alternative Investments. J. Inc. D. R. All Rights Reserved. calculate and so forth.org/caia-program/curriculum/foundations. 2010. Runkle.caia.. A complete list of the action words used within learning objectives is provided in the back of this study guide in the Action Words Table. Preparing for the Level I Examination Candidates should obtain all the reading materials and follow the outline provided in this study guide. • The learning objectives in this study guide are an important way for candidates to organize their study. Marcus. Keywords can help candidates focus their progress towards fulfilling the learning objectives. Z. A. Wiley. ISBN: 978-0470052204. For example. ISBN: 978-0938367222. 2007. • CAIA candidates can expect to see knowledge. Candidates should be able to define all keywords provided. 10th edition. 2nd Edition. Learning objectives provide guidance on the concepts and keywords that are most important to understanding the CAIA curriculum. Charlottesville.. and D.
org. administered twice annually.15% Errata Sheet Correction notes appear in this study guide to address known errors existing in the assigned readings. All equations in the readings are important to understand. Calculator Policy You will need a calculator for the Level I examination.15% 10% . Level I Examination Topic Weights Topic Professional Standards and Ethics Introduction to Alpha Drivers and Beta Drivers Real Estate Hedge Funds Commodities and Managed Futures Private Equity Credit Derivatives Approximate Exam Weight 15% .200 hours of study.org. The CAIA Association allows candidates to bring into the March 2012 Level I Study Guide 3 . based on candidate feedback. is a five-hour computeradministered examination that is offered at test centers throughout the world. it is nearly impossible to provide guidelines that would be appropriate for everyone.Candidates should be aware that an equation sheet will not be provided on the examination. Occasionally.15% 10% .25% 10% .org. Some equations may be provided as part of an examination question. Please report suspected errata to curriculum@caia. Nevertheless. additional errors in the readings and learning objectives are brought to our attention and we will then post the errata on the Curriculum page of the CAIA website: www. The calculations that candidates are asked to perform range from simple mathematical operations to more complex methods of valuation. Examination Format The Level I examination. Preparation Time Regarding the amount of time necessary to devote to the program.caia. For more information visit the CAIA website at www.20% 10% . Therefore. It is the responsibility of the candidate to review these errata prior to taking the examination.caia.15% 10% . we understand that all candidates are different. The Level I examination is composed of 200 multiple-choice questions.15% 20% . we estimate that Level I requires 150 .
No other calculators or electronic devices will be allowed in the testing center. Candidates should be aware that multiple-choice examination questions ask for the best answer.caia. The sample questions do not cover all of the study materials that comprise the CAIA Level I curriculum. As with the Level I examination. Candidates should refer to the CAIA website. www. Chartered Alternative Investment Analyst Association. In some cases this means that it is possible that a choice is technically accurate but is not the correct answer because it is superseded by another choice. for information about examination dates and membership requirements. Accordingly. 4 Copyright (C) 2011. . the CAIA Association will confer the CAIA designation upon the candidate. and assuming that the candidate has met all the Association’s membership requirements. A separate study guide is available for the Level II curriculum. The Level II Examination and Completion of the Program All CAIA candidates must pass the Level I examination before sitting for the Level II examination.examination the TI BA II Plus (including the Professional model) or the HP 12C (including the Platinum edition). Upon successful completion of the Level II examination. these sample questions should not be used to assess a candidate’s level of preparedness for the examination. The sample questions are not a facsimile of the actual questions. nor have they been verified to be equally difficult as the actual questions. Level I Sample Questions The sample questions included in this study guide are designed to be representative of the format and nature of actual CAIA Level I examination questions in March 2012.org. All Rights Reserved. Inc. the CAIA Association administers the Level II examination twice annually. The examination proctor will require that all calculator memory be cleared prior to the start of the examination.
Part I – Introduction to Alpha Drivers and Beta Drivers. 2009. 10th Edition. March 2012 Level I Study Guide 5 . Recommendations. Approaches to active asset management and the concept of the continuum of beta offered by managers are described. Topic 2: Alpha Drivers and Beta Drivers Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. Wiley. 2010 • • • • • • Standard I: Professionalism Standard II: Integrity of Capital Markets Standard III: Duties to Clients Standard IV: Duties to Employers Standard V: Investment Analysis. and Actions Standard VI: Conflicts of Interest Introduces the practices and standards for dealing with ethical considerations experienced in the investment profession on a daily basis. CFA Institute. Part II – Real Estate. • • • • • What is an Alternative Asset Class? Why Alternative Assets are Important The Beta Continuum Alpha versus Beta The Calculus of Active Management Explains the importance of alternative assets and discusses the sources of return to this asset class in terms of beta and alpha drivers. 2009. the Handbook addresses the professional intersection where theory meets practice and where the concept of ethical behavior crosses from the abstract to the concrete. Details of alpha-beta separation and the calculus of active management are explained in terms of the information ratio. Chapter 6 – 9.CAIA Level I Outline Topic 1: Professional Standards and Ethics Reading: Standards of Practice Handbook. Wiley. Chapters 1 – 5. the information coefficient. Topic 3: Real Estate Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. and the breadth.
• • • •
Real Estate Investment Trusts Introduction to NCREIF and the NCREIF Indexes Real Estate as an Investment Core, Value-Added, and Opportunistic Real Estate
Discusses real estate investment trusts and direct real estate investments and their role in investment portfolios. Introduces candidates to various real estate indices and describes approaches such as core, value added, and opportunistic to real estate investment.
Topic 4: Hedge Funds
Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. Wiley. 2009. Part III – Hedge Funds, Chapter 10 – 17. • • • • • • • • Introduction to Hedge Funds Establishing a Hedge Fund Investment Program Due Diligence for Hedge Fund Managers Risk Management Part I: Hedge Fund Return Distributions Risk Management Part II: More Hedge Fund Risks Hedge Fund Benchmarks and Asset Allocation Hedge Fund Incentive Fees and the Free Option Hedge Fund Collapses
Describes various hedge fund strategies, explains their sources of risk and return and provides historical data showing their distributional characteristics. Discusses how asset allocation is applied to hedge funds and explains the role of hedge funds in diversified portfolios. The process of establishing a hedge fund program and conducting due diligence is presented. Describes risk management tools and processes that are employed by investors. Discusses the role of incentive fees in the performance of hedge funds and analyzes several cases involving hedge fund liquidations.
Topic 5: Commodities and Managed Futures
Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. Wiley. 2009. Part IV – Commodities and Managed Futures, Chapters 19 – 22. • • • • Introduction to Commodities Investing in Commodity Futures Commodity Futures in a Portfolio Context Managed Futures
Copyright (C) 2011, Chartered Alternative Investment Analyst Association, Inc. All Rights Reserved.
Commodity markets are introduced and various methods of investing in commodities are described. Futures markets and theories explaining the relationship between spot and futures prices are discussed. The role of commodities and managed futures in a diversified portfolio is analyzed. Trend following and discretionary trading strategies are defined and compared.
Topic 6: Private Equity
Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. Wiley. 2009. Part V – Private Equity, Chapter 23 - 26. • • • • • • Introduction to Venture Capital Introduction to Leveraged Buyouts Debt as Private Equity Part I: Mezzanine Debt Debt as Private Equity Part II: Distressed Debt Trends in Private Equity The Economics of Private Equity
Various investment products covered under the generic name of private equity are described: venture capital, leveraged buyouts, and mezzanine debt. The role of private equity in asset allocation process is discussed. Economic foundations of private equity and various performance measures are presented. An analysis of industry trends in private equity markets is provided.
Topic 7: Credit Derivatives
Reading: CAIA Level I: An Introduction to Core Topics in Alternative Investments. Wiley. 2009. Part VI – Credit Derivatives, Chapters 29 – 31. • • • Introduction to Credit Derivatives Collateralized Debt Obligations Risks and New Developments in CDOs
Describes various features of credit derivatives and explains risks and payoffs of these instruments. Structured products, collateralized debt obligations, and other instruments are analyzed.
March 2012 Level I Study Guide
Topic 1: Professional Standards and Ethics
Standards of Practice Handbook. 10th edition. Charlottesville, Virginia: CFA Institute, 2010. ISBN: 978-0938367222. Standard I: Professionalism Standard II: Integrity of Capital Markets
Buy-side Due diligence Firewalls Fraud Insider trading Market manipulation Material nonpublic information Mosaic theory Plagiarism Pump and dump Restricted list Sell-side Soft commissions Soft dollars Thinly traded security Watch list Whistle-blowing
1. State and interpret Standard I with respect to: a. knowledge of the law. b. independence and objectivity. c. misrepresentation. d. misconduct. 2. Understand procedures for compliance with Standard I with respect to: a. knowledge of the law. b. independence and objectivity. c. misrepresentation. d. misconduct. 3. State and interpret Standard II with respect to: a. material nonpublic information. b. market manipulation. 4. Understand procedures for compliance with Standard II with respect to material nonpublic information.
Copyright (C) 2011, Chartered Alternative Investment Analyst Association, Inc. All Rights Reserved.
b. c. prudence and care. e. loyalty. Recommendations. responsibilities of supervisors. c. b. prudence. State and interpret Standard III with respect to: a. performance presentation. Understand procedures for compliance with Standard IV with respect to: a. fair dealing. e. 3.Standard III: Duties to Clients Standard IV: Duties to Employers Keywords Best execution Block allocation Block trades Brokerage Commissions Composites Custody Directed brokerage Disclosure Execution of orders Fair dealing "Flash" report Global Investment Performance Standards (GIPS) "Hot issue" securities Independent contractors Material changes Misappropriation Oversubscribed issue Round-lot Secondary offerings Self-dealing Whisper number Learning Objectives 1. preservation of confidentiality. preservation of confidentiality. and care. 4. c. additional compensation arrangements. responsibilities of supervisors. b. 2. fair dealing. Understand procedures for compliance with Standard III with respect to: a. suitability. performance presentation. State and interpret Standard IV with respect to: a. loyalty. loyalty. b. and Actions Standard VI: Conflicts of Interest Keywords Additional compensation March 2012 Level I Study Guide Blackout/restricted periods 9 . Standard V: Investment Analysis. additional compensation arrangements. d. d. suitability.
State and interpret Standard V with respect to: a. Maintain a file with proper documentation of the activity or activities. Move to establish a formal written policy identifying types of violations and their penalties within the firm. 4. 3. . disclosure of conflicts. d. Members may accept gifts from clients if they are disclosed and if the employer finds that the gifts will not affect independence and objectivity. c. c. Understand procedures of compliance with Standard VI with respect to: a. c. record retention. All Rights Reserved. Members cannot accept gifts under any circumstances because research has shown that any gift. b.Front-running Incentive fees Performance fees Referral fees Secondary research Learning Objectives 1. priority of transactions. disclosure of conflicts. what is the first step that a member should take if he or she has grounds to believe that imminent or ongoing employer activities are illegal or unethical? a. diligence and reasonable basis. Professional Standards and Ethics Sample Questions 1. State and interpret Standard VI with respect to: a. c. Marco Cancellara. b. According to the Code and Standards. CAIA. c. Maintain confidentiality in order to preserve the integrity of the firm. b. Understand procedures for compliance with Standard V with respect to: a. referral fees. Chartered Alternative Investment Analyst Association. Bring the activity to the attention of his or her employer through his or her supervisor. The president of one particular brokerage firm is 10 Copyright (C) 2011. diligence and reasonable basis. is a security analyst who places trades through a number of brokerage firms. priority of transactions. Members may accept gifts so long as their market value is less than US $100. impairs ethical judgment. According to the Code and Standards. b. Inc. which of the following BEST describes appropriate conduct related to the acceptance of gifts from clients? a. b. b. 3. communication with clients and prospective clients. 2. 2. record retention. communication with clients and prospective clients. large or small.
