AIP AIP Alternative Investments & Derivatives 2 — Questions and Answers
Question 1: A put option is most useful to an investor who wants to:
- Speculate on rising stock prices
- Hedge against a decline in the value of a stock they own (Correct answer)
- Receive regular dividend income from an options position
- Increase portfolio exposure to a particular sector
Correct answer: Hedge against a decline in the value of a stock they own
A put option gives the holder the right to sell at the strike price, providing downside protection if the underlying asset's value falls.
Question 2: What does the term 'alpha' measure in the context of alternative investments?
- The total return of a portfolio over a given period
- The correlation between a fund and its benchmark index
- Excess return generated by a manager above a benchmark on a risk-adjusted basis (Correct answer)
- The standard deviation of returns in a hedge fund
Correct answer: Excess return generated by a manager above a benchmark on a risk-adjusted basis
Alpha represents the value a portfolio manager adds (or subtracts) beyond the return explained by market exposure (beta).
Question 3: Commodity futures contracts are primarily used by producers and consumers to:
- Speculate on equity market movements
- Lock in a future price to manage commodity price risk (Correct answer)
- Avoid paying income taxes on commodity sales
- Purchase physical commodities at a discount
Correct answer: Lock in a future price to manage commodity price risk
Hedgers use commodity futures to fix buy or sell prices in advance, reducing uncertainty about future costs or revenues.
Question 4: What is the primary risk associated with writing (selling) a naked call option?
- Loss limited to the premium received
- Potential for unlimited losses if the underlying asset price rises sharply (Correct answer)
- The obligation to deliver a dividend to the option buyer
- Time value decay working against the option writer
Correct answer: Potential for unlimited losses if the underlying asset price rises sharply
A naked call writer faces theoretically unlimited loss because there is no cap on how high the underlying asset price can rise, forcing the writer to buy it at market to deliver.
Question 5: Which of the following is a key feature of a collateralized loan obligation (CLO)?
- It is backed by residential mortgage loans
- It pools corporate loans and issues tranches with varying risk/return profiles (Correct answer)
- It guarantees principal repayment by the US government
- It is a type of derivative linked to equity index performance
Correct answer: It pools corporate loans and issues tranches with varying risk/return profiles
A CLO pools a diversified portfolio of corporate loans and issues multiple debt tranches that differ in seniority, credit quality, and yield.
Question 6: In private equity, a 'general partner' (GP) typically:
- Passively invests capital without influencing fund operations
- Manages the fund, makes investment decisions, and earns carried interest (Correct answer)
- Guarantees limited partners against all capital losses
- Is required by law to invest no personal capital in the fund
Correct answer: Manages the fund, makes investment decisions, and earns carried interest
The GP actively manages the private equity fund, sources and executes deals, and is compensated through management fees and a share of profits known as carried interest.
AIP AIP Alternative Investments & Derivatives 2
A put option is most useful to an investor who wants to: