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CAIA > Alternative Investments > Flashcards

Alternative Investments Flashcards

1
Q

Real Assets

A

Associated with investments that directly control non financial assets & represent actual rights to consumption. May invest in real estate, timberland, infrastructure & intangible assets.

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2
Q

Hedge Funds

A

Private investment vehicles subject to minimal regulation & able to pursue unique investment opportunities using derivatives, leverage, short positions, & others.

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3
Q

Commodities

A

Investments include physical commodity ownership, forward or futures contracts, securities of commodity producers & exchange-traded funds.

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4
Q

Private Equity

A

Investments include debt & equities securities not publicly traded. May invest in venture capital, leveraged buyouts, mezzanine debt & distressed debt.

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5
Q

Structured Products

A

Create a specific risk, return, tax or other profile buy segmenting cash flows of traditional investments or linking returns to one or more market values. Ex. collateralized debt obligations & credit derivatives

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6
Q

Alternative Investments

A
  1. Real Assets
  2. Hedge Funds
  3. Commodities
  4. Private Equity
  5. Structured Products
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7
Q

Regulatory structures

A

Government regulation & taxation

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8
Q

Securities structres

A

Methods of cash flow securitization & the resulting tradable units

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9
Q

Trading structures

A

Development & execution of trading strategies utilized by investment managers the resulting performance impact of the strategies

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10
Q

Compensation structures

A

Arrangements that impact a manager’s fees, exposure to investment’s performance & conflicts of interest with investors.

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11
Q

Institutional structures

A

Financial institutions and markets that affect the ownership and trading of a particular investment.

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12
Q

Return Characteristics

A
  • Diversifiers b/c low or no correlation with traditional assets
  • Illiquid & lumpy b/c immediate transactions occur at lower prices than for an equivalent liquid asset
  • Abnormal return distributions b/c infrequent trading, nonlinear payoffs & leverage
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13
Q

Alternative Investing Goals

A
  • Active management
  • Absolute & relative return generation
  • Arbitrage
  • Return enhancement
  • Return diverisfication
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14
Q

Absolute Returns

A

Evaluated against a standard of zero or the risk-free rate

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15
Q

Relative Returns

A

Evaluated against a risky benchmark return

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16
Q

Buy-side Institutions

A

Asset managers that focus on acquiring appropriate securities for their investment portfolios

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17
Q

Plan Sponsors

A

Organizations that fund a health care or retirement plan for qualified members. Manages plan assets to meet obligations & determines membership requirements & plan structure.

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18
Q

Foundations

A

Nonprofit funds established to support specific charitable activities on a continuing basis while maintaining real value of portfolio assets. Typically have long investment horizons, high-risk tolerance & low liquidity needs.

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19
Q

Endowments

A

Funds dedicated to providing financial support on an ongoing basis for a specific purpose. Typically have long investment horizons, high-risk tolerance & low liquidity needs.

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20
Q

Family Office/Private Wealth Institutions

A

Investment firms whose client base consists of high net worth families

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21
Q

Sovereign/Non-federal Wealth Funds

A

Pools of assets owned by a government & typically managed by central bank. Purpose is to stabilize economy, provide potential resource for future crises & provide future goods & services to citizens.

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22
Q

Alternative Investment Fund

A

Includes hedge funds, fund of funds, private equity funds & commodity trading advisers. Typically structured as limited partnerships & utilize sophisticated trading strategies. Performance-based fees reward top-performing general partners.

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23
Q

Separately Managed Accont

A

Portfolio owned by a single investor & managed according to their preferences. No shares are issued b/c single investors owns the entire account.

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24
Q

Sell-Side Institutions

A

Focus on selling investment research & transaction execution services rather than managing accounts.

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25
Q

Dealer Banks

A

Underwrite & trade securities & derivatives. Often operate their own hedge funds & private equity funds. Engage in proprietary trading, off-balance sheet financing & over-the-counter derivatives trading. May offer account management services or serve as prime brokers. Large dealer banks have the potential to influence overall health of financial markets.

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26
Q

Retail Brokers

A

Generate investment research & execute securities traders for customers. Engage in proprietary trading.
Front office responsibilities: client meetings to decide investment strategy.
Middle office: managing risk & linking front & back office communication.
Back office: account maintenance, information technology & clearing/settling all trades.

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27
Q

Outside Service Providers

A

Provide professional services vital to the formation & continued operation of alternative investment funds.

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28
Q

Prime Brokers

A

Executes trades on behalf of investment managers, lend securities to short, provide research, provide account statements & other documentation & provide financing. Allow managers to transact with multiple broker dealers & transact in multiple investment types within a single account.

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29
Q

Auditors/Accountants

A

Review all documentation for accounting issues & provide tax advice to managers creating funds. Audits fund records, provides tax & compensation advice & prepares financial statements once fund is operational.

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30
Q

Attorneys

A

Provide legal advice regarding optimal fund structure. Maintain regulatory registrations. Prepare documents (private-placement memoranda, offering documents, partnership agreements, subscription agreements & management company operating agreements).