Cancellara accepts this offer. Petrav is required to apply the Code and Standards in all aspects of her business and is not allowed to hold short positions in her clients’ accounts. and is not allowed to hold short positions in either her clients’ accounts or in her personal account. Wasic did not violate the Code and Standards because the biased data came from another department. does business in. b. Which of the following statements regarding Mr. is a research analyst for a fund of hedge funds. Mr. Wasic violated the Code and Standards because the report misrepresents performance. Cancellara violated the Code and Standards by entering into a soft-dollar arrangement. CAIA. according to the Code and Standards? a. prepared by another department. 5. and is allowed to hold short positions in both her clients’ accounts and in her personal account. Her home country does not allow advisors to hold short positions for their clients or in their personal accounts. She learns that a portion of the firm’s research. Petrav. Ms. is registered in. Cancellara’s business and offers Mr. Cancellara’s actions is consistent with the Code and Standards? a. Petrav is required to apply the Code and Standards in all aspects of her business. Cancellara violated the Code and Standards by accepting a gift that could compromise his independence and objectivity. Petrav is required to apply the Code and Standards in all aspects of her business. c. b. Which of the following describes Ms. Mr. Ms. is affected by survivorship bias such that some of the firm’s performance is exaggerated. b. Cancellara the use of his vacation home for a week. but steers clear of any reference to the exaggerated performance. 4. Mr. Wasic’s behavior with respect to the Code and Standards? a. Joanna Wasic. c. Wasic violated the Code and Standards because the report was prepared by multiple sources and she failed to explicitly acknowledge those sources. Ms. and lives in an emerging country with laws and regulations considered less strict than the Code and Standards. however. but can hold short positions in her personal account as long as they are disclosed. Petrav. Ms. Wasic presents the report to prospective clients in order to solicit new business. CAIA. is an investment advisor for a multinational investment company located in the United States. Nadia Petrav. March 2012 Level I Study Guide 11 . c. There is no violation because the Code and Standards do not preclude customary entertainment. Ms. Ms. Which of the following BEST describes the requirements on Ms. Ms.appreciative of Mr. Ms.
5.org/caia-program/curriculum/foundations 12 Copyright (C) 2011.” For further information see www. Pinto. Chapters 3.. 6. Runkle. D. Compare asset class risk premiums versus trading strategy risk premiums. All Rights Reserved. 2. McLeavey. 9th Edition. 2. 4.caia. Compare efficient versus inefficient asset classes and explain their relationships with traditional and alternative asset classes. Chapters 1. McGraw Hill Publishers. Inc. A. Chapters 1 – 5. Wiley. Kane. Bodie. 2007. 8. R. 8. Describe super asset classes.. and D. 2nd Edition. Part I – Introduction to Alpha Drivers and Beta Drivers. 6. Chartered Alternative Investment Analyst Association. Describe the asset allocation process and compare strategic and tactical asset allocation. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments.Topic 2: Alpha Drivers and Beta Drivers Foundations* Investments. Chapter 1 What is an Alternative Asset Class? Keywords Super asset classes Learning Objectives 1. Compare asset location and trading strategy. 2009. Marcus. candidates must be familiar with the concepts that are covered in “Foundations. and A. Z. DeFusco. 5. 9 and11. 2010. Wiley Publishers. Compare constrained versus unconstrained investing. 3. 9 and 24. . * To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. Quantitative Investment Analysis. ISBN: 978-0-470-44702-4. J.
Describe the proper way to estimate the alpha of an investment product. 2. Describe the asset allocation process and compare strategic and tactical asset allocation. 2. 3. and explain how each type is typically constructed. cheap. fundamental. 3. March 2012 Level I Study Guide 13 . Compare various types of beta investment products or trading strategies (classical. Explain and identify beta drivers and alpha drivers as investment products. calculate alpha of investment products. Chapter 3 The Beta Continuum Keywords Active beta Alpha Alternative beta Bespoke beta Bulk beta Cheap beta Classic beta Endogenous alpha Exchange-traded funds (ETFs) Exogenous alpha Fundamental beta Learning Objectives 1. bespoke. Explain the application of beta and alpha drivers in constructing investment portfolios.Chapter 2 Why Alternative Asset Classes are Important Keywords Absolute return strategies Alpha drivers Alternative/cheap beta Beta drivers Concentrated portfolios Equity risk premium (ERP) Long/short investing Market segmentation Nonlinear return processes Strategic asset allocation (SAA) Tactical asset allocation (TAA) Learning Objectives 1. alternative. active. Given available information on factor returns and factor exposures. and bulk).
5. 5. 3. Describe and apply the relationship between the t-statistic and the information ratio. 2. Describe product innovators. Describe the four business models that are likely to be available to asset managers in the future. Describe and calculate an ex-post information ratio. Calculate an ex-ante information ratio. 6. Chartered Alternative Investment Analyst Association. Understand and identify the components of the information ratio on an ex-post and ex-ante basis.Chapter 4 Alpha versus Beta Keywords Process drivers Product innovators Learning Objectives 1. 7. describe its implications for asset managers. Chapter 5 The Calculus of Active Management Keywords 130/30 products Breadth Fundamental Law of Active Management Information coefficient (IC) Information ratio (IR) Transfer coefficient Learning Objectives 1. 2. Argue why alpha may or may not be a zero-sum game. 4. 3. process drivers and balanced mandate asset managers in asset management industry. Explain and calculate the weights of active positions in optimal portfolios. and explain how the alpha estimation process may be improved. All Rights Reserved. 14 Copyright (C) 2011. Explain why the Sharpe ratio is not an appropriate performance measure for individual managers and calculate whether a new manager should be added to a portfolio. 4. . Inc. Describe the risks associated with information asymmetry in the asset management industry and explain how governance models can address these risks. Describe the process for the construction of benchmarks for alternative assets and identify the variables that affect the ex-post information ratio in this approach. Explain why multi-factor alpha determination models may fail to provide accurate estimates of alpha.
b. Describe 130/30 portfolios and explain how they are constructed and why they have attracted attention. Classic beta Bespoke beta Alternative beta Bulk beta 3. What is considered to be the most important task in distinguishing alpha from beta in the performance of an investment manager? a. As attempting to capture systematic risk premiums. Which of the following types of beta is most associated with active returns rather than with systematic risk premiums? a.10). b. Discuss the role of the transfer coefficient in measuring the ex-ante information ratio and explain the impact of the transfer coefficient on the information ratio of traditional and active management products. 5. Alpha Drivers and Beta Drivers Sample Questions 1.8. As requiring substantial information to implement. Observing alpha and properly deducing beta. Enhanced index and 130/30 funds Enhanced index and long/short investing Passive index and nonlinear returns Passive index and absolute returns 2. As having returns uncorrelated with the overall market. 4. c. Which of the following statements is accurate with regard to the information coefficient (IC) in the Fundamental Law of Active Management (FLoAM)? March 2012 Level I Study Guide 15 . Identifying true systematic risk exposures. Measuring the returns of relevant factors. d. c. b. Correction to reading: Page 49. Equation (5. Which of the following sets of investment categories or products is MOST accurately described as being driven by beta rather than alpha? a. 9. the variance of the residual risk should appear in the denominator. b. Instead of the standard deviation of the residual risk. c. d. As difficult to create without relatively high costs. d. How are beta driven products generally described? a. c.
a. The IC is the correlation between forecasted returns and actual returns across active bets. All Rights Reserved. The IC is the correlation between portfolio returns and market returns through time. . Inc. c. Chartered Alternative Investment Analyst Association. The IC is the correlation between forecasted returns and actual returns through time. 16 Copyright (C) 2011. d. b. The IC is the correlation between portfolio returns and market returns across active bets.
McGraw Hill Publishers.. Runkle. Chapter 6 Real Estate Investment Trusts Keywords Dedicated REIT Down-REIT Equity REITs Finite life REIT Hybrid REITs Mortgage REITs Single-property REIT Umbrella Partnership REIT (an UPREIT) Learning Objectives 1. J. McLeavey. 2007. March 2012 Level I Study Guide 17 . candidates must be familiar with the concepts that are covered in “Foundations. 2. Bodie. 2010. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments.caia. 9th Edition.org/caia-program/curriculum/foundations.” For further information see www. 4.Topic 3: Real Estate Foundations* Investments.. structure. Discuss the rules that REITs must obey to obtain tax-advantage status. A. Chapter 6 – 9. Wiley Publishers. and D. Kane. and the markets in which they invest. 2009. Differentiate the types of REITs as they pertain to investment philosophy. Chapter 7 Introduction to NCREIF and the NCREIF Indexes Keywords Appraised values Comparable sales method * Hedonic price index NCREIF Property Index (NPI) To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. Quantitative Investment Analysis. Pinto. Marcus. and A. ISBN: 978-0-470-44702-4. Chapters 1 and 2. Wiley. Chapter 4 and the chapters cited in Topic 2. Part II – Real Estate. Z. 3. Explain the advantages and disadvantages of real estate investment trusts (REITs). DeFusco. Discuss the economic benefits of REITs compared to other assets. 2nd Edition. R. D.
