CAIA Practice Questions & Answers Correct 100%

What assets are often chracterized as traditional by some and alternatives by others in: hedge funds, private equity, and real assets - Answer Hedge Funds: Liquid alternative mutual funds Private Equity: Closed-end funds with illiquid holdings Real Assets: Public real estate and public equities of corporations with performance dominated by stable positions in real assets 4 major methods of analysis that distinguish the analysis of alternative investments from trad. investments - Answer Return Computation Methods, Statistical Methods, Valuation Methods, Portfolio Management Methods Define investment - Answer Investment is any deferred consumption 4 major types of real assets other than land and other types of real estate - Answer Natural Resources, Commodities, Infrastructure, and IP 4 return characteristics that differentiate trad. and alt investments - Answer Diversification, Illiquidity, Inefficiency, Nonnormality Define Active Management - Answer Refers to efforts of buying and selling securities in pursuit of superior combos of risk and return Define an incomplete market - Answer Refers to lack of investment opportunities that causes market participants to be unable to implement an investment strategy that satisfices their exact preferences such as risk 4 major types of alt investments - Answer Real Assets, HF, PE, Structured Products When did avg quality corp bonds and international equities become commonly viewed as institutional quality inv. in US? - Answer Between 4 major legal documents necessary for establishing and managing a HF - Answer Private-Placement memoranda, partnership agreement, subscription agreement, & management company operating agreement What is qualified majority? - Answer More than 75% of LPs voting to make a decision What is Systematic Risk? - Answer Risk in the potential for economy wide losses attributable to failures or concerns over potential failures in markets 3 constraints against achieving alternative investment benefits through liquid products - Answer Leverage, Regulatory constrains on concentration, Illiquidity constraints Difference between a hard hurdle and soft hurdle rate - Answer Hard hurdle rate limits incentive fees to profits in excess of the hurdle rate Soft hurtle rate allows fund managers to earn an incentive fee on all profits, given the hurdle rate has been acheived is IRR a dollar-weighted return or a time-weighted return? - Answer IRR is the primary method of computing dollar-weighted return What is the primary cause of the shape of the J-curve of interim private equity fund returns? - Answer It is caused by a combo of early expense recognition, early loss recognition, and deferred gain recognition An investment has two solutions for its IRR. What can be said about the investment and the usefulness of the two solutions? - Answer There are two sign changes in the cash flow stream of the investment. None of the IRRs should be used What scenario will a clawback clause lead to payments? - Answer Designed to return incentive fees to LPs when early profits are followed by subsequent losses General term denoting compound interest when the interest is not continuously compounded? - Answer Discrete compounding What is an ex post excess return? - Answer A realized return expressed as an excess return by subtracting the riskless return from the assets total return What does it mean to bootstrap a yield curve? - Answer Process of recursively estimating spot rates using one or more zero-coupon bonds on the short end and coupon bonds on the medium and long term regions of the term structure Which theory of the term structure of interest rates do all bonds have the same expected return? - Answer Unbiased expectations theory What differentiates a relative pricing model from an absolute pricing model? - Answer Relative pricing model prescribes the relationship between two prices Absolute pricing model attempts to describe a value, or a price level, based on its underlying economic factors What does it mean when a future is marked-to-market? - Answer Means that the side of a futures contract that benefits from a price change receives cash from the other side of the contract, throughout the contracts life 5 variables that determine the price of an option on a non-dividend stock according to Black Scholes option pricing model - Answer 1. Price of the underlying asset 2. Strike Price 3. Return vol. of the underlying asset 4. Time to the options expieration 5. Riskless rate What are the carrying costs (and benefits) of physical inventory such as a commodity? - Answer Carrying costs of physical inventory include interest (r) and storage (c), the benefit of physical inventory is the convenient yield What two spot interest rates imply the value of a six-month forward contract from a six-month T-bill? - Answer Current six-month and 12-month spot rates are needed to find the six-month forward contract for a six-month T-bill What is maintenance margin? - Answer Collateral put up by the investor on an ongoing basis until the position is closed out What two assets form a long straddle? - Answer Long call and long put with the same strike price Which is more likely to be ore liquid, a forward contract or a futures contract? - Answer A futures contract is more likely to be more liquid What are the names of the first and second derivatives of an option price with respect to the price of the option's underlying asset? - Answer Delta & Gamma When is Monte Carlo analysis most appropriate as an estimation technique? - Answer It is best used in difficult problems where it is not practical to find expected valued and standard deviations using mathematical solutions Define tracking error - Answer Indicates the dispersion of the returns of an investment relative to a benchmark return, where a benchmark return is the contemporaneous realized return on an index or peer group of comparable risk Define average tracking error - Answer Simply refers to the avg. difference between an investments return relative to its benchmark Define Value at Risk (VAR) - Answer VAR is the maximum loss over a specified time period within a specified probability Define Conditional Value at Risk (CVAR) - Answer CVAR is the expected loss of the investor given that VAR has been equaled or exceeded. CVAR will exceed VAR What is Jensen's Alpha? - Answer Direct measure of the absolute amount by which an asset is estimated to outperform 3 major types of model misspecification in the context of estimating systematic risk - Answer Omitted (or misidentified) systematic return factors Misestimated betas Nonlinear risk-return relationships Does ex ante alpha lead to ex post alpha? - Answer Not necessarily. While ex ante alpha may be viewed as expected idiosyncratic return, ex post alpha is realized idiosyncratic return. Simply put, ex post alpha is the extent to which an asset outperformed or underperformed its benchmark in a specified time period. Ex post alpha can be the result of luck and/or skill. To the extent that an investor suffers bad luck, ex ante will not guarantee ex post alpha. What is the goal of an empirical investigation of abnormal return persistence? - Answer To identify ex ante alpha Two common interpretations of the investment term alpha - Answer 1. Alpha refers to any excess or deficient investment return after the return has been adjusted for the time value of money (risk free rate) and for the effects of bearing systematic risk (beta) 2. Alpha can also refer to the extent to which the skill, information, and knowledge of an investment manager generates superior risk-adjusted returns