2. The Environment of Alternative Investments

Question 1

What is the term for private management advisory firm that serves a group of related and ultra-high net worth investors?

Answer 1

Family office.

Question 2

In a large financial services organisation, what is the name used to denote the people and processes that play a supportive role in the maintenance of accounts and information systems as well as in the clearance and settlement of trades?

Answer 2

Back office operations.

Question 3

Are dealer banks described as buy-side or sell-side market participants?

Answer 3

Sell-side market participants. Making their research available to their clients and are more focused on facilitating transactions than on managing money.

Question 4

List several advantages of Separately Managed Accounts (SMAs) relative to funds.

Answer 4

• 1 a fund investor owns shares of a company (the fund) that in turn owns other investments whereas an SMA investor actually owns the invested assets as the owner on record.
• 2 A fund invests for the common purposes of multiple investors, while an SMA may have objectives tailored to suit the specific needs of the investor, such as tax efficiency.
• 3 A fund is often opaque to its investors to promote confidentiality; an SMA offers transparency to its investor. - Fund investors may suffer adverse consequences from redemptions (withdrawals) and subscriptions (deposits) by other investors, but an SMA provides protection from these liquidity issues for its only investor.
• disadvantage: - fund structure may allow investors to have limited liability, the SMA format may allow losses to be greater than the capital contribution when leverage or derivates are used.

Question 5

Which of the following participants is LEAST LIKELY to be classified as an outside service provider to a fund: Arbitrageurs, accountants, auditors or attorneys?

Answer 5

Arbitrageurs

Question 6

List four major legal documents necessary for establishing and managing a hedge fund.

Answer 6

1. Private-placement memoranda - formal descriptions of an investment opportunity that comply with federal securities regulations.
2. partnership agreement - contract creating a partnership.
3. subscription agreement - application submitted by an investor who desires to join a limited partnership.
4. management company operating agreement - agreement between members related to a limited liability company and the conduct of its business as it pertains to the law.

Question 7

What is systemic risk?

Answer 7

Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants

Question 8

What is the acronym for fund vehicles that are regulated and allow retail access of hedgefund- like investment pools in the European Union?

Answer 8

UCITS (are investment funds regulated by the European Union). Allow retail access and marketing of hedge-fund-like investment pools. UCITS (Undertakings for Collective Investments in Transferable Securities)

Question 9

In terms of financial regulation, what is the FCA?

Answer 9

Financial Conduct Authority – the primary regulator of financial services in the UK.

Question 10

What is progressive taxation of income?

Answer 10

Progressive taxation places higher percentage taxation on individuals and corporations with higher incomes.

Question 11

Where does a plan sponsor fit in a business?

Answer 11

A plan sponsor is a designated party—usually a company or employer—that sets up a healthcare or retirement plan, such as a 401(k), for the benefit of the organization’s employees.

Question 12

Endowment:

Answer 12

is a fund bestowed on an individual or institution (e.g. a museum, university, hospital, or foundation) to be used by that entity for specific purposes and with principal preservation in mind.

Question 13

Sovereign wealth funds:

Answer 13

A sovereign wealth fund is a state-owned investment fund that is used to benefit the country’s economy and citizens. Funding comes from central bank reserves, currency operations, privatizations, transfer payments, and revenue from exporting natural resources.

Question 14

Private limited partnership:

Answer 14

business organisation that potentially offers the benefit of limited liability to the organisation’s limited partners (similar to that enjoyed by shareholders of corporations) but not to its general partners.

Question 15

five private investment pools?

Answer 15

1. Hedge funds 2. Funds to funds 3. Private equity funds 4. Managed future funds 5. Commodity Trading Advisors (CTAs)

Question 16

Separately Managed Accounts (SMAs)

Answer 16

individual investment accounts offered by a brokerage firm and managed by independent investment management firms.

Question 17

What is a mutual fund of 40 act?

Answer 17

registered investment pools offering their shareholders pro rata claims on the fund’s portfolio of assets. Mutual funds that offer their shares for sale to the public are known as “40 act” funds (1940).

Question 18

MLPs:

Answer 18

Master Limited Partnerships: are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims. MLPs are traded on major stock exchanges, but they have legal and tax structures similar to those of private limited partnerships.

Question 19

3 Examples of large dealer banks:

Answer 19

1. Goldman Sachs 2. Deutsche Bank 3. Barclays group all these banks deal in securities and derivatives (OTC derivatives - Over The Counter). Large dealer banks are often engaged in proprietary trading and brokering hedge funds.

Question 20

Who takes part in proprietary trading?

Answer 20

Large dealer banks. It occurs when a firm trades securities with its own money in order to make profit.

Question 21

What side are brokers on between sell or buy sides?

