Hedge Funds

Question 1

Type of Entity

Answer 1

Most hedge funds operate as limited liability companies or as limited partnerships

Question 2

Individual Accredited Investor

Answer 2

(1) Someone with a net worth in excess of $1M (excluding personal residence); (2) Income above $200k (or $300k joint with spouse) for past two years with reasonable expectation income will continue in year of investment

Question 3

Governance

Answer 3

The typical U.S. hedge fund does not have a board of directors or any governing body similar to a mutual fund board of directors.

Question 4

Transparency and Regulation

Answer 4

(1) Were not subject to any minimum disclosure and were lightly regulated; (2) Dodd-Frank required hedge-fund managers to register with the SEC, which means a Chief Compliance Officer must be appointed

Question 5

Performance Standards

Answer 5

(1) Hedge funds gauged by individual returns rather than returns against index or peers. (2) Absolute returns means having positive returns in all types of market conditions.

Question 6

Private Placement Memorandum

Answer 6

(1) Offering Document for a hedge fund (2) No specific disclosure requirement; (3) May include: investment strategies, investor qualifications, risk factors, allocation of gains and losses, lock up period, redemption provisions, tax aspects, fund financial statements

Question 7

Fees

Answer 7

(1) Most hedge funds have a 2% management fee plus 20% profits; (2) Managers do not share in losses; (3) Usually a 40 to 60 bps administrative fee

Question 8

Risk Management

Answer 8

(1) Hedge funds should have a system for identifying, tracking and management risks of fund investments and strategies; (2) A system in place for assuring proper valuation of illiquid securities; (3) There is no standard measure of risk for a hedge fund

Question 9

Use of Derivatives

Answer 9

(1) Derivatives can reduce risk, (2) Substitute for Traditional Securities; (3) Increase returns through Speculation

Question 10

Leverage

Answer 10

(1) Increases returns without increasing investment; (2) Can be accomplished through borrowing or derivatives to magnify both returns and losses.

Question 11

Concentration

Answer 11

(1) Making big bets on securities by investing large amounts of capital into those securities; (2) Increases risk but can increase returns as well

Question 12

Hedging

Answer 12

Taking the opposite of positions to reduce risk

Question 13

Short Selling

Answer 13

(1) One seller borrows securities to sell with intention of closing out position by delivering securities to seller’s portfolio or buying back in open market. (2) Can be used to hedge a long position.

Question 14

Distressed Securities

Answer 14

(1) Securities trading at very low prices due to prospect of bankruptcy or corporate reorganization. (2) Gives these securities the possibility for large capital gains, but usually takes several years for the company to turn around.

Question 15

Arbitrage

Answer 15

Arbitrage is exploiting price discrepancies between very similar or the same securities trading in different markets

Question 16

Market Neutral

Answer 16

(1) Also called long/short; (2) Taking both long and short positions to make profits

Question 17

Global Macro Investing

Answer 17

(1) Macro investing attempts to profit from changes in global economics, and are usually tied to (2) Interest rates, which in turn, impact currencies, stocks and bond markets. (3) Both leverage and hedging techniques may be used, thereby impacting the risks being taken.

Question 18

Venture Capital

Answer 18

(1) Venture Capital is money invested in the very early stages in the life of a company in the hopes of very large gains if the company becomes successful; (2) If unsuccessful, the entire investment could be lost; (3) The equity position is illiquid and difficult to value until the company goes public or is sold

Question 19

Private Offerings

Answer 19

(1) Sales of Securities issued by companies who do not want the expense, time, and inconvenience of issuing public securities. (2) Offered through Private Offering Memorandum that describes the company, risks, and other material factors.

Question 20

Initial Public Offerings

Answer 20

(1) Many Hedge Funds have enough clout to obtain shares of “hot” IPOs, the performance of which can boost returns. (2) IPOs can gain 50%, 100% or more in the initial day of trading.

Question 21

Business Financing

Answer 21

(1) Hedge funds have entered the business of providing financing to business. (2) Uses include: finance takeovers, the purchase of another business, or bridge loans (temporary financing until L-T capital can be arranged.)

Question 22

Fund of Hedge Funds

Answer 22

(1) A fund that invests in many hedge funds, often as many as 15 to 25. (2) Diversification is provided through a multi-manager, multi-strategy approach to investing, (3) Low-minimums (some as low as $5,000, although $25,000 to $1 million), (4) Institutional investors buy FOHFS to hedge against other funds. (5) Typically 1% fee, 10% profits with operating expenses at both levels.