Explain the five goals for adding real estate to an investment portfolio. 3. 3. Explain the three practical effects arising from the smoothing process. Chartered Alternative Investment Analyst Association. including the effects of adding leverage to the NPI. Inc. Compare historical risk. Classify and describe the types of properties underlying the NPI. Compare and contrast the three National Council of Real Estate Investment Fiduciaries (NCREIF) real estate styles and discuss the eight attributes that help to distinguish the type of property. and its capacity to expand the efficient frontier when combined to a portfolio of stocks and bonds. . 2. and the methods used to unsmooth the NPI. Chapter 8 Real Estate as an Investment Keywords Smoothed indices Unsmoothed indices Learning Objectives 1. 18 Copyright (C) 2011. 2. Assess the returns and risks associated with real estate style boxes from an absolute and a relative return investor perspective. and 93. Exhibit 7. All Rights Reserved. Describe the cross-section distribution of NPI component property returns. Exhibit 8. the Sharpe ratio for the unsmoothed NCREIF index should be 0. 3. Describe the diversification benefits of real estate in terms of its correlation coefficients with other asset classes.1. Describe the two methods used to appraise properties and critique appraisal-based indices. Chapter 9 Core. and risk-adjusted real estate returns to other asset classes and draw relevant conclusions. 2.43.Learning Objectives 1. return. as a hedge against inflation. Value-Added.7. and Opportunistic Real Estate Keywords Private equity real estate (PERE) Style boxes Learning Objectives 1. Correction to reading: Page 89.
b.4. how do real estate investment trusts (REITs) perform as diversifiers for balanced portfolios of bonds and stocks? a. c. Discuss the characteristics of private equity real estate. Which of the following scenarios MOST accurately describes the typical US income tax implications of real estate investment trust (REIT) dividends for pension funds? a. Real Estate Sample Questions 1. 3. d. REITs would not pay taxes on their income and pension funds would not pay taxes on the dividends received from REITs. c. and the most recognizable? a. REITs tend to diversify bond portfolios very poorly and diversify large stock portfolios better than small stock portfolios. b. c. How is the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index (NPI) calculated? a. According to the Level I source material. What style of real estate investing is characterized by being the most liquid. REITs tend to diversify bond portfolios very poorly and diversify small stock portfolios better than large stock portfolios. d. the most developed. 2. REITs would pay taxes on their income and pension funds would pay taxes on the dividends received from REITs. d. b. REITs tend to diversify bond portfolios very well and diversify small stock portfolios better than large stock portfolios. REITs would not pay taxes on their income but pension funds would pay taxes on the dividends received from REITs. b. c. d. Monthly based on monthly appraisals Monthly with varied appraisal intervals Quarterly based on quarterly appraisals Quarterly with varied appraisal intervals 4. REITs would pay taxes on their income but pension funds would not pay taxes on the dividends received from REITs. Core Satellite Value-added Opportunistic March 2012 Level I Study Guide 19 . the least leveraged. REITs tend to diversify bond portfolios very well and diversify large stock portfolios better than small stock portfolios.
Which of the following is a characteristic of private equity real estate (PERE) investments? a. c. Chartered Alternative Investment Analyst Association.5. Inc. b. Low to moderate leverage Low risk real estate holdings Easy valuation using transactions data Frequent origination in Europe 20 Copyright (C) 2011. All Rights Reserved. d. .
Wiley. 2007. Runkle. D. ISBN: 978-0-470-44702-4.. Chapter 10 – 17. and D. Z. 9th Edition. 18. A. Wiley Publishers. Part III – Hedge Funds. 7. Chapters 4. 20-21 and the chapters cited in Topics 2 and 3. and A. 5 and 10. J. DeFusco. 2nd Edition. Bodie..Topic 4: Hedge Funds Foundations* Investments. 2010.org/caia-program/curriculum/foundations. McGraw Hill Publishers. Quantitative Investment Analysis. candidates must be familiar with the concepts that are covered in “Foundations. Chapter 10 Introduction to Hedge Funds Keywords 144A securities Accredited investor Activist hedge funds Alpha engines Arbitrage Bottom-up analysis Convergence trading Conversion ratio Convertible arbitrage Convertible bond arbitrage Corporate governance Corporate restructuring Delta Delta hedge Distressed debt hedge funds Dollar neutral Equity long/short Event-driven Factor models Fixed income arbitrage Fixed income yield alternatives Fund of funds (FoFs) Fundamental equity long/short Generalized Autoregressive Heteroskedasticity (GARCH) Global macro Hedge fund Hedge fund of funds (FoFs) Long Term Capital Management Market directional Market neutral Statistical arbitrage Stub-trading Top-down analysis Volatility arbitrage Yield curve arbitrage * To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments. 11.caia. R. Pinto. 2009.” For further information see www. 14-16. Chapters 3. McLeavey. Kane. Marcus. March 2012 Level I Study Guide 21 .
c. c. For distressed securities strategies: a. b. 5. b. c. contrast with merger arbitrage and distressed securities strategies. define the strategy. define the strategy. 11. identify the portfolio risk and return effects from the ability to go both long and short. . identify the main risk exposures of mortgage-backed security arbitrage strategies. identify the sources of return. identify the source of return. c. define fundamental equity long/short strategies. define the strategy. c. All Rights Reserved. b. identify the main sources of return. For activist investing: a. define the strategy. describe a particular distressed securities strategy that is most likely to overlap with private equity firms’ activities. Inc. 8. b. Chartered Alternative Investment Analyst Association. or opportunistic hedge fund. define quantitative equity long/short strategies. define the strategy. 3. compare the exposures of short selling with traditional long-only managers. For regulation D hedge funds a. define the strategy. b. b. 10. e. corporate restructuring. 4. define the source of return. 9. For equity long/short strategies: a. c. describe the available evidence regarding its performance. describe the investment universe. Describe the major characteristics of hedge funds and contrast them with mutual funds.Learning Objectives 1. b. define capital structure arbitrage. define the strategy. For merger arbitrage strategies: a. Determine whether a particular hedge fund strategy is best categorized as a market directional. define mortgage-backed security arbitrage strategies. For fixed income arbitrage strategies: a. For event-driven strategies: a. compare the styles of short selling with equity long/short managers. For convertible bond arbitrage strategies: a. For short selling strategies: a. identify the main sources of return. b. 7. 6. define the strategy. identify the main sources of return. define the strategy. convergence trading. 2. d. b. d. 22 Copyright (C) 2011.
define the role of funds of funds managers. c. For funds of funds: a. c. explain why global macro funds have fallen out of favor. define the rule of “one alpha. Should be: The conversion ratio denotes the number of shares obtained if the holder of the bond elects to convert it into equity. describe the investment universe. For market neutral strategies: a. compare multi-strategy hedge funds to funds of hedge funds. For global macro strategies: a. define volatility arbitrage strategies. $45. calculate the number of shares required in a hedge. define the strategy. b. b. 13. describe the advantages and disadvantages of multi-strategy hedge funds.” c. b. define the strategy. identify the main risk exposure.” d. b. e. 6th paragraph under the heading Convertible bond arbitrage. identify the components of total return to the strategy.e. d. 12. 4th sentence: The conversion ratio is based on the current price of the underlying stock. identify the role of the delta/hedge ratio. 15. and the current price of the convertible bond (i. For multi-strategy hedge funds: a. define stub trading strategies. Correction to reading: Page 139. For relative value arbitrage strategies: a. define the strategy. $900/$45). define the term “dollar neutral. b. f. define the role of factor models. 16. 14. identify the market neutral nature of the strategy. Chapter 11 Establishing a Hedge Fund Investment Program Keywords Absolute return Benchmark Cash substitute Catastrophe bias March 2012 Level I Study Guide 23 .c. identify the main advantages and disadvantages associated with funds of funds as compared to direct investment in hedge funds. d.
.4 (and its discussion) on pages 154. Corrections to reading: The reference to Figure 11. Discuss the academic evidence regarding the impact of hedge funds on the financial markets. e. discuss the academic evidence on the contribution of hedge fund allocations to the performance of a broad stock market based portfolio. Identify the opportunistic investment potential of hedge funds. c. 13.4 on page 160: Continued on next page: 24 Copyright (C) 2011. contrast the historical absolute performance of hedge funds with the performance of the S&P 500. 16.Correlation Equitization Hedge fund of funds Hurdle rate Idiosyncratic risk Investment opportunity set Performance persistence Portable alpha Risk budgeting Learning Objectives 1. Chartered Alternative Investment Analyst Association. 11. discuss the academic evidence on the diversification benefits of hedge fund allocations. Calculate hedge fund allocations based on risk budgeting constraints. Define risk budgeting. 6. Identify the purpose of a hedge fund of funds program. Calculate alpha of a hedge fund and explain how it can be ported to another investment product. 4. 3. 10. Discuss the academic evidence on hedge fund of funds programs. Identify the goals of an opportunistic hedge fund investment program. 9. contrast the historical volatility of hedge fund returns with the historical volatility of the S&P 500 returns. 17. 7. Calculate the hurdle rate for a hedge fund of funds investment as an addition to a diversified portfolio. Explain why hedge funds should be part of a diversified portfolio. identify the main drawbacks of the academic evidence on hedge fund performance. All Rights Reserved. For historical performance of hedge funds: a. 8. 14. Understand the portable alpha strategy. Discuss the academic evidence on hedge fund return persistence. d. Identify the absolute return nature of hedge fund products. 15. 2. Identify potential goals of a hedge fund investment program. 5. Identify the risk budgeting potential of hedge fund investments. Inc. b. 162 and 164 (both occasions) should refer to the following matrix rather than the Figure 11. Discuss the academic evidence regarding hedge fund investments as substitutes for investment grade bonds. 12.
000 × ($250 × 1.51 -0 .4 that appears on page 160 is correct in regards to the discussion on page 160.03 0. 0 .0 6 0 .49 0 .000.0 0 -0.00 Figure 11.49 EAFE 0.7 3 -0.6 4 1 .6 9 -0 .5 0 H FR I CO M P. middle of page: $405.8 6 H FRI FO F 0 .01 0.0 0 0. Page 165. Chapter 12 Due Diligence for Hedge Fund Managers Keywords Account representative Active risk Administrative review Assets under management Benchmark Capacity Clawback Counterparty risk Disaster planning Drawdown Due diligence Fees High watermark Incentive fee Investment markets Investment securities Investment style Legal review Limited partnership Lockup period Margin call Master trust Notice period Outside service providers Passive securities benchmark Prime broker Redemptions Reference checks Regulatory registrations Risk management Separate accounts Short volatility risk Shorting volatility Subscription amount Learning Objectives 1.0 3 -0.86 1 .0 8 -0. March 2012 Level I Study Guide 25 .246 S&P500 futures contracts Should be: $405.0 8 1 .0 0 -0 .0 8 -0.72 0 . Describe the phases of due diligence.000.7 3 0.6 9 0.50 0 .00 0 .000 ÷ ($250 × 1.0 8 0 .300) = 1.5 1 10 YR U ST -0.0 6 N A SD A Q 0 .6 4 0.7 2 0 .246 S&P500 futures contracts.82 -0 .55 0 .300) = 1.Correlation Matrix S&P 50 0 S&P 5 00 10 -y ear U ST N A SDAQ EA FE H FRI C om po site H FRI F OF 1.5 5 1.0 1 1 .0 0 0 .8 2 0.