Answer 21

On the sell side, retail brokers that receive commissions for executing transactions and that have research departments that make investment recommendations. Brokers are the middlemen, and can offer advantages in expertise in the trading process, their access to other traders and exchanges, with an ability to facilitate clearance and settlement.

Question 22

M&A

Answer 22

Mergers and Acquisitions

Question 23

Difference between front and middle office operations?

Answer 23

Front office operations involve investment decision-making and, in the case of brokerage firms, contact with clients. Then the middle office operations form the interface between the front and the back office, with focus on risk management.

Question 24

Name four outside service providers:

Answer 24

1. Prime broker - clears and finances trades for clients, provides research, arranging financing and producing trades for its client.
2. Accountants - helps prepare partnership returns and the necessary forms for the investors in the fund to report their shares of partnership income, deductions, gains, and losses. Also audits and tax returns.
3. Attorneys - helps determine the best legal structure for a fund’s unique investment strategies, objectives, and desired investors.
4. Fund administrators - responsible for bookkeeping, third-party information gathering, and securities (onshore and offshore).

Question 25

Hedge Fund Infrastructure is build of what?

Answer 25

1. Financial platforms - systems that provide access to financial markets, portfolio management systems, accounting and reporting systems, and risk management systems.
2. Financial software - prepackaged software programs and computer language tailored to the needs of financial organisations.
3. Financial data providers - supply raw financial market data, including security prices, trading information, and indices.

Question 26

What are depositories and custodians? Also, name a holding body of one of these?

Answer 26

responsible for holding their clients’ cash and securities and settling clients’ trades, both of which maintain the integrity of clients assets while ensuring trades are settled quickly. Depository Trust Company (DTC) is the principal holding body of securities for traders all over the world and is part of the Depository Trust Company Corporation (DTCC.

Question 27

What are the difference between commercial banks, investment banks, and universal banking?

Answer 27

Commercial bank focusses on the business of accepting deposits and making loans, with modest interest related services. Investment bank focuses on providing sophisticated investment services, including underwriting and raising capital, as well as other activities such as brokerage services, mergers, and acquisitions. Universal banking - used mainly in Germany, where banks can engage in both commercial and investment banking.

Question 28

What is the difference between primary and secondary markets?

Answer 28

Primary markets refer to the methods, institutions, and mechanisms involved in the placement of new securities to investors. Whereas, secondary markets facilitate trading among investors of previously existing securities.

Question 29

Securitization:

Answer 29

bundling assets, especially unlisted assets, and issuing on the bundled assets. Can allow firms to divest illiquid assets such as accounts receivable to lay off risk and obtain cash.

Question 30

How would you explain the bid-ask spread?

Answer 30

The price difference between the highest bid price (the best bid price) and lowest offer (the best ask price).

Question 31

What is market making?

Answer 31

a practice whereby an investment bank or another market participant deals securities by regularly offering to buy securities and sell securities.

Question 32

Who are the participants that place market order?

Answer 32

Market orders: transactions executed without delay may place these, which cause immediate execution at the best available price. The participants are market takers: which buy at ask prices and sell at bid prices, generally paying the bid-ask spreaking for taking liquidity.

Question 33

How are third and fourth markets different from the secondary and primary?

Answer 33

Third markets are regional exchanges where stocks listed in primary secondary markets can also be traded. It is a segment of the OTC market where nonmember investment firms can make markets in and trade securities without going through the exchange. Fourth markets are electronic exchanges that allow traders to quickly buy and sell exchange-listed stocks via the electronic communications systems offered by these markets.

Question 34

What are the five primary forms of hedge fund regulation?

Answer 34

1. Requirements regarding establishing a hedge fund, including registration, licensing, minimum capital, and waiting periods.
2. Registrations or restrictions on investment advisers and hedge fund managers.
3. Restrictions on distributions and marketing of hedge funds including which marketing channels may be used (e.g. banks), whether advertising is permitted, and to whom funds may be sold.
4. Restrictions on operation of a hedge fund, including leverage, liquidity, risk reporting, and location of outside service providers.
5. Requirements regarding ongoing reporting.

Question 35

Soft dollar arrangements, must be disclosed to clients in trading practices. What are soft dollar arrangements?

Answer 35

refers to an agreement or an understanding by which an investment adviser receives research services from broker-dealer in exchange for a fee (such as a commission) paid out of the fund or client account.

Question 36

Federal Reserve Board leverage rules include the Regulation T margin rule, what is this rule?

Answer 36

currently requires a deposit of at least 50% of the purchase cost or short sale proceeds of a trade (margin).

Question 37

MiFID

Answer 37

Markets in Financial Instruments Directive: provides regulation for investment services across the 31 member states of the European Economic Area.

