Hedge Funds

1. AWJ Capital is a hedge fund with USD100 million of initial investment capital. It charges a 2%
management fee based on year-end AUM and a 20% incentive fee. In its first year, AWJ Capital has a
30% return. Assume management fees are calculated using end-of-period valuation.

2. What are the fees earned by AWJ, assuming that the incentive fee is calculated from the return net of the
management fee? What is an investor's net return given this fee structure?

3. If the fee structure specifies a hurdle rate of 5% and the incentive fee is based on returns above the
hurdle rate, what are the fees earned by AWJ, assuming the performance fee is calculated net of the
management fee? What is an investor's net return given this fee structure?

4. In the second year, the fund value declines to USD110 million. The fee structure is as specified for
Question 1 but also includes using a high-water mark (computed net of fees). What are the fees earned
by AWJ in the second year? Given this fee structure, what is an investor's net return for the second year?

5. In the third year, the fund value increases to USD 128 million. The fee structure is as specified in
Questions 1 and 4. What are the fees earned by AWJ in the third year? Given this fee structure, what is
an investor's net return for the third year?

6. A PE fund invests USD15 million in a nascent luxury yacht manufacturer and USD17 million in a new
casino venture. The yacht manufacturer generates a USD9 million profit when a larger competitor
acquires the company, but the casino venture turns out to be a flop when its state licensing is eventually
denied, generating a USD10 million loss. If the manager's carried interest incentive fee is 20% of the
profits, what would this incentive be with a European-style waterfall whole-of-fund approach, and what
would it be if the incentive is paid on an American-style waterfall deal-by-deal basis (assuming no
clawback applies)?

7. An investor is contemplating investing EUR100 million in either the ABC Hedge Fund (ABC HF) or the
XYZ Fund of Funds (XYZ FOF). XYZ FOF has a "1 and 10" fee structure and invests 10% of its AUM
in ABC HF. ABC HF has a standard "2 and 20" fee structure with no hurdle rate. Management fees are
calculated annually on AUM at the beginning of the year. For simplicity, assume that management fees
and incentive fees are calculated independently. ABC HF has a 20% return for the year before
management and incentive fees.
Calculate the return to the investor from investing directly in ABC HF.

Calculate the return to the investor from investing in XYZ FOF. Assume that the other investments in
the
XYZ FOF portfolio generates the same return before management fees as ABC HF, and that XYZ FOF
has the same fee structure as ABC HF.

Why would the investor choose to invest in a fund of funds instead of a hedge fund, given the effect of
the "double fee" demonstrated in the answers to Part 1 and 2?

8. The Granite Rock Fund invests in leveraged-buyout Company A and start-up Company B, each for
USD10 million. One year later, the leveraged-buyout company returns a USD14 million profit, and two
years later, the start-up company turns into a complete bust, deemed to be worth zero. If the GP's carried
interest incentive fee is 20% of aggregate profits, and there is a clawback provision, how much-carried
interest will the GP initially accrue and ultimately receive?

9. A real estate investment fund has a USD100 million initial drawdown structure in its first year and fully
draws this capital to purchase a property. The fund has a soft hurdle preferred to return 8% per annum to
investors and an 80%/20% carried interest incentive split after that. At the end of Year 2, the property is
sold for a total of USD160 million. What are the correct distributions of the LPs and the GP?
 Furthermore, how would these have been different if the real estate investment fund had a hard hurdle of
8% per annum instead of a soft hurdle?
10. United Capital is a hedge fund with USD 250 million of initial capital. United charges a 2% management
fee based on assets under management at year-end and a 20% incentive fee based on returns in excess of
an 8% hurdle rate. In its first year, United appreciated 16%. Assume management fees are calculated
using end-of-period valuation. The investor's net return assuming the performance fee is calculated net of
the management fee, is closest to:

11. Capricorn Fund of Funds invests GBP100 million in Alpha Hedge Fund and ABC Hedge Fund.
Capricorn Fund of Funds has a "1 and 10" fee structure. Management fees and incentive fees are
calculated independently at the end of each year. After one year, net of their respective management and
incentive fees, Capricorn's investment in Alpha is valued at GBP80 million, and Capricorn's investment
in ABC is valued at GBP140 million. The annual return to an investor in Capricorn Fund of Funds, net of
fees assessed at the fund-of-funds level, is closest to:

12. The following information applies to Rotunda Advisers, a hedge fund:

■USD288 million in AUM as of the prior year-end
■ 2% management fee (based on year-end AUM)
■ 20% incentive fee calculated:
● net of management fee
● using a 5% soft hurdle rate
● using a high-water mark (the high-water mark is USD357 million)
■ Current-year fund gross return is 25%.
The total fee earned by Rotunda in the current year is closest to:
13. A hedge fund has the following fee structure:
Annual management fee based on year-end AUM 2%
Incentive fee of 20%
Hurdle rate before incentive fee collection starts 4%
The current high-water mark is USD 610 million

The fund has a value of USD583.1 million at the beginning of the year. After one year, it has a value of
USD 642 million before fees. The net percentage return to an investor for this year is closest to:

14. A Canadian hedge fund has a value of C$100 Mn at the beginning of the year. And a 20% incentive fee
with a 10% hard hurdle rate. Incentive fees are calculated net of management fees. The Value at the
year-end before fees is C$112 MN calculating the net return to the investor.

