Chapter 1 CAIA Flash Cards
Define Alternative Investments
Alternative Investments are any investments that is not simply a long position in traditional investments
Define an Institutional Quality Investment
A type of investment that financial institutions such as pension funds or endowments might include in their holdings, because they are expected to deliver a reasonable return at an acceptable level of risk
List the four types of Alternative Investments
Real Assets
Hedge Funds
Private Equity
Structured Products
Real Assets
Natural Resources, commodities, real estate, infrastructure, & intellectual property
Hedge Funds
includes Managed Futures
Private Equity
includes mezzanine and distressed debt
Structured Products
includes credit derivatives
Real Assets
Real assets are investments in which the underlying assets involve direct ownership of nonfinancial assets rather than ownership through financial assets, such as the securities of manufacturing or service enterprises. Real assets tend to represent more direct claims on consumption than do common stocks, and they tend to do so with less reliance on factors that create value in a company, such as intangible assets and managerial skill. So while a corporation such as Google holds real estate and other real assets, the value to its common stock is highly reliant on perceptions of the ability of the firm’s management to oversee creation and sales of its goods and services.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 4). Wiley. Edición de Kindle.
Commodities
Commodities are homogeneous goods available in large quantities, such as energy products, agricultural products, metals, and building materials.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 5). Wiley. Edición de Kindle.
Commodity Exposure
Commodity Exposure can be obtained through futures contracts, physical commodities, natural resource companies, & ETF’s
Infrastructure Invesments
Claims on the income of toll roads, regulated utilities, ports, airports, and other real assets that are traditionally held and controlled by the public sector (i.e., various levels of government). Investable infrastructure opportunities include securities generated by the privatization of existing infrastructure or by the private creation of new infrastructure via private financing.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 6). Wiley. Edición de Kindle.
Hedge Fund
a privately organized investment vehicle that uses its less regulated nature to generate investment opportunities that are substantially distinct from those offered by traditional investment vehicles, which are subject to regulations such as those restricting their use of derivatives and leverage. Hedge funds represent a wide-ranging set of vehicles that are differentiated primarily by the investment strategy or strategies implemented.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 6). Wiley. Edición de Kindle.
Private Equity
The term private equity is used in the CAIA curriculum to include both equity and debt positions that, among other things, are not publicly traded. In most cases, the debt positions contain so much risk from cash flow uncertainty that their short-term return behavior is similar to that of equity positions. In other words, the value of the debt positions in a highly leveraged company, discussed within the category of private equity, behaves much like that of the equity positions in the same firm, especially in the short run.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (pp. 6-7). Wiley. Edición de Kindle.
Venture Capital
Venture capital refers to support via equity financing to start-up companies that do not have a sufficient size, track record, or desire to attract capital from traditional sources, such as public capital markets or lending institutions. Venture capitalists fund these high-risk, illiquid, and unproven ideas by purchasing senior equity stakes while the start-up companies are still privately held. The ultimate goal is to generate large profits primarily through the business success of the companies and their development into enterprises capable of attracting public investment capital (typically through an initial public offering, or IPO) or via their sale to other companies. In the context of investment management, venture capital is sometimes treated as a separate asset class from other types of private equity.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 7). Wiley. Edición de Kindle.
Leveraged Buyouts
(LBOs) refer to those transactions in which the equity of a publicly traded company is purchased using a small amount of investor capital and a large amount of borrowed funds in order to take the firm private. The borrowed funds are secured by the assets or cash flows of the target company. The goals can include exploiting tax advantages of debt financing, improving the operating efficiency and the profitability of the company, and ultimately taking the company public again (i.e., making an IPO of its new equity). Management buyouts and management buy-ins are types of LBOs with specific managerial changes.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 7). Wiley. Edición de Kindle.