Identify two distinct information processing skills. 14. 36. 21. and hedge fund investment securities. 16. Define the role of an account representative. Identify the role of leverage limits in hedge fund risk management. Define active risk. . Identify potential effects of high employee turnover on hedge fund performance. 31. Define the short volatility strategy. Inc. 33. Identify the role of disaster planning in the hedge fund business. 29. short volatility risk. 20. Contrast drawdown in long-only investments with drawdown in hedge fund investments. 4. 25. Identify the role of current portfolio position snapshots in the due diligence process. 15. Discuss the hedge fund investment idea generation process. 35. Identify the main implications of the limited partnership structure of a hedge fund investment.). 11. 10. define: 26 Copyright (C) 2011. criminal and regulatory actions in due diligence analysis. Define master trust. 24. Identify the role of the CFO of a hedge fund in the relationship between a hedge fund manager and an investor. Identify the role of hurdle rates in evaluating hedge fund manager performance. 28. Identify three fundamental questions for understanding the nature of a hedge fund manager’s investment program.2. 27. Identify three essential questions for understanding a hedge fund manager’s investment objective. 3. 9. 18. Discuss the black box investment process. 7. For hedge fund fees. Define drawdown. hedge fund investment markets. Identify the role of prime brokers in the hedge fund business. 22. Understand the structural review phase of due diligence. Identify the various regulatory registrations required of a hedge fund manager (U. Identify relevant outside service providers to hedge fund managers. Identify three relevant questions for the risk review phase of due diligence analysis. 8. Identify tax consequences of a master trust structure to investors. Chartered Alternative Investment Analyst Association. 17. All Rights Reserved. and counterparty risk. Discuss the review of civil. Identify the role of passive benchmarks in evaluating hedge fund manager performance. 19. Discuss capacity in hedge fund investments. 12. 6. Define process risk. 32. 30. Discuss documentation of hedge fund investment styles. Identify the role of hedge fund ownership in due diligence analysis. 13.S. Identify three relevant performance review questions. Contrast separate accounts with limited partnerships. 26. 34. Identify the role of withdrawals in due diligence analysis. 23. Identify relevant questions about the hedge fund manager’s organization. 5.
Identify potential sources for due diligence reference checks. and activist funds. Describe the style analysis and asset-based approach to modeling hedge fund returns. convergence trading funds. Explain the similarities and differences among the return distributions for distressed securities funds. Identify the role of high subscription amounts in hedge fund investments. 3. c. d. Chapter 13 Risk Management Part I: Hedge Fund Return Distributions Keywords Asset-based analysis Double alpha strategy Kurtosis Leptokurtosis Long bias Market risk Moments Platykurtosis Skewness Short volatility exposure Learning Objectives 1.a. incentive fees. the “2 and 20” fee structure. b. Define the notice period. 5. Explain the similarities and differences among the return distributions of equity long/short funds. 39. 38. 4. Identify the role of maximum subscription amounts in hedge fund investments. hedge funds having more market exposure. hedge funds that minimize credit risk and market risk. 6. 41. and Regulation D funds. b. market directional funds. short selling funds. Identify relevant due diligence questions to be asked to existing hedge fund clients. 43. 2. opportunistic funds. 37. Compare and contrast the skewness and kurtosis of return distributions for convergence trading and corporate restructuring funds with: a. Identify the benefits of a lock-up period to an investor. high watermarks. clawback. b. 40. March 2012 Level I Study Guide 27 . merger arbitrage funds. c. Describe the academic evidence on the suitability and limitations of the use of market factors. corporate restructuring funds. event driven funds. Define the lock-up period. Describe the major risks affecting: a. d. 42. emerging markets funds.
3rd sentence: …that the kurtosis associated with the return pattern is almost the same as that of the general stock market: 8. 9. Chapter 14 Risk Management Part II: More Hedge Fund Risks Keywords Backfilling Beta expansion risk Catastrophe bias Credit risk Data risk Event risk Liquidation bias Liquidity risk Mapping risk Multimoment optimization Performance measurement risk Process risk Risk buckets Selection bias Short volatility risk Short volatility bias Style analysis Short volatility strategy Survivorship bias Transparency risk Value at Risk (VaR) Volatility event 28 Copyright (C) 2011. Define short volatility risk. Inc. Correction to reading: Page 215: 2nd paragraph under the heading Activist hedge funds. 12. Identify three strategies that have positively skewed returns. fixed income yield alternative funds. Chartered Alternative Investment Analyst Association. Should read: …that the kurtosis associated with the return pattern is almost the same as that of the SB High Yield Index of 7. Explain the risk management implications of the similarities between selling insurance and convergence trading. and corporate restructuring funds. . Explain the purpose of multi-moment optimization. All Rights Reserved. convertible bond arbitrage funds. 11.7. Identify the similarities between selling insurance. Explain the similarities and differences among the return distributions of global macro funds and funds of funds.65.29. 13. 8. 14. 15. Describe the distribution of returns for three strategies that exhibit the most market risk. Explain the similarities and differences among the return distributions of fixed income arbitrage funds. 10. convergence trading. equity market neutral funds. and corporate restructuring funds. Identify two strategies that have both low market risk and low insurance risk. and relative value arbitrage funds.
Correction to Reading: Level I: An Introduction to Core Topics in Alternative Investments Part III – Hedge Funds. The following Exhibit presents the complete set of performance figures for both the 2007 and 2008 event periods and the following paragraphs present the correct discussion of those figures. Define risk management risk. 16. Define catastrophe/liquidation bias. 5. Explain differences in the academic evidence of hedge fund returns. Define mapping risk. Almost one year later in September and October 2008 we saw the culmination of the crisis when Lehman Brothers filed for bankruptcy and AIG had to be rescued through U. However. the data presented in this exhibit is incomplete and in some cases incorrect. Identify the drawbacks of applying the VaR methodology to hedge fund investments. Define volatility event. government intervention. Define backfilling. 4. 19. 15. 11. 17. 6. 2. Define selection bias. 18.S. 7. Define performance measurement risk. the first signs of the crisis appeared in July and August of 2007. Identify ways of managing mapping risk. Define short volatility bias. 20. 14. Chapter 14. 13. 10. 21. Define event risk. Explain the effect of lack of transparency on portfolio-level risk aggregation. 4th and 5th paragraphs of this page discuss the performance of various hedge fund strategies during the recent financial crisis. Define and calculate Value at Risk (VaR). 3. Define beta expansion risk. 1. The discussion refers to figures appearing in Exhibit 14. Continued on next page: March 2012 Level I Study Guide 29 .7. Page 247 The 3rd. As the text states. Define data risk. 9. 8. Define survivorship bias. Identify ways of managing process risk. 12. Identify the difficulties of using a Sharpe ratio analysis to compare hedge fund returns. Identify the liquidity risk exposure of arbitrage strategies.Learning Objectives Define process risk. 22. Define transparency risk.
71% -6.49 -5.38% -8.02% -1.95 -0.82% -7.58% -1.25 -5. July and August of 2007 were the beginning of a long crisis of confidence in the financial markets that lasted for several months.93% -9.73 -2. 30 Copyright (C) 2011.42% -6.06% 3.88% -3.26% -1.45% -1.93% -2.97% 0.11 -3.45 -4.50% -2.08 -1.07 -0. Student t-statistics greater than or equal to 1.99% 2.93 -1.59 -8.30 in absolute values are significant at the 10%.50% -9.45% -8.07 0.35 -0.58 -8.18% -1. Treasury bonds.21 0.37% -2. The summer of 2007 saw the start of the subprime mortgage meltdown and subsequent credit and liquidity crisis (we will have much more to say about this in our chapters on credit derivatives).04 -2.67% -1. Last.94% -1.83 -2.47% -4.22 -0.58% -1.34 -23.57% 0.98 -1.40 -1.7 we also present the returns associated with large-cap stocks.31 -0.11 -14. As might be expected.153% t-Stat July-Aug -1.75% -2.58% -14.84 -1.51 -11.32 -2.58% -0.33 We put these claims to the test by conducting an event analysis.50 -3.01% -6.31% -1.60% -4.43% 0.79 -12.81% -6.29 -0.28 -1. every hedge fund strategy.05% t-Stat -3. 1.40% -16.45% -9. high-yield bonds.58 -2. When we examine the two-month event period of September and October of 2008.25% New Exhibit 14.91% -7.22 -3.20% 1.16 0. earned negative returns over this two-month period.88% 0.81% -2. For each hedge fund style.87 0.21 -1.84% 1.04 -5.92 -12. we focus on the two-month event period of July and August 2007. with the exception of short sellers and global macro managers.13% -1. Treasury bonds performed well as many investors sought the safe haven of U.00 -5.7 t-Stat Sep .89% 0.48 -1. For example. These two months capture the beginning of the turmoil from the subprime mortgage meltdown crisis and were characterized by substantial volatility in financial markets.15 -1.86 0.24 5.69% -1.364% 2.70 -3.76% -0.63 -5. Next.62 -0.38% -2.91 -0.65% -0.08% 0. we present the returns for July and August 2007 and September and October 2008.65 -5.16 -1. in Exhibit 14.08 -0. high-yield bonds were significantly negatively impacted in July.82% -3.38 -27.49% -1. we focus on the two-month event period of September and October 2008 when credit crisis reached its peak.88 0.08% -0.22 -3.81 -3.15 -25. First. we can reach some quick conclusions.59 -5.37% 1.62 -1. Treasury Sep-08 -5.97.91% -2. Further.541% 2.57 -1.90 -1.84% -4. We also present the t-statistics associated with the two event periods.65 -24. Treasury bonds during this period of uncertainty.19 -0.63% -8.60% 0.58% -0.21% -5.70% -3.87% -7.16 -1.22% -6. We use the data from the Hedge Fund Research Inc.22 0.60 -1. all of these negative returns were statistically significant.74 -4.46% -8.40% 0.18% -0.26 -2.S.80% -15.14% -6.04 -1.51% 1.91% -1.70% -2.49% -1.44% -0.136% t-Stat -0.46% 5.98 -4.46 -2.66 -2.01 Jul-07 -0.47 Aug-07 -1.46 -3.42 -0.57 -2.90 -2.19 -7.14% 9.20 0.01% -8.68 -5. but did recover somewhat in August. Using data from January of 1990 through October of 2008.03% -16.42 -0.35 Oct-08 -7.54% -6.7 presents the results of our analysis.96 -17.05% -1.17% -0.Oct -4.53% -2.28 -0.13 -1.50% -1.75% -3.55 -6. For comparison. Inc. U.65 -13.72 -3. All Rights Reserved.53 -14.06 -1.62 14.02 -1.29% t-Stat -1.S.65 0.63 0.100% -3. we present the cumulative return for each of the two event periods.20% t-Stat -5.98% 0. we conducted an event analysis. and U.87% -2.90% -1.48% -0.84% -1.02 4.S.Strategy Distressed/Restructuring Merger Arbitrage Private Issue/Regulation D Equity Market Neutral Quantitative Directional Short Bias Emerging Markets Equity Long Short Event-Driven Fund of Funds Composite Fund Weighted Composite Global Macro Relative Value Fixed Income-Convertible Arbitrage Multi-Strategy S&P 500 High Yield 10-Year U.84 -13.20% -3.28 -3.20 -0. Exhibit 14.78 -0.31% -0.43 -1. Hedge Fund Indices.499% 1.32% -1.19% -6.61% 1. Chartered Alternative Investment Analyst Association.79% -0.44 -1. and 1% level of confidence.81 -1.11 -0.89% -1.68.90% -11.12% -10.11% -0.32 -0.07% 0. respectively. .55 0.S. 5%.74 -0.59 -16.36 1.27% -0.90 -1.73% -0. and 2.33% 0.58 -1.