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31
Q

Fund Administrators

A

Verify operation controls, assets under management & performance figures. May also be key figure with regard to tax issues & audit preparation.

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32
Q

Hedge Fund Infrastructure

A

Reduce complexity of operating a hedge fund by providing platforms, software & data.

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33
Q

Consultants

A

Provide portfolio allocation & investment manager selection advice. May also help identify client investment objectives & provide ongoing monitoring of portfolios and managers.

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34
Q

Depositories/Custodians

A

Hold client assets & provide information services, trade clearance & trade settlement.

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35
Q

Commercial Banks

A

Assist with capital management & provide loans, lines of credit & external credit enhancement.

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36
Q

Financial Markets

A
  1. Primary markets
  2. Secondary markets
  3. Third markets
  4. Fourth markets
  5. Private markets
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37
Q

Primary Markets

A

Relate to the sale of new security issues. New equity issues involve initial public offerings & seasoned issues or secondary issues.For traditional securities, an investment bank serves as the underwriter, taking on responsibility for origination, risk bearing & distribution. Role = often an exit strategy for alternative investments. Global primary market securities include American Depository Receipts & Global Depository Receipts.

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38
Q

Secondary Markets

A

Where securities trade after initial issuance. Provide liquidity and price/value information. This market lowers costs of capital for firms raising external capital in the primary market. Consist of both physical exchanges & over the counter markets.

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39
Q

Securitization

A

Process of pooling assets & then issuing new securities that derive cash flows from the pool. May be publicly listed or unlisted & vary in terms of liquidity.

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40
Q

Call Markets

A

Only allow securities to trade at specific times. All trades, bids & asks are declared. One negotiated price is set that clears the market.

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41
Q

Continuous Markets

A

Allows securities to trade at any time the market is open. Prices are set by the auction process or dealer bid-ask quotes.

42
Q

Bid-Ask Spread

A

In secondary markets, dealer banks serve as intermediaries & trade for their own accounts with other dealer banks & brokers/dealers. Generally do not charge commissions on transactions & instead make profit from bid-ask spread.

43
Q

Third Markets

A

Over the counter markets where nonmember firms can both make markets in & trade exchange-listed securities without the exchange, reducing transaction costs.

44
Q

Fourth Markets

A

Allow private electronic exchange of securities between investors WITHOUT using a broker as intermediary. Members avoid bid-ask spread by submitting orders that are matched to other outstanding orders through CROSSING. Used by institutions that trade very large volumes of securities.

45
Q

Private Markets

A

Do not involve exchange trading or over the counter trading. Alternative assets are commonly traded here. Flexible, low cost & fast. Lack transparency & regulation.

46
Q

Over-the-counter Markets

A

Terms are not specified by exchange, allowing participants more flexibility to negotiate the mutually agreeable trades.

47
Q

American Depository Receipts

A

Claims to foreign stocks in US dollars & traded on US markets.

48
Q

Global Depository Receipts

A

Issued outside US in issuer’s home country but usually in US dollars.

49
Q

Financial Services Authority (FSA)

A

UK Regulatory Institution - 80% of European HF assets are located in the UK. Must maintain minimum levels of capital and receive periodic reviews.

50
Q

Swiss Financial Market Supervisory Authority (FINMA)

A

Switzerland Regulatory Institution - 33% of a Funds of Hedge Funds are located here.

51
Q

Forms of Taxation

A

Income tax, real estate tax, wealth tax, estate tax, transaction tax, and foreign investment income tax

52
Q

What type of locales do hedge funds seek?

A

Those which offer income tax relief at the corporate level

53
Q

Ex Post Distributions

A

Summarize historical or realized values of the random variable. Can be used to approximate ex ante distributions if the distribution has a constant mean and variance and a large number of historical data points available.

54
Q

Ex Ante Distributions

A

Summarize possible future values of the random variable.

55
Q

Normal Distribution

A

Bell-shaped symmetrical curve. Mean, median, and mode are all equal. The two halves are identical. 69% of data lie within one standard deviation of the mean. 95% of data lie within two standard deviation of the mean.

56
Q

Compounding

A

The growth in value realized on a reinvested assets. Recognizes interest earned on reinvested interest.

57
Q

Continuous Compounding

A

The continuous reinvestment of interest.

58
Q

Logarithms

A

Can be used to calculate continuously compounded rate.

59
Q

Geometric Mean Return

A

Facilitated through log returns. = eM - 1

60
Q

If monthly log returns are normally distributed…

A

then quarterly log returns are also normally distributed.

61
Q

Main Causes of Non-Normality

A

Autocorrelation, illiquidity, and non-linearity

62
Q

Autocorrelation

A

Occurs when the return in one period is directly related to the return from the prior period. Will cause more extreme outcomes than predicted by normal distribution.