Mezzanine Debt
Mezzanine debt derives its name from its position in the capital structure of a firm: between the ceiling of senior secured debt and the floor of equity. Mezzanine debt refers to a spectrum of risky claims, including preferred stock, convertible debt, and debt that includes equity kickers (i.e., options that allow investors to benefit from any upside success in the underlying business, also called hybrid securities).
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 7). Wiley. Edición de Kindle.
Distressed Debt
Distressed debt refers to the debt of companies that have filed or are likely to file in the near future for bankruptcy protection. Even though these securities are fixed-income securities, distressed debt is included in our discussion of private equity because the future cash flows of the securities are highly risky and highly dependent on the financial success of the distressed companies, and thus share many similarities with common stock. Private equity firms investing in distressed debt tend to take longer-term ownership positions in the companies after converting all or some portion of their debt position to equity. Some hedge funds also invest in distressed debt, but they tend to do so with a shorter-term trading orientation.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 7). Wiley. Edición de Kindle.
Structured Products
Instruments created to exhibit particular return, risk, taxation, or other attributes. These instruments generate unique cash flows as a result of partitioning the cash flows from a traditional investment or linking the returns of the structured product to one or more market values.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 7). Wiley. Edición de Kindle.
Collateralised Debt Obligations
Collateralized debt obligations (CDOs) and similar instruments are among the best-known types of structured products. CDOs partition the actual or synthetic returns from a portfolio of assets (the collateral) into securities with varied levels of seniority (the tranches).
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 8). Wiley. Edición de Kindle.
Credit Derivatives
facilitate the transfer of credit risk. Most commonly, credit derivatives allow an entity (the credit protection buyer) to transfer some or all of a credit risk associated with a specific exposure to the party on the other side of the derivative (the credit protection seller). The credit protection seller might be diversifying into the given credit risk, speculating on the given credit risk, or hedging a preexisting credit exposure.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 8). Wiley. Edición de Kindle.
The Five Primary types of structures
Regulatory structures Securities structures Trading structures Compensation structures Institutional structures
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 9). Wiley. Edición de Kindle.
Regulatory Structure
Refers to the role of government, including both regulation and taxation, in influencing the nature of an investment. For example, hedge funds (but not their managers) are often less regulated and typically must be formed in particular ways to avoid higher levels of regulation. Taxation is another important feature of government influence that can motivate the existence of some investment products and plays a major role in the transformation of underlying asset cash flows into investment products.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (pp. 10-11). Wiley. Edición de Kindle.
Securities Structure
Refers to the structuring of cash flows through leverage and securitization. Securitization is the process of transforming asset ownership into tradable units. Cash flows may be securitized simply on a pass-through basis (i.e., a pro rata or pari passu basis). Cash flows can also be structured through partitioning into financial claims with different levels of risk or other characteristics, such as the timing or taxability of cash flows.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 11). Wiley. Edición de Kindle.
Trading Structure
Refers to the role of an investment vehicle’s investment managers in developing and implementing trading strategies. A buy-and-hold management strategy will have a minor influence on underlying investment returns, while an aggressive, complex, fast-paced trading strategy can cause the ultimate cash flows from a fund to differ markedly from the cash flows of the underlying assets. The trading strategy embedded in an alternative asset such as a fixed-income arbitrage hedge fund is often the most important structure in determining the investment’s characteristics.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 11). Wiley. Edición de Kindle.
Compensation Structure
Refers to the ways that organizational issues, especially compensation schemes, influence particular investments. Thus, in the case of a hedge fund, compensation structures would include the financial arrangements contained in the limited partnership formed by the investors and the entity used by the fund’s managers.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 11). Wiley. Edición de Kindle.
Institutional Structure
Refers to the financial markets and financial institutions related to a particular investment, such as whether the investment is publicly traded. Public trading or listing of a security is an essential driver of an investment’s nature. Other institutional structures can determine whether an investment is regularly traded, is held by individuals at the retail level, or tends to be traded and held by large financial institutions such as pension funds and foundations.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 11). Wiley. Edición de Kindle.
