Hedge funds

Question 1

What is an event-driven hedgefund

Answer 1

Attempts to profit from situations such as M&A, restructuring, bankruptcy, etc.

Question 2

Describe long-short equity hedge

Answer 2

Equity-oriented posittions on either side, depending on outlook, not meant to be market neutral.

Question 3

Describe portable alpha

Answer 3

Market neutral pure play, buy a stock you think will increase, while for example neutralizing market risk by selling index futures to achieve zero beta. So a market neutral position on the stock.

Question 4

What is statistical arbitrage

Answer 4

Quantitative and often automated trading systems that seek out temporary and modest misalignments in prices. Different from convential as its not risk-free based on unambiguous mispricing.

Question 5

Describe price smoothing

Answer 5

Hedge funds with illquid assets may smoothe reported prices, leading to serial correlation between returns

Question 6

What is the bakcfill bias

Answer 6

Hedge funds only report when they choose to, and thus probably only when they perform well.

Question 7

What is survivorship bias

Answer 7

Ill-performing funds cease operations and leave the database, leaving only the successful ones behind

Question 8

What are changing factor-loadings?

Answer 8

Changing exposure to different risk-factors due to hedge fund flexibility, making performance hard to judge

Question 9

Why has alpha decreased for many HFs?

Answer 9

-Decrease of transaction costs on financial markets
-increaes of capital (more HFs, more competition)
-Information more readily available -> less anomalies
-Tightening of regulations and effort of compliance after financial crisis
-Decrease of financial incentives for HF managers because they have so much invested that the small returns are enough to make them rich

Question 10

Can hedge funds hedge market risk?

Answer 10

-You would expect so, but correlation is higher than you would think due to high number of HFS
-Diversification benefits by FoFs are thus negligible
-Most HF strategies are thus not a good hedge

Question 11

Potential reasons for HF outperformance

Answer 11

-Skill
-Investment flexibility
-Fraud
-Data issues
-Risk
-Problems measuring returns for HFs with CAPM

Question 12

Model classifications

Answer 12

-Empirical: from data to model
-Theoretical: from theory to model -> black scholes

-Deterministic: random term
Probabilistic: no random term

Discrete: variable can only take discrete values
Continuous: variable can take any value within range

Cross-sectional: comparing multiple units at a point in time
Time series: track one unit over time
Panel: track multiple units over multiple time periods

Question 13

What is a high water mark?

Answer 13

If a fund experiences losses, incentive fee is only paid when it makes up for those losses -> creates incentive to shut down fund after poor performance and start over

Question 14

Why do we care about both alphas and betas for HFs?

Answer 14

We can achieve beta by simply buying (levered) ETFs -> we only care about alpha, but need beta to determine it
Investors could short market index to remove market risk from HF investment

Question 15

What is alpha transfer, and how can it be achieved?

Answer 15

Portable alpha strategy earns beta in one asset and alpha in another
-Often implemented using futures contracts
Steps:
1. invest where you can find alpha, e.g., Jap. small caps
2. hedge systematic beta away, e.g., short Nikkei futures
3. Establish exposure to desired asset class by using futures or ETF

Question 16

Why can hedge fund risk not be described with Stdev and sharpe?

Answer 16

Returns do not follow a normal distribution

Question 17

What can break an alpha transfer strategy?

Answer 17

-CAPM needs to hold
-Alpha forecast needs to be correct
-Beta forecast needs to be correct
-Epsilon should be negatiev or positive, as it cannot be hedged away

Question 18

Imagine you have a stock and you write a put option. Does this increase or decrease down-market beta?

Answer 18

Increase