Describe instant history bias and the way it may affect databases and hedge fund indices. Identify the factors that affect performance of various hedge fund indices and explain why performance of these indices may differ substantially from each other. 2. 3. Understand how the option-like nature of hedge fund fees can affect manager behavior.Chapter 15 Hedge Fund Benchmarks and Asset Allocation Keywords Backfill bias Crowded shorts Hazard rate Instant history Liquidation bias Survivorship bias Learning Objectives 1. March 2012 Level I Study Guide 31 . Explain the problem associated with strategy definition and its impact on hedge fund databases. Explain the major trade-off that must be taken into account in constructing investable hedge fund indices. Chapter 16 Hedge Fund Incentive Fees and the Free Option Keywords Incentive fee option Learning Objectives 1. 4. 8. 2. 4. 5. Explain the problems with using the mean-variance expected utility approach to asset allocation with hedge funds. Describe survivorship bias and the way it may affect databases and hedge fund indices. 7. Understand typical hedge fund fee structures. 3. 6. Discuss the empirical evidence on the hedge fund incentive fee option value. Describe the typical fee structure of hedge funds that report to databases and its impact on the reported monthly returns. Understand the option-like nature of hedge fund fees. Describe the problem with estimating the size of the hedge fund universe.
Which of the following terms is defined as a decline in the net asset value of a hedge fund during a specific period of time? a. d.27. b.Correction to reading: Page 276.875 32 Copyright (C) 2011. 1. respectively. 6.25 whereas the short exposure comprises an exchange trade fund that passively replicates the overall stock market. . Hedge Funds Sample Questions 1.1. Explain Marin Capital’s main trading strategy and the major factors behind its collapse.125 1. 4. What is the beta of this equity long/short fund? a. Explain Bernie Madoff’s scheme.74 and 1. b. Explain Carlyle’s main trading strategy and the major factors behind its collapse. d.250 1. Capacity Leverage Drawdown Lock-up 2. 6th. 2. An equity long/short hedge fund has the following portfolio composition: Long positions Short positions 150% of the portfolio value 50% of the portfolio value The long exposure comprises a single asset with a beta of 1.29. Explain Amaranth’s main trading strategy and the major factors behind its collapse. Chartered Alternative Investment Analyst Association. Inc. c. c. 1.78. Understand the conclusions that can be drawn from these cases. Explain Bayou’s main trading strategy and the major factors behind its collapse. All Rights Reserved. Exhibit 16. 8th and 9th Sharpe ratios should be 2. Explain Peloton’s main trading strategy and the major factors behind its collapse. 2. 5. Chapter 17 Hedge Fund Collapses Learning Objectives 1. the 5th. 3.375 1. 7.
b. 5. Private securities of companies in financial distress or in bankruptcy Public securities of companies in financial distress or in bankruptcy Private securities that are newly issued by public companies Public securities that are newly issued by companies going public 4. d. To investigate whether performance persistence exists. c. In which types of securities do Regulation D hedge funds typically invest? a. simultaneous short positions in out-of-the-money calls and puts. High alpha and platykurtosis High alpha and leptokurtosis Negative alpha and platykurtosis Negative alpha and leptokurtosis March 2012 Level I Study Guide 33 . To provide an improved risk measure of idiosyncratic risk. To measure the extent to which hedge funds are diversifiers. b. d.3. For what primary reason would an investor examine the serial correlation of hedge fund returns? a. c. To estimate the sign and magnitude of the fund’s alpha. c. b. Derek Fund combines a well-hedged position in competitively-priced assets with very large. A due diligence analysis focused on a time period exhibiting relative market calmness would be expected to show the fund exhibiting which of the following return characteristics? a. d.
2nd Edition. Chapters 12.4. 9th Edition. McGraw Hill Publishers. Chapter 19 Introduction to Commodities Keywords Capital assets Commodity futures contracts Commodity-linked notes Contango Convenience yield Financial futures Initial margin Interest rate parity theorem Maintenance margin Margin call Normal backwardation Storage costs Variation margin Learning Objectives 1. calculate the futures price for an asset that pays no income. candidates must be familiar with the concepts that are covered in “Foundations. Compare commodities to capital assets. c. 2.org/caia-program/curriculum/foundations. commodity exchange-traded funds. 2009. For exposure to commodities. 3. b. a “pure play” investment.caia. .” For further information see www. 2010. describe: a.. Chartered Alternative Investment Analyst Association. R. DeFusco. Chapters 19 – 22. b. commodity futures contracts and margin requirements. the purchasing of the underlying commodity. ISBN: 978-0-470-44702-4. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments. For the relationship between futures prices and spot prices: a. D. commodity-linked notes. A. and To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. Quantitative Investment Analysis. Marcus.Topic 5: Commodities and Managed Futures Foundations* Investments. and A. Chapters cited in Topics 2 . * 34 Copyright (C) 2011. and D. Pinto. d. Wiley Publishers. commodity swaps.. McLeavey. 22 and 23 and the chapters cited in Topics 2 . All Rights Reserved. forward contracts. Wiley. Runkle. Part IV – Commodities and Managed Futures. Z. calculate the futures price for an asset with a known dividend yield. Inc. J.4. Kane. 2007. Bodie.
define storage cost. Exhibit 19. March 2012 Level I Study Guide 35 ." It should read: "Ser(T-t) (receive principal and interest). define convenience yield." It should read "S (to borrow the asset). identify the determinants of speculator profits in the commodity markets. For economics of the commodity markets: a. e. d. 4. define a contango market. calculate the futures price for a commodity futures contract. b. Correction to reading: Page 319.” Chapter 20 Investing in Commodity Futures Keywords Collateral yield Commodity futures indices Commodity Research Bureau (CRB) Index Dow Jones-AIG Commodity Index (DJ-AIGCI) Managed futures accounts Mount Lucas Management Index (MLMI) Real assets Roll yield Standard & Poor’s Goldman Sachs Commodity Index Note: The Dow-Jones-AIG Commodity Index is now the Dow Jones-UBS Commodity Index. g. However. define normal backwardation.6. identify mispricing arbitrage opportunities in the commodity markets. e. f." In the "Cash Outflow" column. we will continue to refer to the index as it was named prior to the change in 2009. h. formulate the interest rate parity relationship. identify arbitrage opportunities for situations where futures prices are lower than fair value. identify the role of futures in hedging producers’ risk. compare backwardated commodity markets to contango markets. calculate the futures price for a currency contract. i. compare pricing of commodities to pricing of financial assets. the 1st line reads: "S (to purchase the asset). d. c. f. g.c. j. the 2nd line reads: "F (receive principal and interest). identify arbitrage opportunities for situations where futures prices are higher than fair value. In the "Cash Inflow" column. identify the role played by speculators in the commodity market.
d. For the Goldman Sachs Commodity Index (GSCI): a. h. c. identify the main characteristics. c. describe the weighting methodology. d. e. For the Dow Jones-AIG Commodity Index (DJ-AIGCI): a. Define real assets. Discuss the empirical evidence for the diversification potential of commodity futures added to portfolios of financial assets. identify the main characteristics. Chapter 21 Commodity Futures in a Portfolio Context Keywords Downside risk protection Efficient frontier Treasury inflation-protected securities (TIPS) Learning Objectives 1. b. c. 5.Learning Objectives 1. 2. Describe the Reuters/Jefferies Commodity Research Bureau (CRB) Index. 36 Copyright (C) 2011. d. identify the main characteristics of the historical return distribution. define an unleveraged index. Inc. discuss the economic exposure. g. define collateral yield. f. describe the weighting methodology. All Rights Reserved. identify the components. 8. identify sources of return. 4. identify the five groups of real assets represented. 3. distinguish between circumstances resulting in positive roll yield and those resulting in negative roll yield. describe the weighting methodology. b. identify the main characteristics. . d. For the Mount Lucas Management Index (MLMI): a. 6. identify the main characteristics of the historical return distribution. b. Chartered Alternative Investment Analyst Association. b. For commodity indices: a. identify the main characteristics of the historical return distribution. Compare and contrast commodity and capital asset price movements with respect to the business cycle and event risk. identify the components. c. 7. contrast the returns with those earned by managed futures accounts. identify desirable characteristics. Explain how real assets such as commodity futures can hedge against the decline of stocks and bonds prices in an inflationary environment. calculate roll yield.
Identify how adding a passive commodity index to a portfolio of stocks and bonds changes the efficient frontier. Identify how extreme market events can affect the return correlation of equity instruments. 9. public commodity pool. and the Mount Lucas Management Index (MLMI) to a portfolio of stocks and bonds. 4.S. Compare the risk and return characteristics of commodity indices to traditional broad market indices. Define: a. private commodity pool. 6.2. Identify the potential of downside risk protection offered by commodities when added to portfolios of stocks and bonds. portfolio of stocks and bonds. Exhibit 21. commodity pool. Compare the effects of adding the Goldman Sachs Commodity Index (GSCI). Identify why international stocks generally do not offer inflationary protection for a U. 3. 2nd to last paragraph. 5. Define the efficient frontier. 8. c. Explain why commodities are perceived to be a better inflationary hedging tool than Treasury inflation protected securities (TIPS). March 2012 Level I Study Guide 37 . last sentence (referring to Exhibit 21.2) reads: “The two lowest-yielding classes over this time period are the DJ-AIGCI and the MSCI EAFE…” This should read: “The two lowest-yielding classes over this time period are the CRB and the EAFE…” Chapter 22 Managed Futures Keywords Chicago Board of Trade (CBOT) Chicago Mercantile Exchange (CME) Commodity Exchange Act Commodity Futures Trading Commission (CFTC) Commodity pool operator (CPO) Commodity pools Commodity trading advisor (CTA) Individually managed account Managed futures National Futures Association (NFA) New York Mercantile Exchange (NYMEX) Private commodity pools Public commodity pools Learning Objectives 1. b. 7.1 reference. Correction to reading: Page 354. the Dow Jones-AIG Commodity Index (DJ-AIGCI).
c. $1. registration requirements established by the Act. Discuss the empirical evidence on the portfolio performance benefits of investment in CTAs. Describe the history of organized futures trading in the U. and the dividend yield at 1%? a. identify the: a. d. Describe how one can detect the level of skill of a CTA by using a naïve benchmark. Chartered Alternative Investment Analyst Association. b. the risk-free rate at 5%. 5. 3. c. d. .545 $1. 4. Which of the following comes closest to the fair price on a 6-month futures contract on the Standard & Poor’s (S&P) 500 index given the following information: an index at 1500. 3.590 2. standards established by the Act. Which of the following BEST explains the shape of the forward curve? a. For the Commodity Exchange Act. private and public commodity pools. role of the National Futures Association (NFA) as established by the Act. All Rights Reserved.2. Consider the case of a non-dividend-paying financial asset where F > Ser(T-t). Contango futures markets have an upward sloping forward curve. Identify the potential downside risk protection offered by managed futures for portfolios of stocks and bonds. 9. can the hedge fund manager earn a profit? a. d. By buying the underlying asset and buying the futures contract. 8. Describe conclusions that can be made by analyzing historic return distributions for different managed futures indices. in this case. By selling short the underlying asset and selling the futures contract. By buying the underlying asset and selling the futures contract. Compare the effects of adding managed futures versus adding passive commodities to a portfolio of stocks and bonds. Define the relationship between commodity pool operators (CPOs) and commodity trading advisors (CTAs).560 $1. b. b. b. Commodities and Managed Futures Sample Questions 1. Identify standard fees charged by CTAs and CPOs. c. By selling short the underlying asset and buying the futures contract.S. How.530 $1. The additional risk accepted by hedgers over short periods The additional risk accepted by hedgers over long periods The additional risk accepted by speculators over short periods The additional risk accepted by speculators over long periods 38 Copyright (C) 2011. 6. 7. Inc. c. 10.
