Introduction

Question 1

Hedge Funds are:

Answer 1

Absolute return funds. Return independently of market conditions. No benchmark, low beta. Focus on generating alpha.

Question 2

Investment objectives of HF:

Answer 2

Focus on capital protection (low risk). Target SR close to 1 and then leverage up or down.

Question 3

Investment policies of HF:

Answer 3

All instruments and markets. Allow short selling and leverage.

Question 4

Who can invest in HF?

Answer 4

Only Institutional investors or High Net Worth individuals (absolutely no retail). Are usually very secretive about performance.

Question 5

Typical fee for HFs:

Answer 5

1.5% management - 20% performance (approximately)

Question 6

Are Hedge Funds liquid?

Answer 6

Not really, investors can’t just pull money in and out, strategies can go on for years.

Question 7

Rule on Performance fee for HFs:

Answer 7

The High-Water Mark rule. Meaning managers don’t get performance fees simply by gaining money back. Only when they reach new levels of returns do they get performance fees.

Question 8

Do HFs always aim for Beta=0?

Answer 8

No. Usually they are slightly overweight either in the short position or the long position. Actually what happens most frequently is that they are in the long position since they want to get market risk premium (expected returns on market).

Question 9

Should you short a bubble?

Answer 9

Very hard to short a bubble since you can be short-squeezed, hard to understand if and when will it burst, and losses can go on for a very long time.

Question 10

Explain Equity Long-Short

Answer 10

Long undervalued stocks and short overvalued stocks.

Question 11

If you want to short an asset, what should you use? Why?

Answer 11

Should use futures. This is because they have a settlement date and/or price. Also, you will always be Margin Called

Question 12

Characteristics of Equity Long-Short Portfolios:

Answer 12

Low risk (can be increased w/ leverage)
Returns uncorrelated w/ market performance

Question 13

Equity Long-Shorts can be divided in:

Answer 13

Long Bias
Short Bias
Pure Market Neutral

Question 14

Explain Global Macro

Answer 14

The aim of Global Macro strategies is to trade macroeconomic conditions and their impact on financial markets.

Question 15

How do you put Global Macro in practice?

Answer 15

Establish directional positions in different asset classes and geographical regions

Question 16

What is usually the major focus in Global Macro?

Answer 16

Interest rate positions

Question 17

Explain Systematic Trading

Answer 17

Investment decisions are made by a system, often an algorithm. Basing themselves on technical patters, fundamental data, market anomalies…

Question 18

Important in Systematic Trading:

Answer 18

Diversification. Avoids model misspecification or changing market patters

Question 19

Explain Fixed Income Arbitrage

Answer 19

Point is to exploit inefficiencies between related fixed income securities while hedging for interest rate risk

Question 20

Name common trades in Fixed Income Arbitrage

Answer 20

Yield Curve Arbitrage (2-10, 5-30)
Intermarket spreads (Bund vs Treasury Yield)

Question 21

Name the Fixed Income Arbitrage positionings

Answer 21

Duration neutral
Long Bias
Short Bias

Question 22

Explain Specialized Credit

Answer 22

Long undervalued credit and short overvalued credit

Question 23

Explain Event-Driven

Answer 23

Trade Corporate events (M&A deals, buybacks, etc)

Question 24

How do trade M&A deals

Answer 24

Usually by longing the target company and shorting the acquirer (basically betting that the acquirer will overpay).

Question 25

Explain Volatility Arbitrage

Answer 25

Buy/sell options or convertible bonds while hedging for equity risk (this is done by shorting/buying the underlying)

Question 26

Explain Funds of Funds (FoF)

Answer 26

Invest in other funds and combine.

Question 27

Advantages of FoF

Answer 27

Diversification.
Specialization (each fund focuses on what they know best)

Question 28

Disadvantages of FoF

Answer 28

Fees-on-Fees structure is expensive.

Question 29

Explain Multi-Strategy

Answer 29

Try to hire the best possible people for each type of strategy.

Question 30

Advantages of Multi-Strategy

Answer 30

Diversification without Fees-on-fees
Fast in shifting portfolio weights depending on market conditions

Question 31

General assessment of HFs historical performance:

Answer 31

Outperform when it’s going down. Don’t catch up when it’s going up.

Question 32

Why do Multi-Strategy funds tend to have good SRs

Answer 32

High diversification

Question 33

Biases when assessing hedge funds performance

Answer 33

Back Fill Bias (only report if they’re successful)
Survivorship Bias

Question 34

What is Back Fill Bias?

Answer 34

Only successful funds report their performance

Question 35

What is Survivorship Bias? (in the context of HFs performance)

Answer 35

Many funds die, data only takes into account those that survive.

Question 36

How can you generate alpha?

Answer 36

Have an active investment strategy (go beyond Beta and passive investment)
Risk control

Question 37

Methods for Risk Control

Answer 37

Risk Limits VaR stops
Risk weightings

Question 38

When Backtesting, the level of confidence depends on:

Answer 38

Stability of Backtest
Stability of further out-of-sample tests

Question 39

Enumerate the Backtesting guidelines

Answer 39

1. Compute daily returns
2. Compute performance statistics
3. Analyse Calendar performance of strategy

Question 40

Enumerate performance statistics

Answer 40

Annualized return
Annualized standard deviation
Sharpe Ratio
Positive days/months
Skewness, Kurtosis and Distribution of Returns
Autocorrelations

Question 41

Why are autocorrelations important

Answer 41

If returns are autocorrelated, we may be overestimating a strategies performance. Return may be driven by the autocorrelation instead of the strategy.