15. Springfield fund of funds invests in two hedge funds. DXS and REF funds. Springfield initially invested
$50 MN in DXS and $100 MN in REF. After one year, DXS and REF have valued at $55.5 MN and
$104.5 MN, respectively, net of both hedge management fees and incentive fees. Springfield fund of
funds charges 1% management fees on AUM at the beginning of the year and 10% incentive fees
independent of management fees. Calculate the annual return for Springfield fund of funds.

16. Let us say the fund value at the inception is 100 MN

Soft hurdle rate 6%
2 / 20 fee structure
High water mark
Management fees payable at the beginning fund value
Incentive fees payable net of management fees
The fund at a year 1 value of 117.5 MN
The fund value at year 2 123 MN
The fund value at year 3 138 MN
Calculate the return for the investor at the end of year 3
17. ABC hedge funds had $100 MN under AUM at the start of period 1. The fund grew to $120 MN at the
end of Period 1; at the end of period 2, the fund value fell to $90 MN period 3 final valuation for the
 fund's assets is $140 MN. If the incentive fees are not calculated based on the net of management fees,
Calculate the return to the investors at the end of each period given a "2 and 20" fee structure with a
high-water mark (computed net of fee) provision for incentive fees. Management fees are calculated at
the end of AUM.

a. Incentive fees calculate the net of management fees. Calculate the returns for each period for the investor.

18. Asset Value (Before Fees) is $110.00 MN at initiation

$102.2 MN at the end of the year 1
$118.0 MN at the end of year 2

Fee Structure
2 and 20 based on the beginning assets' Value
Incentive fees net of management fees
Soft Hurdle rate of 5%
High water mark
Calculate the Net return for Year 1 and Year 2

Note: After deducting the Management fees, incentive fees are calculated. The soft Hurdle rate is only
to check eligibility, not to deduct the hurdle amount. High water will be checked. The incentive will be
calculated beyond HWM if the NAV > HWM.

19. Bedlam Capital is a hedge fund with an initial investment capital of $100 million. In its first year, the
fund earns a return of 40%. The fund charges a 2% management fee based on assets under management
at the end of the year and a 25% incentive fee with a hurdle rate of 5% (applicable on the beginning
capital position for the year).
2018 = $140m
2019 = $120m
2020 = $145m

Given that the high watermark provision applies, the incentive fee is based on returns over the hurdle
rate. and is calculated net of the management fee, calculate the total fees and the investor's effective
return every three years.

Calculate the arithmetic and geometric mean annual returns over the 3 years based on the fee structure
specified in Part 1.

Calculate the capital gain to the investor and the total fee paid to the hedge fund over the 3 years

20. Scenario 1
Management fees 2% Year end
Incentives 20% Independent of Management Fees
Beginning Value $800 MN
40% return at the end of 1 year
Calculate return

Scenario 2
Management fees 2% Year end
Incentives 20% Net of Management Fees
Beginning Value $800 MN
40% return at the end of 1 year
Calculate return

Scenario 3 (Hard Hurdle Rate)

Management fees 2% Year end
Incentives 20% Net of Management Fees
 Hard Hurdle rate 7%
Beginning Value $800 MN
40% return at the end of 1 year
Calculate return

Scenario 4 (Soft Hurdle Rate)

Management fees 2% Year end
Incentives 20% Net of Management Fees
Soft Hurdle rate 7%
Beginning Value $800 MN
40% return at the end of 1 year
Calculate return

Scenario 5 (High Water Mark)

Management fees 2% Year end
Incentives 20% Net of Management Fees
High Water Mark $1038 MN
Beginning Value $865 MN
40% return at the end of 1 year
Calculate return

21. Calculation on High water mark, hurdle rates and Incentive fees calculations
Ending Values
Beginning Value $100 MN Year 1 $110 MN
The high-water mark is Not given 0 Year 2 $112 MN