63
Q

Illiquidity

A

Transactions do not take place on a regular basis and require appraisal valuations. Appraisals often exhibit positive autocorrelation that produces non-normal returns.

64
Q

Shapes of probability distributions

A

Described by the moments of distribution, including both raw (mean) and central moments (variance, skewness, and kurtosis).

65
Q

Mean

A

First raw moment of probability distributions

66
Q

Variance

A

Second central moment of probability distributions

67
Q

Standard Deviation

A

o, square root of the variance. Often used to measure volatility.

68
Q

Skewness Statistic

A

Third central moment of probability distributions. Measures the departure from symmetry.

69
Q

Positively Skewed Distribution

A

Tails are elongated to the right. More outliers to the right of the mean.

70
Q

Negatively Skewed Distribution

A

Tails are elongated to the left. More outliers to the left of the mean.

71
Q

Kurtosis Statistic

A

Standardized fourth moment of probability distributions. Refers to the degree of peakedness and, for normal distribution, equals 3.

72
Q

Mesokurtic Distribution

A

Has zero excess kurtosis

73
Q

Leptokurtic Distribution

A

Has a peak that extends above a normal distribution and tails that are fatter than those of a normal distribution. Greater percentage of small deviations from the mean and a greater percentage of extremely large deviations from the mean.

74
Q

Platykurtic Distribution

A

Has a peak that lies beneath a normal distribution. Smaller percentage of small deviations from the mean.

75
Q

To find the boundary of a portfolio

A

Calculate the portfolio mean and variance.

76
Q

If log returns are uncorrelated over time…

A

…the variance of a multi-period log-return equals the sum of the inter-period log-return variances.

77
Q

If the variances of daily log-returns are identical & if returns are independent…

A

then the T-period log-return variance is simply T times the variance of daily log-return where T is the number of days.

78
Q

Jarque-Bera Statistic

A

Used to test data for departures from the normal distribution. Follows a chi-square distribution with 2 degrees of freedom. The hypothesis of normality is rejected if the Jarque-Bera statistic for the sampled data extends the critical value.

79
Q

Target Semi-Standard Deviation

A

Differs from volatility risk by focusing solely on returns that fall below a pre-specified target return, T.

80
Q

Semi-Standard Deviation / Downside Standard Deviation

A

If T is set equal to the mean return

81
Q

Tracking Error

A

Measures the extent to which the investment returns deviate from the benchmark returns over time.

82
Q

Maximum Drawdown

A

The worst percent loss experienced from peak to trough over a specified period of time.

83
Q

Value at Risk (VaR)

A

Measure of potential loss. Interpreted as the worst possible loss under normal conditions over a specified period for a given confidence level.

84
Q

Strengths of VaR

A

Simply to apply, can be applied across segments within a fund or across funds, useful when it makes no sense to examine the worst-case scenario.

85
Q

Weakness of VaR

A

Misleading for non-normal distributions.

86
Q

Conditional VaR (CVaR)

A

Also known as expected shortfall or expected tail loss. The expected loss given that the portfolio return already lies below the pre-specified worst-case quantile return.

87
Q

Parametric VaR

A

Common method of calculating VaR. Assumes returns are normally distributed.

88
Q

Factor Model VaR

A

VaR is calculated as a function of variances and covariances of the factors and of the exposures of the security returns to the factors.

89
Q

Autoregressive Conditional Heteroskedasticity (ARCH) & Generalized Autoregressive Conditional Heteroskedasticity (GARCH) models

A

Estimate volatility by placing greater weight on more recent data than older data.

90
Q

The only case in which the portfolio VaR equals the sum of the individual asset VaRs

A

If the individual asset outcomes are perfectly and positively correlated.

91
Q

ARCH Models

A

Used to forecast variances based on recent volatility in prior periods.

92
Q

GARCH Models

A

Used to forecast vairances based on recent unexpected returns and past variances. Allows volatility to change based on the past history, even if the price level for the variable has not changed.

93
Q

3 Primary Components of Asset Pricing Models

A
  1. the risk free rate of return, 2. factor risk premiums, 3. factor sensitivities for the asset.
94
Q

Asset Pricing Models

A

Can be used to separate risks and returns into diversifiable (idiosyncratic) and non-diversifiable (systematic) components and to quantify the compensation expected to be received for risk.

95
Q

Ex Ante Asset Pricing Models

A

Important for developing frameworks to analyze investment performance.

96
Q

According to Capital Asset Pricing Model,

A
  • The expected return on any asset is solely determined by systematic risk (beta).
  • No additional expected return will be earned by bearing-non-systematic or idiosyncratic risk.
97
Q

Ex Post Asset Pricing Model

A

After-the-fact historical returns.

98
Q

Single Factor Asset Pricing Model

A

Single risk factor model. The Capital Asset Pricing Model is an example.

99
Q

Systematic Rsiks

A

Driven by non-diversifiable market factors.

100
Q

Idiosyncratic risks

A

Driven by diversifiable investment-specific factors that cfan be offset by combining assets within a portfolio.

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