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CAIA > The Environment of Alternatives > Flashcards

The Environment of Alternatives Flashcards

1
Q

What are the four categories of participants?

A

Buy side, Sell side, Outside service providers, and Regulators

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2
Q

What are plan sponsors?

A

Healthcare or retirement providers focusing on 401k

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3
Q

Is a plan sponsor on the buy or sell side?

A

Buy

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4
Q

What is a foundation?

A

A not-for-profit that donates funds and support to other organizations for a charitable purpose

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5
Q

Is a foundation on the buy or sell side?

A

Buy

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6
Q

What is an endowment?

A

A fund bestowed on an individual or institution to be used by the entity for a specific purpose.

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7
Q

Is an endowment on the buy or sell side?

A

Buy

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8
Q

What is a family office?

A

A group of investors joined by family ties who manage their investments as a single entity.

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9
Q

Is a family office on the buy or sell side?

A

Buy

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10
Q

What is a sovereign wealth fund?

A

A state-owned investment funds held by the states central bank for purpose of future generations or to stabilize state currency.

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11
Q

Is a sovereign wealth fund on the buy or sell side?

A

Buy

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12
Q

What is a private limited partnership?

A

Potentially offers the benefit of limited liability to the organizations limited partners. For tax purposes, limited partnerships tend to flow taxable revenue and expenses directly through to their partners.

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13
Q

Is a private limited partnership on the buy or sell side?

A

Buy

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14
Q

What are the 5 key differentiators of a SMA?

A
  1. The investor is actually the owner on record.
  2. The SMA is tailored to a specific investor, ie they may have certain tax efficiency needs and the SMA would address those.
  3. They are more transparent.
  4. Protection from liquidity issues.
  5. They have the potential for greater losses especially if leverage or derivatives are used.
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15
Q

What is an MLP?

A

Structured like a limited partnership they have prorate claims, they are traded on major stock exchanges, and their legal and tax structures are similar to limited partnerships?

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16
Q

Is an MLP on the buy or sell side?

A

Buy

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17
Q

Is a SMA on the buy or sell side?

A

Buy

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18
Q

What are two examples of large dealer banks?

A

Goldman Sachs, Deutsche, Barclays, etc.

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19
Q

What is the role of a large dealer bank?

A

To act as intermediaries in markets for securities, repurchase agreements, securities lending, and over the counter derivatives. Also often engaged in proprietary trading and hedge funds.

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20
Q

What is the role of dealer banks in the primary market?

A

Intermediary between issuers and investors, provide liquidity, act as underwriters

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21
Q

What is the role of a dealer bank in the secondary market?

A

Trade directly or by the phone, take on the intermediary role of facilitating trades.

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22
Q

What is proprietary trading?

A

When a firm trades with their own money in order to make a profit.

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23
Q

What is off-balance-sheet financing?

A

A practice where large expenditures are kept off of a companies balance sheet. They do this to keep their debt to equity and leverage ratios low.

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24
Q

Why are brokers used most of the time?

A

Because traders want to remain anonymous

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25
Q

What are the three operational areas of a brokerage firm?

A

Front, back, and middle

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26
Q

What is the the role of the front office operation?

A

Decision making and client contact

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27
Q

What is the role of the back office operation?

A

Maintenance of accounts/info systems, clearance and settlement of trades

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28
Q

What is the role of the middle office?

A

To form interface between front and back, primarily in the form of risk management.

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29
Q

What are some of the outside service providers?

A

Prime brokers, accountants, auditors, attorneys, fund administrators, consultants, depositories and custodians, consultants, hedge fund infrastructures

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30
Q

What are the primary functions of prime brokers?

A

Clearing and financing trades for clients, providing research, arranging financing, producing portfolio accounting

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31
Q

What are the main documents attorneys provide?

A
  1. Private placement memoranda (offering documents)
  2. Partnership agreement
  3. Subscription agreement
  4. Managed Company Operating agreement
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32
Q

What is a private placement memoranda?

A

This is also known as an offering document. This outlines the investment opportunity per federal securities regulations.

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33
Q

What is the subscription agreement?

A

The application of an investor to join a limited partnership.

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34
Q

What is the managed company operating agreement?

A

It is related to the limited liability company and the conduct of its business.

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35
Q

What is the role of fund administrators?

A

Bookkeeping, third party info gathering, securities valuation functioning

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36
Q

What are the three main components of hedge fund infrastructure?

A
  1. Platform
  2. Software
  3. Data Providers
37
Q

What are consultants continuously being hired to do?

A

Act as the Chief Investment Officer- ie OCIO (outsourced chief investment officer)

38
Q

How are consultants often times paid?

A

Fees from clients or compensation packages from managers the drum up business for.

39
Q

Who is responsible for holding clients cash/securities and settling clients trades?

A

Depositories and custodians

40
Q

What is the principal holding body of securities for traders all over the world?

A

DTC- Depository Trust Company

41
Q

What is a primary market?

A

Methods, institutions, and mechanisms involved in the placement of new securities to investors.

42
Q

What is a secondary market?

A

The secondary market facilitates trading between investors.

43
Q

What is securitization?

A

Involves bundling assets (particularly unlisted assets) and issuing claims on bundled assets

44
Q

Where are most investments listed?

A

The secondary market because there is more liquidity and transparency.

45
Q

What is the bid-ask spread?

A

The difference between the best bid price and the best ask price.

46
Q

What is market making?

A

A practice where a investment bank or another market participant deals securities by regularly offering to buy or sell. They seek to receive the bid ask spread through regularly selling at the ask and buying at the bid.

47
Q

What are market orders?

A

They cause immediate execution at the best available price.

