Alternative Instruments Flashcards
1
Q
Categories of Alternative Investments
A
- Hedge Funds
- Private Equity
- Real Estate
- Commodities
- Others (e.g., collectibles, patents)
2
Q
Alternative vs. Traditional Investments
A
- Different types of assets held, structure of investment vehicles
- Higher fees (management, incentive)
- Less liquid
- Less regualted, less transparent
- Different tax treatments
3
Q
Benefits of Alternative Investments
A
- Potential portolio diversification benefits
- Low correlation with traditional investment returns
- Higher average returns than traditional investments
- Return measures biased upward, risk measured biased downward
- Survivorship bias
- Backfill bias
4
Q
Hedge Funds
A
- Investment companies structured as limited partnerships
- Use leverage, derivatives, short selling
- Limited to qualified investors
- Lockup period: Minimum time before investors can withdraw funds
- Notice period: Days within which a fund must fulfull a redemption request
5
Q
Hedge Fund Strategies: Event Driven
A
Event-driven strategies
- Merger arbitrage: Buy shares of firm being acquired, short shares of acquirer
- Distressed/restructuring: Buy if restructuring will increase value
- Activist shareholder: Gain board seat to influence company decisions
- Special situations: Spinoff, asset sales, securitiy issuance or repurchase
6
Q
Hedge Fund Strategies: Relative Value
A
Relative value strategies
- Covertible argibtrage: Convertible bonds versus underlying stok
- Asset-backed: ABS, MBS
- General fixed income
- Volatility: Trade options based on implied versus expected volatility
- Multi-strategy: Across asset classes
7
Q
Hedge Fund Strategies: Macro / Equity
A
- **Macro strategies: **Trade strategies, currencies, commodities based on global economic trends
-
Equity hedge fund strategies
- Market neutral: Equals values in long and short positions
- Fundamental growth: Identiy high-growth companies
- Fundamental value: Identify undervalued companies
- Quantitative directional: May have net long or short exposure
- Short bias: Net short exposure
- Fund of funds: Invest in multiple hedge funds
8
Q
Hedge Fund Valuation Issues
A
- Should use bid prices for long positions, ask prices for short positions
- Values of non-traded securities estimated with pricing models
- Illiquid securities
- Reduce market price to account for illiquidity based on size of position held
- _Trading NAV _is adjusted for illiquidity
9
Q
Hedge Fund Strategies - Problem
A
.
10
Q
Private Equity
A
- Invest in private companies or take public companies private
- Private equity strategies:
- Leveraged buyout
- Venture capital
- Development capital / minority equity / private investment in public equity (PIPE)
- Distressed investing
11
Q
Leverages Buyouts
A
- Most common private equity strategy
- Funded by debt
- Bank debt, high yield bonds
- Mezzanine financing:Subordinated debt, includes warrants or conversion to equity
- Management buyout: Current managers involved in purchase, remain with company
- Management buy-in: Replace managers of acquired company
12
Q
Venture Capital
A
-
Formative stage
- Angel investing: Business plan, market potential
- Seed stage: Product development, market research
- Early stage: Begin production and sales
- Later stage: Company expansion
- Mezzanine stage: Prepare for IPO
13
Q
Private Equity Structure and Fees
A
- Typically structured as limited partnership
- Investors privde committed capital which fund managers draw down to invest in portfolio companies
- Management fees typically 1% to 3% of committed capital
- Incentive fees typically 20% of profits
- Fees paid periodically may exceed 20% over time: Clawback provision requires managers to return excess fees
14
Q
Private Equity Exit Strategies
A
- Trade sale: Sell portfolio company to competitor
- Secondary sale: Sell portfolio company to other private equity investors
- IPO: Sell portfolio company shares to public
- Recapitalization: Issue portfolio company debt to fund divident payment (to private equity owner)
- Write-off/liquidation: Take loss
15
Q
Private Equity Valuation
A
- Same techniques used to value publicly traded companies are used to value equity portfolio companies
- Market/comparables approach
- Discounted cash flow approach
- Asset-based approach
- Private companies may require different discount rates or price multiples than publicly traded companies