Chapter 13 Part 10

Question 1

regulators have slated repeatedly that a firm and its representatives may not rely solely on the client’s status as

Answer 1

an accredited investor to determine suitability. They must gather additional information about the client’s needs, investment objectives, and risk tolerance in order lo make sure he is a suitable hedge fund investor

Question 2

Promotions of hedge funds or funds of funds to clients must represent a

Answer 2

fair and balanced picture. This means that any statements about the fund’s advantages, such as investment flexibility and superior performance, must be accompanied by a discussion of
the risks.

Question 3

hedge fund risks

Answer 3

illiquid, increased risk/return, less transparency, tax considerations, higher fees

Question 4

Illiquid investments

Answer 4

Often, investors are subject to lock-up periods and must wait anywhere from one to two years before they can withdraw their money. Alternatively, a fund may limit withdrawals to certain times each year, such as semiannually or quaiterly. There is generally no secondary market for hedge funds’ shares, and no uniform standards about how to price them. Hedge funds are not appropriate for investors who need ready access to their money

Question 5

Increased Risk/Return

Answer 5

Hedge funds may employ a high degree ofleverage, invest in illiquid assets, or employ complex investment strategies. These strategies may increase the fund’s potential returns, but they also increase the risk of investors losing their entire capital. Investors who cannot afford to lose their capital should not invest in hedge funds or funds of funds

Question 6

Less Transparency

Answer 6

As already mentioned, hedge funds are unregistered investment pools, which means there is less investor protection and disclosure. Unlike mutual funds, most hedge funds are not required to provide periodic information to investors about pricing and share value. Valuing hedge fund assets can be difficult since many funds invest in financial instruments, such as derivatives and illiquid securities that are inherently difficult to value

Question 7

Tax Considerations

Answer 7

Many hedge funds and funds of hedge funds have complex tax structures. The information that investors need to file their tax returns may be delayed, resulting in the need to file for an extension

Question 8

Higher Fees

Answer 8

Hedge funds often charge higher and more complex fees than other types of pooled investments. One typical arrangement is a two and twenty fee. In this arrangement, a hedge fund manager charges a 2% management fee and then takes 20% of any profits earned. When investing in hedge funds, a clear understanding of the fee structure is necessary in order to assess the risk.

Question 9

a limited partnership is an investment program in which

Answer 9

all profits and losses flow through directly to investors

Question 10

General partners, on the other hand, are responsible for managing the partnership and are required only to contribute

Answer 10

at least 1 % of its capital. The general pattner may be a corporation or an individual

Question 11

Every limited partnership must have at least

Answer 11

one general partner and one limited partner. The partnership is created when two or more persons sign a Certificate of Limited Partnership that describes the terms and conditions under which the partnership will operate. The certificate is a public document that must be filed with the appropriate state official

Question 12

The Agreement of Limited Partnership is a

Answer 12

contract between the general partners and the limited partners spelling out each partner’s rights and obligations. The agreement may be part of the Certificate of Limited Partnership or may be a separate document

Question 13

An assessment takes place when

Answer 13

a limited partner is required to contribute more money to the partnership. If a limited paitnership includes the assessment feature, an adviser should always inform a client that he may be required to contribute more money to the partnership

Question 14

Partnerships are considered

Answer 14

long-term investments (10 to 20 years in some cases). For these reasons, an IAR should never recommend that a client place more than a small portion of his assets in a limited partnership (usually 10% or less).

Question 15

Many investors purchase limited partnerships for their potential tax benefits. However, since an investment in a limited partnership is considered a

Answer 15

passive activity, investors must understand the tax treatment of income and losses generated by the partnership. All tax information is reported to the investor on Form K-l.

Question 16

Passive activity describes an investment in which

Answer 16

the owner of the business does not materially participate in its operations. It is important for investors to realize that any losses that the partnership generates are categorized as passive losses and may be deducted only against other income from passive activities

Question 17

The losses that the limited partner incurs through the partnership may not be used to offset

Answer 17

earned income (wages and salaries) or portfolio income (the income from most other types of investments, such as dividends and capital gains). If the limited parmer's passive losses exceed his passive income, then the losses may be carried forward into future years. Investing in a limited partnership makes filing tax returns more complicated for individual investors.
The increased costs and time of preparing tax returns are factors that investors should consider before purchasing a partnership.

Question 18

Some limited partnerships are sold

Answer 18

publicly and registered with the SEC
under the Securities Act of 1933. However, most are sold as private placements under Regulation D and are exempt from registration. As we examined in Chapter 2, private placements, under federal law, may be sold only to a maximum of 35 nonaccredited investors and may not be advertised publicly

Question 19

For any clients considering a limited pmtnership, an iar should always tell them to scrutinize the offering documents carefully, particularly the section pertaining to risks. An investor in a public limited partnership must receive a copy of the prospectus before the sale is completed. However, an investor buying a private placement will receive

Answer 19

an offering memorandum that contains similar information

Question 20

Many limited partnerships require investors to sign a

Answer 20

subscription agreement stating that they have read the prospectus, understand the risks, and meet the minimum financial rcquirements. The investor is accepted as a limited partner only when the general partner signs the subscription agreement. The executed subscription agreement may be considered the investor’s confirmation