00. d.48% March 2012 Level I Study Guide 39 . Increased downside risk and a worsened risk-return tradeoff Increased downside risk and an improved risk-return tradeoff Decreased downside risk and a worsened risk-return tradeoff Decreased downside risk and an improved risk-return tradeoff 5. b.4. which of the following rates is closest to the one-year risk-free interest rate in the foreign currency? a. c.24% 15. what is the effect of adding managed futures to a diversified portfolio of stocks and bonds? a.12% 10. Consider a situation in which the domestic one-year risk-free interest rate is 10%. and a one-year futures contract on the foreign currency has a price of 1. d. c. Assuming continuous compounding. According to the Level I readings.36% 20. b. 5. the current spot exchange rate with a particular foreign currency is 1.05 domestic units per unit of foreign currency.
Quantitative Investment Analysis.caia. Define venture capital. List and describe the aspects of the entrepreneur’s business opportunity upon which venture capitalists focus.org/caia-program/curriculum/foundations. 2nd Edition. 40 Copyright (C) 2011. 4. 2. 2010. Chapter 23 . 6. McLeavey. Pinto. A. ISBN: 978-0-470-44702-4. candidates must be familiar with the concepts that are covered in “Foundations. 2009. Inc. List sources of venture capital and describe how the structure of the venture capital marketplace has changed over previous years. and D. Z. Marcus.28. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments. R. McGraw Hill Publishers. Identify the venture capitalist’s relationship with investors including the role of protective covenants and venture capital fees.” For further information see www. Part V – Private Equity. Chapter 23 Introduction to Venture Capital Keywords Alpha testing Balanced VC funds Beta testing Burn rate Clawback Distressed debt Expansion Gatekeeper Investment advisors J-curve effect Late stage Mezzanine financing Private equity Prudent person Venture capital Learning Objectives List four distinct strategies encompassed by the term private equity. Chartered Alternative Investment Analyst Association. 7. Wiley. * 1. D. Chapters cited in Topics 2 – 5. Identify important developments in the history of venture capital. Runkle. DeFusco. J. All Rights Reserved.Topic 6: Private Equity Foundations* Investments.. Bodie. 3.. . 5. Kane. To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. Describe expected returns in the venture capital market relative to those in the public stock market. and A. 9th Edition. Wiley Publishers. Chapter 18 and the chapters cited in Topics 2 – 5. 2007.
For example. Page 413. When the first round of bugs has been fixed. taxes. Note: The discussions involving “beta testing” and “alpha testing” are not entirely correct. Chapter 24 Introduction to Leveraged Buyouts Keywords Agency costs Buy and build Corporate governance Earnings before interest. replace 2nd sentence with: Some of this will have been accomplished with the alpha and beta testing of the product. The next step is to test the second-generation prototype with potential end users. the alpha testing refers to the first test of newly developed products (e. and amortization (EBITDA) Economic value-added (EVA) Equity kicker Exit strategy Junk bonds Leveraged build-up Leveraged buyout (LBO) Management buyout (MBO) Material adverse change clause Merchant banking Vintage year March 2012 Level I Study Guide 41 .8. 4th paragraph. the product goes into beta test with actual users.. refers to a test of new or revised product that is performed by users at their facilities under normal operating conditions. First. 9. vendors of packaged software often offer their customers the opportunity of beta testing of new releases. replace the 1st. therefore. Beta testing. Page 414. List and describe various venture capital investment vehicles.g. typically. This beta testing follows alpha testing. Explain the life cycle of a venture capital fund and describe each of the stages of financing. 2nd and 3rd sentences with: The start-up company should now have a viable product that has been alpha-tested in the laboratory and has been betatested with potential users. depreciation. under heading Early stage venture capital 1st paragraph. 10. List specializations within the venture capital industry. 5th sentence revised as: It is not until the product is tested using the second-generation prototype with potential end users that revenues may be generated and the start-up becomes a viable concern. under heading The J Curve For a Start-Up Company 4th paragraph. hardware or software) in a laboratory setting. Corrections to reading: Pages 413-414.
2. 2. 9. depreciation. Describe the layers of LBO financing. 6. 3. Inc. Identify advantages of mezzanine debt to the investor and to the issuer. Describe the role of the material adverse change clause in LBO failures. taxes. Explain the concept of a vintage year as it relates to the J-curve effect. 11. 4. Describe the general purpose of mezzanine financing and the rationale for its return expectations. Define corporate governance and list three types of agency costs associated with LBOs. All Rights Reserved. 15. Compare LBOs to venture capital deals. Identify important developments in the history of LBOs and describe the recent historical performance of LBOs. Define earnings before interest. 5. Define leveraged buyouts (LBOs). 7. 8. Compare the structure of LBO funds to that of hedge funds and venture capital funds.” Chapter 25 Debt as Private Equity Part I: Mezzanine Debt Keywords Blanket subordination Inter-creditor agreement Mezzanine debt Mezzanine financing Payment-in-kind Springing subordination Story credits Takeout provisions Learning Objectives 1. Outline risks associated with LBOs. Recognize the type of transactions that use mezzanine financing. 12. Chartered Alternative Investment Analyst Association. Compute the annual compounded return for a theoretical LBO investment. Describe three important benefits for the public market that result from principles of corporate governance applied by LBO firms. Compare mezzanine funds to other forms of financing. last paragraph. 10. 42 Copyright (C) 2011. 4.Learning Objectives 1. 3. Compare the five general categories of value creation methods through LBOs. 3rd sentence should read “…present value stream of management fees worth $1. Describe fee structures for LBO firms. . Correction to reading: Page 436. and amortization (EBITDA). 13. 14. Describe the practice of merchant banking.006 billion.
2. Describe restrictions on the senior creditor and the mezzanine investor that may be included in the inter-creditor agreement. Identify factors that have influenced growth in the distressed debt market since the 1990s. Describe the nature of distressed debt investors. 2. Contrast deal terms for hedge funds with deal terms for private equity firms. 7. Chapter 27 Trends in Private Equity Keywords Auction market Club deal Death spiral Direct secondaries Leveraged loans Structured PIPEs or Structured Private Investment in Public Entities (PIPEs) Toxic PIPEs Learning Objectives 1. Illustrate how an investor can gain control of a company through Chapter 11 bankruptcy proceedings. 5. 5. March 2012 Level I Study Guide 43 . 4. Identify two of the main risks of distressed debt investing. Describe the advantages and disadvantages of the club deal in the LBO market.5. Understand the basics of the Chapter 11 bankruptcy process. Chapter 26 Debt as Private Equity Part II: Distressed Debt Keywords Chapter 7 bankruptcy Chapter 11 bankruptcy Covenant-light loans Cramdown Debtor-in-possession (DIP) financing Distressed debt investing Vulture investors or Vultures Learning Objectives 1. 4. 3. Describe an arbitrage strategy in the distressed debt market. 6. Describe the efficiency and development of an auction market environment for private equity. Define leveraged loans. Recognize the types of active and passive distressed debt strategies. Describe the advantages and disadvantages of the development of a secondary market for private equity. 3.
describe how a traditional PIPE transaction works. b. given by the average. explain how toxic PIPEs work. All Rights Reserved.6. the return patterns for leveraged buyouts (LBOs) are shown to exhibit which of the following characteristics? a. standard deviation. Compare the return distributions of the four private equity categories. It is senior to debt represented by bank loans. Describe the interest of the various parties in the leveraged loan market including equity firms and collateralized loan obligation funds. For private investments in public entities (PIPEs): a.” This should be “32. c. Chartered Alternative Investment Analyst Association. Significant negative skewness Significant positive skewness A near symmetrical distribution Significant negative kurtosis 2. In general.81.7. 2. skewness. Which of the following is TRUE of mezzanine financing? a. Rank the risk-adjusted average returns (Sharpe ratio) for the four private equity categories and understand reasons for the differences in performance. 7. and kurtosis. Exhibit 28. Compare the investment results of investing in the four private equity categories to that of investing in the S&P 500. Correction to reading: Page 518. Chapter 28 The Economics of Private Equity Keywords Distressed debt Diversification Leveraged buyout (LBO) Mezzanine debt Venture capital Learning Objectives 1. 4. describe a safeguard that can help prevent toxic PIPEs and death spirals. note below Exhibit states a Kurtosis value of “2. Inc. 3.81. Discuss the diversification benefits of including private equity in a portfolio of traditional investments. c. 44 Copyright (C) 2011.” Private Equity Sample Questions 1. b. d. .
Leveraged buyouts are most risky and distressed debt is least risky. Flat revenues in the early years followed by profits in the later years. Which of the following describes the J-curve effect in the typical life cycle of a venture capital firm? a. d. Priority of payment The takeout provision Acceleration Subordination 5. c. Mezzanine financing tends to attract the most capital in a robust economy. Losses in the early years followed by profits in the later years. 4. b. c. c. d. d. 3. Venture capital is most risky and mezzanine debt is least risky. March 2012 Level I Study Guide 45 . Mezzanine financing typically has an equity kicker. c. Return expectations for mezzanine funds is at about the same level as leveraged buyout (LBO) funds. Moderate profits in the early years followed large profits in the later years. Which of the following statements BEST describes the risk spectrum of private equity strategies? a. Venture capital is most risky and distressed debt is least risky. b. d. Leveraged buyouts are most risky and mezzanine debt is least risky. What characteristic of mezzanine investing allows an investor to purchase the senior debt once it has been repaid to a certain level? a. Profits in the early years followed by losses in the later years. b.b.