Management fees Beginning of the fund value 2% Year 3 $130 MN

Performance Fees Net of Management fees 20%

Hurdle Rate Soft 5%

22. Assume a hedge fund managing $100 million that earns a return of 10% during a year—an excellent
return in this environment — the fund would have a 2/20 fee structure. The amount eligible for the total
fee would be and net return to the investor
a. Suppose there is a soft hurdle rate of 3%. Management fees and incentive fees are calculated
independently (year-end AUM).
b. Suppose there is a hard hurdle rate of 3%. Management fees and incentive fees are calculated
independently (year-end AUM).
c. Suppose there is a soft hurdle rate of 3%. Management fee and incentive fee calculated net of
management fees (year-end AUM)
d. Suppose there is a hard hurdle rate of 3%. Management fee and incentive fee calculated net of
management fees (year-end AUM)

23. Calculate the high-water mark (without performance fees) for the following data (Not applicable for cal.)
Hurdle rate 10% (Beginning value)
1% Management Fees at the beginning of the Value
Performance Fees 20% (Net of fees and expenses)

Year Starting Value Expenses

0 1,00,00,000
1 5,000
2 5,150
3 5,350
4 5,450
5 5,600
24. A British hedge fund has a value of £100 million at the beginning of the year. The fund charges a 2%
management fee based on assets under management at the end of the year and a 20% incentive fee with a
soft hurdle rate of LIBOR + 2.5%. Incentive fees are calculated net of management fees. If the relevant
LIBOR rate is 2.5% and the fund's Value at the end of the year before fees is £120 million, the net return
to investors is closest to

25. A hedge fund has a 2-and-20 fee structure, based on beginning-of-period assets, with a soft hurdle rate of
3%. Incentive fees are calculated before management fees. An endowment invests $60.0 million in the
hedge fund. The Value of the endowment's investment, before fees, decreases to $56.2 million after one
year and increases to $58.0 million the next year. In the second year the endowment will be charged
management and incentive fees closest to:

26. A Hong Kong hedge fund was valued at HK$400 million at the end of last year. At year's end the Value
before fees was HK$480 million. The fund charges 2 and 20. Management fees are calculated on end-of-
year values. Incentive fees are independent of management fees and calculated using no hurdle rate. The
previous year the fund's net return was 2.5%. The annualized return for the last two years is closest to:

27. An investor made an investment in a hedge fund at the beginning of the year, when the NAV after fees
was €80 million. The NAV after fees for Year 1 was €75 million. For Year 2, the end-of-year Value
before fees is €90 million. The fund has a 2 and 20 fee structure. Management fees are paid
independently of incentive fees and are calculated on end-of-year values. Incentive fees are calculated
using a high-water mark and a soft hurdle rate of 2%. Total fees paid for Year 2 are:

28. Starline, a hedge fund, has a 1/10 fee structure with a High Watermark provision and hard hurdle rate of
5%. Management fees are paid at the beginning of AUM, and Incentive fees are calculated net of
management fees. The fund starts with $200m of investments. Value at the end of year 1: $214m, at the
end of year 2: $225m, Value at the end of year 3: $230m, Value at the end of year 4: $229m. You must
find out the total fees paid at the end of each year and net return to the investors.

29. Question #1 of 41 Question ID: 434453

3 0 .  A)
3 1 .  B)
3 2 .  C)
33. Question #2 of 41 Question ID: 434451
3 4 .  A)
3 5 .  B)
3 6 .  C)
37. Question #3 of 41 Question ID: 416054
3 8 .  A)
3 9 .  B)
4 0 .  C)
41. For a given set of underlying real estate

properties, the type of real estate index that is

most likely to have the lowest standard
42. deviation is a(n):

43. REIT trading price index.

44. appraisal index.

45. repeat sales index.

46. Explanation

47. Appraisal index returns are based on estimates

of property values. Because estimating values

tends to introduce smoothing into
48. returns data, appraisal index returns are likely

to have lower standard deviations than index

returns based on repeat sales or
49. trading prices of REIT shares.

50. Historical data on returns of assets valued with

appraisal methods are to exhibit:

51. downward-biased Sharpe measures.

52. smoothing.

53. overstated correlations with other asset classes.

54. Explanation

55. Appraisal methods tend to produce smoothed

return patterns understate standard deviations

of returns. This causes correlations
56. with other asset classes to be understated and
Sharpe ratios to be biased upward.
57. A British hedge fund has a value of £100

million at the beginning of the year. The fund

charges a 2% management fee based on
58. assets under management at the end of the year

and a 20% incentive fee with a soft hurdle rate

of LIBOR + 2.5%. Incentive fees
59. are calculated net of management fees. If the

relevant LIBOR rate is 2.5% and the fund's

Value at the end of the year before fees
60. is £120 million, the net return to investors