The directive’s main objectives are to increase competition and investor protection in investment services

Question 38

The MiFID II is a revision directed toward extending the reach of MiFID to cover gaps in the 2007 document as well as address emerging issues, such as lack of transparency in trading occurring in dark pools. A dark pool is?

Answer 38

non-exchange trading by large market participants that is hidden from the view of most market participants.

Question 39

What are liquid alternative investments?

Answer 39

Liquid alternatives are alternative investment strategies that are available through alternative investment vehicles such as mutual funds, ETFs, and closed-end funds that provide daily liquidity. Liquid alts are also known as 40 Act funds.

Question 40

What are the five distinct types of liquid alternative funds?

Answer 40

1. Unconstrained clones: liquid funds that follow virtually the same strategy as private placement products with underlying liquid assets, such as some hedge funds or managed futures funds.
2. Constrained clones: these liquid funds implement a similar strategy as private placement products but are limited in risk exposure by leverage, concentration, or liquidity constraints.
3. Liquidity-based replication products: these liquid funds are designed to mimic illiquid private placement investment, using liquid securities as proxies.
4. Skill-based replication products: these liquid funds are designed to mimic a highly skilled private placement strategy using a simplified and more mechanical strategy.
5. Absolute return or diversified products: these liquid funds are designed to offer absolute returns and/or diversifying returns not directly related to opportunities historically available in private placements and potentially inconsistent with alternative strategies as typically deployed.

Question 41

What are the differences between a Hedge Fund Replication and Close-End Mutual Fund?

Answer 41

Hedge fund replication: attempt to mimic the returns of an illiquid or highly sophisticated hedge fund strategy using liquid assets and simplified trading rules. Closed-end mutual fund: provide investors with relatively liquid access to the returns of underlying assets even when the underlying assets are illiquid.

Question 42

Four factors determining performance of liquid alternative compared to private placements:

Answer 42

1. The permissible investment strategies differ. Private placements often enjoy important flexibility with regard to leverage (including the magnitude of short position) and concentration (lack of diversification).
2. Similarly, private placements may be able to generate higher returns due to their investment flexibility to hold more illiquid assets, thereby potentially receiving higher liquidity premiums.
3. Fees differ between liquid alternatives and private placements. Liquid alternatives tend to have lower fees because most do not have incentive fees, especially asymmetric incentive fees wherein managers benefit from sharing upside profits but are limited in their exposure to downside losses.
4. Managerial skill may differ. The higher potential fees from the asymmetric incentive fees of private placements may attract managers with greater skill. Some liquid alternative funds implement simplified trading rules rather than hiring sophisticated management teams.

Question 43

What is Section 1256 contracts?

Answer 43

Section 1256 contracts, which include many futures and options contracts, have potentially enormous tax advantages in the United States.

Question 44

recognize major European regulatory institutions

Answer 44

UCITS

MiFID

FINMA

AIF

AIFMD

Question 45

Non-U.S. Hedge Fund Regulations

Answer 45

Undertakings for Collective Investment in Transferable Securities (UCITS)

Commission de Surveillance du Secteur Financier (CSSF)

Markets in Financial Instruments Directive (MiFID)

dark pool refers to non-exchange trading by large market participants

Alternative Investment Fund Managers Directive (AIFMD)

alternative investment funds (AIFs).

The FCA (Financial Conduct Authority) UK

France’s Autorites des Marches Financiers (AMF)

ARIA funds (Agreea Regles d’Investissement Allegees)

The Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)

Swiss Financial Market Supervisory Authority (FINMA)

Australian Securities and Investment Commission (ASIC)

Australian / foreign investment funds (FIFs).

Brazil’s Securities Commission (CVM)

Canada, principal protected notes (PPNs)

The Canadian Securities Administrators (CAS)

Japanese Financial Services Agency (FSA)

Monetary Authority of Singapore (MAS)

United Arab Emirates (UAE)

GCC (Gulf Cooperation Council)

Dubai Financial Services Authority (DFSA)

Question 46

Describe key components of U.S. Hedge Fund Regulations

Answer 46

1. Primary Market ( U.S. Securities Act of 1933 (the Securities Act)
2. Regulation of Advisors ( U.S. Investment Company Act of 1940 ( the ’40 Act )
3. Soft Dollar Agreements
4. Regulation T margin rule ( FINRA)

Question 47

Liquid alts ?

Answer 47

offering retail access rather than “being able to be converted into cash quickly,”

ETF, Mutual Funds

Question 48

Three Constraints against Achieving Alternative Investment Benefits through Liquid Products

Answer 48

Leverage of hedgefunds wich is restricted within US mutual funds

Constrains on concentration ( diversification )

Illiquidy constraints ( no more than 15% in illiquidy assets )

Question 49

Growth and Growth Factors in Liquid Alternatives

Answer 49

2007 - 2015 from 100 Billions to 500 Billions

Growthfactor 20% per annual