Wiley Publishers. All Rights Reserved. 4. Compare and contrast revolvers with term loans. Compare and contrast the three types of credit risk. Kane. 10. Describe the emerging markets debt market. 9th Edition. Pinto.. Bodie. Inc. 2nd Edition. McLeavey. . Runkle. Marcus. Wiley. 2009. Quantitative Investment Analysis. 8.” For further information see www. ISBN: 978-0-470-44702-4. Chapters 22. 9. * To understand the CAIA Curriculum and to pass the CAIA Level I exam successfully. 7. 2010. J.. Describe two methods of measuring credit risk. 46 Copyright (C) 2011. Describe three traditional methods of managing credit risk. Chapter 29 Introduction to Credit Derivatives Keywords Credit call option Credit default swap (CDS) Credit linked note (CLN) Credit put option Credit spread risk Default risk Downgrade risk International Swaps and Derivatives Association (ISDA) Nationally Recognized Statistical Rating Organizations (NRSROs) Qualifying affiliate guarantees Qualifying guarantees Rating migration Revolvers Spread product Learning Objectives 1. and D. Describe the distressed debt market. Describe the leveraged bank loan market.Topic 7: Credit Derivatives Foundations* Investments. and A. Describe the high yield debt market. 6. Chartered Alternative Investment Analyst Association.6. 2007. 23 and the chapters cited in Topics 1 . candidates must be familiar with the concepts that are covered in “Foundations. List four advantages that credit derivatives provide. 3. 5.caia. Chapters 29 – 31. McGraw Hill Publishers. DeFusco. Chapters cited in Topics 1 . Z. 2. D. A. Readings CAIA Level I: An Introduction to Core Topics in Alternative Investments. Understand the diversification potential of credit risky investments. R.6. Part VI – Credit Derivatives.org/caia-program/curriculum/foundations.
1st paragraph. Should read: The credit protection seller takes on all of the economic risk …….11. 15.05% rather than -0. List five types of terms negotiated by parties to a CDS. the 3rd line should read “In general. Corrections to reading: Page 535 Next to the last paragraph. 13. the credit protection buyer can deliver the following:” Chapter 30 Collateralized Debt Obligations Keywords Arbitrage CDOs Balance sheet CDOs Bankruptcy remote Cash flow CDO Cash-funded CDOs Collateralized bond obligation (CBO) Collateralized debt obligation (CDO) Collateralized loan obligation (CLO) Correlation products Credit enhancement Credit tranching External credit enhancement First-loss tranche Overcollateralization Reserve account Special purpose vehicle (SPV) Spread enhancement Subordination Synthetic arbitrage CDOs Synthetic CDOs Unfunded CDO Waterfall March 2012 Level I Study Guide 47 . Compare and contrast the cash flows of a total return credit swap for the swap buyer with those for the swap seller. List four types of risks associated with credit derivatives. 12. Understand credit put options and credit call options. Page 543. Compare and contrast a total return credit swap with a credit default swap (CDS). Page 548. 14. Explain why an investor would purchase a credit linked note (CLN). the average monthly return on leveraged loans should read +0. 16. 5th sentence: The credit protection buyer takes on all of the economic risk……. List six kinds of trigger events provided by the International Swaps and Derivatives Association (ISDA). 17.05%.
d.10. hedge fund CDOs.Learning Objectives 1. All Rights Reserved. 3. b. cash funded CDO with synthetic CDOs. Explain why synthetic CDOs using credit default swaps (CDSs) are often called correlation products. . Exhibit 30. funded with unfunded CDOs. Describe synthetic arbitrage CDOs. 9. Correction to reading: Page 568. 48 Copyright (C) 2011. 8. 4. distressed debt CDOs. Compare and contrast cash flow arbitrage CDOs to market value arbitrage CDOs. cash flow CDO with market value CDOs. Describe three phases of most arbitrage CDOs. 5. d. Identify key benefits to banks from CLOs. collateralized commodity obligations. Inc. c. Compare and contrast the structure of: a. Explain how special purpose vehicles work in the CDO market. the X-axis label “Default Rate” should be “Decline in Portfolio Value. Describe the structure of a cash funded balance sheet CDO. Chartered Alternative Investment Analyst Association. balance sheet CDOs with arbitrage CDOs.” Chapter 31 Risks and New Developments in CDOs Keywords CDO squared Collateralized commodity obligation (CCO) Distressed debt CDO Hedge fund CDOs Market Value CDOs Private equity CDOs Single-tranche CDO Weighted average rating factor (WARF) Weighted average spread (WAS) Learning Objectives 1. Describe the nature of new developments in: a. b. 2. Calculate the profits from an arbitrage CDO trust. 11. private equity CDOs. 10. Calculate the net gain (or loss) of a synthetic balance sheet CDO using a total return swap to the bank sponsoring a credit loan obligation (CLO) trust. 7. 6. c. Explain factors impacting the growth (or contraction) in the collateralized debt obligation (CDO) market.
4. Corrections to reading: Page 578 and 579.0 15.5 19. corrections to Exhibit 31. Discuss the implications of the weighted average rating factor (WARF) and weighted average spread (WAS) over the London Interbank Offered Rate (LIBOR) for the CDO manager.9 9. 2.0 30.8 3.0 2.0 15.0 15. Identify key risks associated with CDOs.5 $10 Euro 16.1 14.0 20.S.5 10.7 16. Allocation of NAV (%)* Current DSF Allocation (year -end 2001) Investment Strategy Distressed Risk Arbitrage Convertible Arbitrage Equity Market Neutral Fixed Income Relative Value Hedge Equity (U.6 9.8 2. CDO squared. Exhibit 31.9 5.0 20. f.30 $250 Source: Bloomberg Interest Rate Libor + 60 Libor + 160 Libor + 250 Libor + 250 Residual Exhibit 31.0 15.) Hedge Equity (Global) Macro Discretionary Macro Systematic Portfolio Insurance Multi-strategy 12. single tranche CDOs.4: Diversification by Investment Strategies Max. 3. second to last sentence. If the portfolio NAV is greater than the initial NAV.9 NAV -.9 10. the second paragraph in the "WARF versus WAS” section.3 and Exhibit 31.Net Asset Value.0 20. Source: Standard & Poor's Page 589.0 30.3: Diversified Strategies CFO Tranche A B C-1 C-2 Equity Rating (S&P) AAA A BBB BBB unrated Amount (millions) $125 $32.2 $66. section should read: Continued on next page: March 2012 Level I Study Guide 49 . the excess amount will not be subject to these minimum constraints.e.0 30.
second lien loans are subprime loans and can dramatically raise the WARF. A collateralized debt obligation (CDO) trust holds $500 million in bonds with a 9% coupon. Downgrade risk is most influenced by world events while credit risk is most influenced by company-specific events. d. b. Downgrade risk originates from a review by an independent agency while credit spread risk originates from a reaction in the financial markets. How does downgrade risk differ from credit spread risk? a. be wary of the CDO manager raising the WARF to boost the WAS. c. there might be an incentive to raise the WARF to boost the WAS because any extra or arbitrage income spread accrues to the equity tranche. which of the following values is closest to the annual cash flow that the equity tranche holders can expect to receive? 50 Copyright (C) 2011. Chartered Alternative Investment Analyst Association. c. All Rights Reserved. a $50 million B tranche with a coupon of 10%. and any fees. Downgrade risk originates from interest rate shifts while credit spread risk originates from shifts in default possibility. . Inc. Ignoring bond defaults. Formulation period Revolving period Amortization period Ramp-up period 4. d. The CDO has three tranches: A $400 million A tranche with a coupon of 9%. for the equity tranche. Downgrade risk moves only down while credit spread risk can move either up or down. Which of the following is NOT one of the three periods of the life cycle of collateralized debt obligations (CDOs)? a. and a $50 million equity tranche with an expected return of 12%." Credit Derivatives Sample Questions 1. changes in market values. b. Which of the following is the term for corporate bank loans that are legally committed lines of credit? a. Call options Revolvers First loss loans Collateralized debt obligations 3. d. c. The last two sentences of the last paragraph in the same section should read: "However. 2. b.Unfortunately. Bottom line: For higher-rated tranches of a CDO.
March 2012 Level I Study Guide 51 . The structure offers the best over-collateralization potential. The structure has very limited customization potential. c. c.a. the structure incorporates credit default swaps (CDSs). b.000 $0 5. $6. Which of the following is a characteristic of a single-tranche collateralized debt obligation (CDO)? a. b.000 $4.000 $4.500. d. Typically. The entire portfolio risk is transferred to the investors.000.000. d.
4. 3. 3. 5. C C C A A Topic 5: Commodities and Managed Futures 1. 3. 2. 2. A D D A C Topic 3: Real Estate 1. 2. 5. C B C B B Topic 7: Credit Derivatives 1. . 4. Chartered Alternative Investment Analyst Association. 5.Sample Questions Answer Key Topic 1: Professional Standards and Ethics 1. 5. A A D D A Topic 6: Private Equity 1. D A D A D Topic 4: Hedge Funds 1. 3. 2. 5. 2. 4. 3. 4. 5. 4. C B A C B 52 Copyright (C) 2011. 4. All Rights Reserved. Inc. B A C A C Topic 2: Alpha Drivers and Beta Drivers 1. 3. 4. 2. 5. 2. 3.
causing the positive cash flow to harm the position’s return profile.) March 2012 Level I Study Guide 53 . D. lowering the bond’s value. D. B.. Fundamental Responsibilities. Correct Answer: B Apply Make use of Alicia Weeks. C. must adhere to the CFA Institute’s codes and standards. Correct Answer: C Argue Prove by reason or by presenting the associated pros and cons. change in regulations. works in an Asian country where there are no securities laws or regulations. According to CFA Institute Standard I. You have to apply the CFA Institute Standard I to find the correct answer. The convertible may remain overvalued. The implied volatility may decrease. The short convertible may be called in and the position must be delivered. need not concern herself with ethics codes and standards. The implied volatility may increase. Real Estate Investment Advisor.g. in a question example and in a description. Example of Term Use You have to analyze the positions and factors impacting them. along with definitions and two examples of usage. C. Below is a list of all action words used in this study guide. What risks are associated with this hedge? A. Should you not understand what is required for any learning objective. must adhere to the standards as defined in a neighboring country that has the strictest laws and regulations. debate Why did the shape of the supply curve for venture capital funds change after 1979? You have to describe how the curve has changed AND argue why it changed by providing reasons and supporting the reasons with statements of facts (e. we suggest you refer to the table below for clarification. action words are used to direct your study focus. CFA. Term Analyze Definition Study the interrelations Question Example George has identified an opportunity for a convertible arbitrage reverse hedge. must adhere to the standards as defined in a neighboring country that has the least strict laws and regulations. lowering the bond’s value. Alicia: A.Action Words In each of the above learning objectives. forcing the hedge to be unwound at an inopportune time. B.
firm commitments are expected to decline. All Rights Reserved. The Sharpe ratio is the inverse of the Treynor ratio. C. The Sharpe ratio is based on total risk while the Treynor ratio is based on systematic risk.26% 8. size. Correct Answer: A Calculate Use a mathematical formula to determine a result A T-bill has a face value of $10. C.34% 8. Inc. B. B. Both ratios contain excess return in the numerator. Through increased supply of capital. Correct Answer: D 54 Copyright (C) 2011. firm commitments are expected to rise. C.Term Assess Definition Determine importance. D. Chartered Alternative Investment Analyst Association.18% 8. You have to correctly classify the aspects of private equity firms relating to the various compliance issues. Through decreased supply of capital.54% You have to calculate the effective annual yield. D. . Both ratios express a measure of return per unit of some measure of risk. what is its effective annual yield? A. Through decreased after-tax return on venture investments. Through increased after-tax return on venture investments. firm commitments are expected to rise. firm commitments are expected to rise. or value Question Example How are lower capital gains taxes expected to impact firm commitments? A. If the T-bill matures in 90 days. 8.000 and sells for $9.800. You have to compare the three approaches based on their most important similarities and their most important differences Compare Describe similarities and differences Which of the following least accurately compares the Sharpe and Teynor ratios? A. Example of Term Use You must assess the significance of the change in the tax rate for firm commitments. D. Correct Answer: D Classify Arrange or organize according to a class or category Classify compliance issues considered by examiners when investigating firms that market private equity securities. B.
