Mixed Deck — All CFM Topics Flashcards

An investor's risk tolerance is best described as:

Answer: The level of portfolio volatility they can financially and emotionally sustain

Risk tolerance encompasses both the financial capacity to absorb losses and the psychological willingness to endure portfolio volatility without making panic decisions.

What does a Price-to-Book (P/B) ratio below 1.0 typically indicate?

Answer: The stock is trading below the net asset value recorded on the company's balance sheet

A P/B below 1.0 means the market values the company at less than its book equity, which may signal deep value opportunity or concerns about asset quality and future profitability.

In the context of hedge fund prime brokerage, 'rehypothecation' refers to:

Answer: The prime broker's right to use client assets posted as collateral for its own financing purposes

Rehypothecation allows a prime broker to use a hedge fund's pledged collateral for its own financing needs, which reduces borrowing costs but creates counterparty risk for the fund.

When a CFM professional encounters an unfamiliar challenge in fund administration & operations, what is the recommended first course of action?

Answer: Research applicable standards, consult with subject matter experts, and document the approach

Professional practice requires a methodical approach to unfamiliar challenges: research the applicable standards, consult experts when needed, and document the reasoning for the chosen approach.

In quantitative fund analysis, maximum drawdown is most useful for assessing which risk characteristic?

Answer: The worst peak-to-trough loss experienced over a period

Maximum drawdown captures the largest cumulative loss from a peak, directly reflecting downside risk and the magnitude of potential loss an investor could face.

In mean-variance optimization, the efficient frontier represents portfolios that:

Answer: Maximize return for every level of risk

The efficient frontier consists of portfolios that maximize expected return for each level of risk (standard deviation), with no other portfolio offering a better risk-return tradeoff.

How should CFM professionals handle confidential information related to due diligence & fund selection?

Answer: Follow established protocols for data protection, access control, and disclosure in accordance with applicable regulations

Confidential information must be handled according to established protocols, regulatory requirements, and professional ethics standards, including proper access control and disclosure procedures.

Which of the following is a key structural difference between a hedge fund and a private equity fund?

Answer: Hedge funds typically allow periodic redemptions; private equity funds lock up capital for the fund's life

Hedge funds generally offer liquidity windows while private equity funds employ long-term lockups matched to illiquid investment horizons.

A fund manager claims a 3-year track record but recently replaced the lead portfolio manager. How should a due diligence analyst treat this performance history?

Answer: Discount it since strategy continuity may be broken

When key personnel change, past performance may not reflect future management style, so the track record should be discounted or contextualized accordingly.

What is the primary role of the Securities and Exchange Commission (SEC)?

Answer: Ensure safe trading practices in financial markets

The Securities and Exchange Commission (SEC) is an independent agency of the U.S. federal government responsible for protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. It achieves this by enforcing federal securities laws and regulating the securities industry, including stock exchanges and brokers.

How does a 'clawback provision' protect investors in a private equity fund context?

Answer: It requires the general partner to return previously paid carried interest if overall fund returns fall below the hurdle rate

A clawback ensures that if early profitable exits cause the GP to receive more carried interest than they are entitled to based on total fund performance, the GP must return the excess to limited partners.

Which economic indicator reflects the total value of goods and services produced?

Answer: Gross Domestic Product

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period. It serves as a comprehensive measure of a country's economic activity and is a key indicator of economic health and growth.

An investment fund that relies on the '3(c)(7)' exemption from Investment Company Act registration must limit its investors to:

Answer: Qualified purchasers owning at least $5 million in investments

The 3(c)(7) exemption is available to funds that sell exclusively to 'qualified purchasers,' which includes individuals owning at least $5 million in investments.

Which of the following is a component of the Capital Asset Pricing Model (CAPM)?

Answer: Risk-free rate

The Capital Asset Pricing Model (CAPM) is a financial model that calculates the expected return on an asset or investment. Its key components include the risk-free rate, which represents the return on an investment with zero risk (e.g., U.S. Treasury bonds), the market risk premium, and the asset's beta. The risk-free rate serves as the baseline return an investor expects for taking no risk.

A variance swap pays the difference between realized variance and the swap's strike variance. Compared to a volatility swap, variance swaps are:

Answer: More difficult to replicate and have convex payoff relative to volatility

Variance swaps have a convex payoff relative to volatility (since variance = vol²), making them more sensitive to large moves and harder to hedge linearly.

The Investment Company Act of 1940 requires that a majority of a mutual fund's board of directors must be:

Answer: Independent directors not affiliated with the fund's investment adviser

The Investment Company Act requires a majority of fund board members to be independent directors unaffiliated with the fund's investment adviser.

Which strategy profits from low volatility and a range-bound underlying asset?

Answer: Long iron condor

A long iron condor involves selling an OTM strangle and buying a wider OTM strangle, profiting when the underlying stays within a defined range.

What is the primary risk of an overly aggressive portfolio?

Answer: It faces higher volatility and risk of loss

Overly aggressive portfolios may yield higher returns but are exposed to greater volatility and potential losses.

Form PF, filed with the SEC, is primarily used to:

Answer: Report systemic risk data about private funds to regulators (SEC and FSOC)

Form PF collects confidential information about private fund advisers' exposures to assist regulators in monitoring systemic risk.

A CFM candidate reads that a fund claims to be 'ESG-integrated' but has no documented process for incorporating ESG data into investment decisions. This is an example of:

Answer: Greenwashing

Greenwashing occurs when a fund or company overstates or misrepresents its ESG credentials without substantive underlying practices.