48
Q

What are market takers?

A

Those who place market orders. They are paying the bid-ask spread for taking liquidity.

49
Q

Which exchange has physically centralized trading?

A

NYSE

50
Q

Which exchange uses computer networks between dealers?

A

NASDAQ

51
Q

What is the third market?

A

Regional exchanges that allow brokers and dealers to set up trades away from the exchange by listing their prices on the NASDAQ intermarket.

52
Q

What happens in the fourth market?

A

High frequency trading, electronic trading, lower transaction costs.

53
Q

Where does most trading happen?

A

The fourth market.

54
Q

What is systemic risk?

A

The potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets.

55
Q

What are the five primary forms of hedge fund regulations?

A
  1. Establishment: ie registration, licensing, minimum capital, and waiting periods.
  2. Restrictions on investment advisors/hedge fund managers.
  3. Distribution and marketing.
  4. Operations: ie leverage, liquidity, risk, reporting, location of outside service partners.
  5. Requirements on ongoing reporting.
56
Q

What two areas can regulations regarding hedge funds be divided into?

A
  1. Regulations on securities to the public (ie the Securities Act of 1933)
  2. Regulations of advisors to investment pools (Investment Act, ‘40 Act).
57
Q

What does the Securities Act of 1933 relate to?

A

Regulations on securities to the public

58
Q

What does the ‘40 Act regulate?

A

Advisors to investment pools

59
Q

If a hedge fund is unregistered what must a hedge fund manager do?

A

Register as a investment advisor with the SEC.

60
Q

What does the ‘40 Act fund lay out in regards to regulations?

A
  • Antifaud provisions
  • Obligations to act in the best interest of the client
  • Disclosure of all relevant facts to the client
  • Reasonable degree of care in provisions of advice
  • Avoid misleading clients through omission or misstatement
61
Q

What is a soft dollar arrangement?

A

The agreement through which an investment advisor receives research services from a BD for a fee.

62
Q

What is a Regulation T margin rule?

A

Requires a deposit of at least 50% of purchase cost or short sale proceeds.

63
Q

How will some hedge funds get around Regulation T Margin Rule?

A

By registering as a BD or by using a joint back office account in which the parent BD will determine the amount to which they can short sell.

64
Q

What is UCITS?

A

Undertakings for Collective Investment in Transferrable Securities- created for the EU, hedge-like investment vehicles that are highly regulated.

65
Q

What is the Market in Financial Instruments Directive?

A

A law requiring uniform regulation for investment managers in EU Economic Area.

66
Q

Why was the Market in Financial Instruments Directive II established?

A

To avoid dark pools.

67
Q

What is a dark pool?

A

Non exchange trading by large market participants that is hidden from view of most market participants.

68
Q

What does the AIFMD (Alternative Investment Fund Managers Directive) capture?

A

Hedge funds, private equity, infrastructure funds, real estate, non UCITS retail funds.

69
Q

What is the primary regulator of investments in the UK?

A

FCA- Financial Conduct Authority- and Prudential Regulatory Authority

70
Q

What does the Capital Requirement Directive state?

A

That hedge fund managers are required to maintain minimum capital resources to ensure that if necessary they can wind up in an orderly manner.

71
Q

What does France use to regulate?

A

Autorites des Marches Financiers

72
Q

What does ARIA (Agree a Regees d Investissement Allegees) do?

A

Allows three types of hedge funds: fund of hedge funds, unleveraged hedge funds, and leveraged hedge funds

73
Q

What body regulates Germany?

A

BaFin

74
Q

What are the two main thing BaFin distinguishes in regards to hedge funds?

A

Fund of hedge funds can be public whereas individual hedge funds must be private.

75
Q

Where does FINMA (Financial Market Supervisory Authority) have power?

A

Switzerland

76
Q

Swiss fund of hedge funds account for how much of the worldwide assets invested in fund of hedge funds?

A

1/3

77
Q

What do European policy makers believe caused the 07-09 financial crash?

A

Short selling

78
Q

What role do small nations play in hedge fund regulations?

A

Provide tax-neutral areas where funds can quickly and inexpensively be formed.

79
Q

What are liquid alternatives?

A

Alternative strategies that offer liquidity through the ability to sell positions in the market.

80
Q

What are the 5 distinct types of liquid alts?

A
  1. Unconstrained clones
  2. Constrained clones
  3. Liquid based replication products
  4. Skill based replication
  5. Absolute return or diversified products
81
Q

What are unconstrained clones?

A

They follow virtually the exact same strategy as the private placement.

82
Q

What are constrained clones?

A

They implement a similar strategy as a private placement but are limited in risk exposure by leverage, concentration, and liquidity constraints.

83
Q

What is liquidity based replication products?

A

Designed to mimic illiquid placements using liquid securities as proxies

84
Q

What is an absolute return product?

A

Designed to offer absolute returns or diversifying returns not directly related to opportunities historically available in private placements.

85
Q

How much money was invested in liquid alts prior to 07-09 crisis?

A

$100 billion

86
Q

How much is invested in liquid alts now and at what rate is it expected to grow?

A

Half a trillion, with 20% a year annual growth rate.

87
Q

Why are assets growing in liquid alternatives?

A
  1. Retail investors continue to look to diversify.

2. The shift from defined benefit to defined contribution opening diversification.

88
Q

What are the three constraints limiting liquid alts from being available in some retail accounts?

A
  1. Mutual funds are limited to borrowing 33% of their assets.
  2. Regulations on concentration.
  3. Illiquidity restraints.
89
Q

What does investment income include?

A

Dividend income, interest income, capital gains

CAIA (4 decks)

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