Diversifier
An investment with a primary purpose of contributing diversification benefits to its owner.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Absolute Return Products
Investment products viewed as having little or no return correlation with traditional assets, and have investment performance that is often analyzed on an absolute basis rather than relative to the performance of traditional investments.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Diversification
Can lower risk without necessarily causing an offsetting reduction in expected return and is therefore generally viewed as a highly desirable method of generating improved risk-adjusted returns.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Alternative Investments
May be viewed as being likely to have return characteristics that are different from stocks and bonds, as demonstrated by their lack of correlation with stocks and bonds. The distinctions between traditional and alternative investments are also indicated by several common return characteristics found among alternative investments that either are not found in traditional investments or are found to a different degree.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Illiquidity
The investment trades infrequently or with low volume (i.e., thinly). Illiquidity implies that returns are difficult to observe due to lack of trading, and that realized returns may be affected by the trading decisions of just a few participants.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Lumpy Assets
Assets that can be bought and sold only in specific quantities, such as a large real estate project.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 13). Wiley. Edición de Kindle.
Efficiency
Refers to the tendency of market prices to reflect all available information.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 14). Wiley. Edición de Kindle.
Inefficiency
Inefficiency refers to the deviation of actual prices from valuations that would be anticipated in an efficient market.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 14). Wiley. Edición de Kindle.
Information Asymmetries
Refer to the extent to which market participants possess different data and knowledge. In traditional investments, most securities are regulated and are required to disclose substantial information to the public. Many alternative investments are private placements, and therefore the potential for large information asymmetries is greater. These information asymmetries raise substantial issues for financial analysis and portfolio management.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 18). Wiley. Edición de Kindle.
Incomplete Markets
Refer to markets with insufficient distinct investment opportunities. The lack of distinct investment opportunities prevents market participants from implementing an investment strategy that satisfies their exact preferences, such as their preferences regarding risk exposures. In an ideal world, securities could be costlessly created to meet every investor need.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 18). Wiley. Edición de Kindle.
Moral Hazard
The risk that the behavior of one or more parties will change after entering into a contract. As a result of this inability to contract efficiently, the investor might be unable to diversify perfectly.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 18). Wiley. Edición de Kindle.
Active Management
Refers to efforts of buying and selling securities in pursuit of superior combinations of risk and return.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 18). Wiley. Edición de Kindle.
Passive Investing
Tends to focus on buying and holding securities in an effort to match the risk and return of a target, such as a highly diversified index. An investor’s risk and return target is often expressed in the form of a benchmark, which is a performance standard for a portfolio that reflects the preferences of an investor with regard to risk and return.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (pp. 18-19). Wiley. Edición de Kindle.
Active Management
Typically generates active risk and active return.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Active Risk
Risk that causes a portfolio’s return to deviate from the return of a benchmark due to active management.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Active Return
The difference between the return of a portfolio and its benchmark that is due to active management.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Absolute Return Standard
Means that returns are to be evaluated relative to zero, a fixed rate, or relative to the riskless rate, and therefore independently of performance in equity markets, debt markets, or any other markets.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Relative Return Standard
Returns are to be evaluated relative to a benchmark.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Pure Arbitrage
The attempt to earn risk-free profits through the simultaneous purchase and sale of identical positions trading at different prices in different markets.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 19). Wiley. Edición de Kindle.
Return Enhancer
The primary objective of including an investment product in a portfolio is the superior average returns that it is believed to offer, then that product is often referred to as a return enhancer.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 20). Wiley. Edición de Kindle.
Return Diversifier
If the primary objective of including the product is the reduction in the portfolio’s risk that it is believed to offer through its lack of correlation with the portfolio’s other assets, then that product is often referred to as a return diversifier.
Chambers, Donald R.. Alternative Investments: CAIA Level I (Wiley Finance) (p. 20). Wiley. Edición de Kindle.