the payments of the constant payment mortgage are initially greater than those of the constant amortization mortgage.757 $9. short convertible position plus a long position in the stock. C. Correct Answer: C March 2012 Level I Study Guide 55 . short convertible position plus a call option on the stock.000? A.797 $9. D. Modified VaR incorporates non-normality while traditional VaR assumes normality. the constant payment mortgage loan balance exceeds that of the constant amortization mortgage during the first six months of the loan. B. B. Correct Answer: D Construct Make or form by combining or arranging parts or elements A reverse convertible arbitrage hedge consists of a: A. What is the asked price of the bill if it matures in 60 days and has a face value of $10. Correct Answer: D Contrast Expound on the differences Which of the following best characterizes a difference between Value at Risk (VaR) and Modified Value at Risk? A. B. Correct Answer: C Compute Determine an amount or number The “asked” discount yield on a T-bill is 5%. the present value of the payment streams of the two loan types are the same.917 You have to compute a value from a set of inputs. Modified VaR is for a single trading period while traditional VaR is multiple period. D. the initial payment will be the same.837 $9. Modified VaR uses a user defined confidence interval while VaR uses a 99% interval. C. Example of Term Use You have to compare indices to arrive at the answer. short convertible position plus a put option on the stock. You have to contrast the assumptions of the first model to those of the second model so that the differences are clear. Modified VaR is expressed as a percent while VaR is a dollar value. B. You have to combine positions to construct the hedge. long convertible position plus a put option on the stock.Term Compare and Contrast Definition Examine in order to note similarities or differences Question Example A comparison of monthly payments and loan balances of the constant payment mortgage with the constant amortization mortgage with the same loan terms will show that: A. D. C. C. D. $9. but at some time period the payments of the constant payment mortgage become less.
Correct Answer: A You must defend the use of an adjusted stochastic instead of a traditional stochastic. Spread Average Spread squared Average squared You need to choose the word that best describes the concept from a list. B. The initial margin is 60%. All Rights Reserved. Example of Term Use You must critique the various risk measures so that the advantages and disadvantages have been enumerated and justified. in this case. prime rate. which of the following best describes the appropriateness of the IRR approach? A. Correct Answer: C Describe Convey an idea or characterize Which of the following words best describes expected return? A. Inc. B. The IRR approach does not rank different sized projects as well. The IRR approach does not consider future cash flows. Defend To support or maintain through argument. Chartered Alternative Investment Analyst Association. Correct Answer: B Determine Establish or ascertain definitively. The IRR approach requires annuity computations. . D. Correct Answer: B 56 Copyright (C) 2011. 25% 33% 41% 49% You have to determine a precise value from a set of inputs. B. The IRR approach requires the user to supply an interest rate. calculation or investigation Assume you sold short 100 shares of common stock at $50 per share. federal funds rate. You have to define. as after consideration. B. What would be the maintenance margin if a margin call was made at a stock price of $60? A. C. Define State the precise meaning The interest rate charged by banks with excess reserves at a Federal Reserve Bank to banks needing overnight loans to meet reserve requirements is called the: A. D. the federal funds rate. D.Term Critique Definition Evaluate with reasoned judgment Question Example Compared with ranking investment opportunities using NPV. justify Justify the use of an adjusted stochastic. C. C. C. discount rate. call money rate. D.
You have to place a series of thoughts together as an explanation of a term or issue. Call option hedge Traditional convergence hedge Implied volatility convergence hedge Reverse hedge Example of Term Use You have to differentiate one type of hedge from another. B. Distinguish Separate using differences Which of the following best distinguishes between the covariance and the correlation coefficient? A. The covariance is the square root of the correlation coefficient. the current yield plus the dividend yield. Correct Answer: D Discuss Examine or consider a subject Discuss the limitations of private equity data. You have to present a discussion of a set of ideas in a list or paragraph. You need to identify the term that best explains a term or issue. the capital gain yield plus the dividend yield over the period. The correlation coefficient is scaled and bounded between +1 and -1. D. C. The covariance indicates the extent to which two assets move together or apart. Terminal wealth will be less than initial wealth. Final wealth will be greater than initial wealth. Which of the following best explains risk from the standpoint of investment? A. The correlation coefficient is the expected product of the deviations of two variables. Formulate State or reduce to a formula Investors will lose money. Explain why return on assets (ROA) rather than return on equity (ROE) might be the preferred measure of performance in the case of hedge funds.Term Differentiate Definition Constitute the distinction between. 2. B. Correct Answer: D Explain Illustrate the meaning 1. More than one outcome is possible. Correct Answer: D The holding period return (HPR) on a share of stock is equal to: A. D. B. C. C. D. the dividend yield plus the risk premium. Correct Answer: B March 2012 Level I Study Guide 57 . B. C. 1. You have to distinguish between risk measurement approaches based on their assumptions regarding the distribution of returns. the capital gain yield minus the inflation rate over the period. D. distinguish Question Example What type of convertible hedge entails shorting a convertible and going long in the underlying stock? A. You have to formulate the meaning of some term or issue. or 2.
30-day CD. how are the hedges set up. the bank will pay you 6% interest. Stock funds Bond funds Mixed asset classes. the bank will pay you 4%. B. You have to interpret the features of an investment scenario. B. Correct Answer: C Illustrate Clarify through examples or comparisons For two types of convergence hedges. gold. C. B. D. commodities. C. Correct Answer: D List Create a series of items List the determinants of real interest rates. All Rights Reserved. what situations present profitable opportunities. C. Name State a word by which an entity is designated or distinguished from others As of December 31. 2-year CD if you expect that interest rates will fall in the future. 30-day CD if you expect that interest rates will fall in the future. such as asset allocation funds Money market funds Correct Answer: A 58 Copyright (C) 2011. D. You have to differentiate from a list those items that are consistent with the question. stocks and bonds. D. Example of Term Use You have to identify the term that best meets the criterion of the question. Inc. which class of mutual funds had the largest amount of assets invested? A. You need to name the correct statement or phrase from a group of potential answers.Term Identify Definition Establish the identity Question Example The investments that have historically performed best during periods of recession are: A. and what are the associated risks? You have to provide an example for each hedge or compare the two to illustrate how they work. 1999. You should choose the: A. If you invest in a 30-day CD. If you invest in a 2-year CD. and you are considering how to invest the proceeds. no matter what you expect interest rates to do in the future. 2-year CD. treasury bills. Chartered Alternative Investment Analyst Association. . no matter what you expect interest rates to do in the future. Interpret Explain the meaning Your certificate of deposit will mature in one week.
which of the following best ranks. multiply them together. D. IPOs. and continued private Merged. and liquidated You have to choose the correct ranking of a number (4) of items according to a particular criterion (percentage).50 last year. liquidated. B.’s stock is determined to be 13% per year. add them together. Which of the following would be the most appropriate risk measure for Ms. $20. multiply them together. merged.25 $36.75 $31. Arnold to suggest in response to this concern? A. Drawdown Skewness Kurtosis Variance Correct Answer: B March 2012 Level I Study Guide 59 . divide by T and subtract one. Correct Answer: D Price State the amount by which an asset is valued or value an asset in monetary terms Widgets Inc. divide by T and subtract one. Add one to each return. merged. D. IPOs.’s stock. Correct Answer: B Rank Determine relative position According to the analysis by Gompers and Lerner. continued private. take the Tth root and subtract one. the four outcomes for total venture-backed firms? A. Example of Term Use You must outline the study’s most important findings rather than explain them in detail. Required return on Widget Inc. and IPOs Continued private. C. C. B. A. C. from low to high (by percentage). assuming the constant dividend growth model holds. D. B. and continued private IPOs. take the Tth root and subtract one.75 You have to price. Add one to each return. merged. Add one to each return. a value from a set of inputs. Add one to each return. Correct Answer: A You have to recommend which procedure reflects best practices. add them together. C. Liquidated. liquidated. D.Term Outline Definition Summarize tersely Question Example Which of the following best characterizes the steps in computing a geometric mean return based on a series of periodic returns from T time periods? A. Determine a fair market price for Widget Inc. paid a dividend of $2. B. and the dividend is expected to grow at 3% per year forever. Recommend Indicate as preferred Sue Arnold works for a hedge fund and has been asked to develop a methodology for the fund to measure and report on the potential tendency of various investment strategies to have a much higher probability of large negative outcomes than large positive outcomes.25 $25. according to a formula.
372 6. If Diversified's net asset value was $36. D.713. You have to use facts or values from a situation to answer a specific question. D.g. C. D. how many shares does the fund have? A.. growth in an industry). the prudent man rule) to another result or concept (e. You have to present a list or set of sentences that states main ideas. B.000.000 and liabilities of $43. Chartered Alternative Investment Analyst Association.000.372 7. Summarize Cover all the main points succinctly Summarize the performance of trend and momentum strategies. An increase in the number of fund shares outstanding An increase in the fund's accounts payable A change in the fund's management An increase in the value of one of the fund's stocks Correct Answer: D Use Apply for a purpose or employ Illustrate the financial benefits of merger arbitrage using an actual merger transaction. Correct Answer: C State the main risks faced by distressed securities investors. and compare their performance to the buy-and-hold strategy. B. Correct Answer: C Solve Find a solution Diversified Portfolios had year-end assets of $279. Inc. C. You have to use reasoning to illustrate an understanding of a specific issue. Understand Perceive and comprehend nature and significance.263. State Set forth in words or declare 4..488. assuming all other things remain unchanged? A. C.Term Relate Definition Show or establish logical or causal connection Question Example Which of the following effects does NOT help to explain growth in the venture capital industry? A. B.938. Amendments to the prudent man rule The rise of limited partnerships as an organizational form Decline in the valuations of small capitalization stocks The activities of investment advisors in the venture capital market Example of Term Use You must relate effects or factors (e.372 5. You have to summarize a longer discussion or complicated concept or set of results by focusing on the main ideas.g. All Rights Reserved. grasp meaning Which of the following would increase the net asset value of a mutual fund share.000.372 You have to place various inputs into a formula and solve for the unknown. 60 Copyright (C) 2011.37. .
$11. D.000 and liabilities of $17.11 $24. C. Correct Answer: B March 2012 Level I Study Guide 61 .81 Example of Term Use You have to determine a numerical value from a set of inputs and a formula. B.000 shares in the fund at year-end.000. What was Multiple Mutual's net asset value? A.000.96 $31. There were 24.Term Value Definition Assign or calculate numerical quantity Question Example Multiple Mutual Fund had year-end assets of $457.26 $18.300.000.
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