(R50) Introduction to Alternative Investments

Question 1

Define traditional and alternative investments

Answer 1

Traditional: long positions in bonds, stocks, and cash Alternative: everything else

Question 2

Describe characteristics of alternative investments

Answer 2

• Actively managed so higher fees
• Low level of regulation and transparency
• Provides more diversification
• Possibly higher returns

Question 3

Define Hedge Funds and their goal

Answer 3

Private investment partnerships that use a variety of strategies and are highly leveraged, use long and short positions, and use derivatives. For high net worth individuals only

Goal is to generate high absolute returns

Question 4

Funds of Hedge Funds

Answer 4

Funds that hold a portfolio of hedge funds, more commonly shortened to funds of funds

Question 5

Four strategies of hedge funds

Answer 5

1. Event-driven: profit from short-term events
2. Relative-value: profit from pricing discrepencies
3. Macro: top down approach to identify trends
4. Equity Hedge: bottom up approach

Question 6

Distressed investing

Answer 6

Investing in securities of companies in financial difficultly. Private equity funds that specialize in distressed investing typically buy the debt of mature companies in financial difficulty

Question 7

High-water Mark

Answer 7

The highest value, net of fees that a fund has reached in history. It reflects the highest cumulative return used to calculate an incentive fee

Question 8

Management Fee

Answer 8

A fee based on assets under management or committed capital, as applicable

Question 9

Performance Fee

Answer 9

Fees paid to the general partner from the limited partner(s) based on realized net profits.

Question 10

Drawdown

Answer 10

A reduction in net asset value, which may require liquidations

Question 11

Lockup period

Answer 11

The minimum holding period before investors are allowed to make withdrawals of redeem shares from a fund

Question 12

Notice period

Answer 12

The length of time (typically 30-90 days) in advance that investors may be required to notify a fund of their intent to redeem some or all of their investment

Question 13

Define private equity investment

Answer 13

Involves investing in private companies or public companies with the intention of taking them private

Question 14

Define leveraged buyout

Answer 14

Private equity strategy; target company’s management team converts the target to a privately held company by using heavy borrowing to finance the purchase of the target company’s outstanding shares

Question 15

Mezzanine Financing

Answer 15

Debt or preferred share with a relationship to common equity from a feature such as attached warrants or conversion options. Mezzanine financing is subordinate to both senior and high yield debt but is senior to equity. It is referred to as “mezzanine” because of its location on the balance sheet

Question 16

Define venture capital

Answer 16

Private equity strategy; Investments that provide “seed” or startup capital, early stage financing, or later-stage financing (including mezzanine stage financing) to companies that are in early development stages and require additional capital for expansions or preparation for an initial public offering

Question 17

What are the stages of venture capital investing?

Answer 17

1. Formative stage (early stages)
   
   1. Angel investing, seed-stage, early-stage
2. Later-stage (growth/expansion phase)
3. Mezzanine-stage: preparing to go public

Question 18

What is a trade sale in private equity?

Answer 18

Type of private equity exit strategy; Its a sale of the company to a strategic buyer by auction or in private

Question 19

Which alternative investments have lower correlation with traditional investments?

Answer 19

Hedge funds, private equity, real estate, commodities

Question 20

Characteristics of Real Estate

Answer 20

• Potential for total returns (capital appreciation and income stream)
• Greater stability of cash flows
• Requires operational management

Question 21

What are the real estate investment categories?

Answer 21

• Residential properties;
• Commercial real estate;
• REITs;
• Mortgage-backed securities
• Timberland and farmland.

Question 22

Define commodity investments

Answer 22

Physical products with carrying costs (transportation, storage, precious metals); made up of commodity derivatives

Question 23

Commodity swap

Answer 23

A swap in which the underlying is a com- modity such as oil, gold, or an agricultural product.

Question 24

Management buy ins

Answer 24

Leveraged buyout in which the current management team is being replaced the acquiring team will be involved in managing the company

Question 25

Management Buy-Out

Answer 25

A leveraged buyout event in which a group of investors consisting primarily of the the companies existing management purchase at least controlling interest in its outstanding shares. At the extremes, they may purchase all shares and take the company private

Question 26

Define infrastructure

Answer 26

Real, capital-intensive, long-live assets intended for public use (typically owned, financed, or operated by gov’t). Involves private sector

Question 27

Define two broad categories of infrastructure (Economic vs. Social)

Answer 27

• Economic: support economic activity (roads, bridges, tunnels, airports, gas, water, etc.)
• Social: support education, health care, correctional facilities

Question 28

Define two broad categories of infrastructure (Brownfield vs. greenfield)

Answer 28

• Brownfield: investments in existing assets
• Greenfield: investments in assets that need to be constructed

Question 29

What is reporting NAV (Net asset value)?

Answer 29

The quoted market price that is not adjusted for liquidity