CPM Alternative Investments in Portfolios 1 — Questions and Answers
Question 1: Which of the following is considered an alternative investment in a traditional portfolio context?
- U.S. Treasury bonds
- S&P 500 index funds
- Private equity, hedge funds, and real assets (Correct answer)
- Savings accounts
Correct answer: Private equity, hedge funds, and real assets
Alternative investments include asset classes outside traditional stocks and bonds, such as private equity, hedge funds, real estate, commodities, and infrastructure.
Question 2: The primary reason portfolio managers include alternative investments is to:
- Guarantee higher returns than equities
- Improve risk-adjusted returns through diversification due to low correlation with traditional asset classes (Correct answer)
- Eliminate all market risk
- Reduce portfolio complexity
Correct answer: Improve risk-adjusted returns through diversification due to low correlation with traditional asset classes
Alternatives typically have lower correlations with stocks and bonds, providing diversification benefits that can improve overall portfolio risk-adjusted returns.
Question 3: Private equity investments are characterized by:
- Daily liquidity and market-quoted prices
- Illiquidity, long lock-up periods, and potential for higher returns than public markets as compensation for illiquidity (Correct answer)
- Low risk and stable returns
- High transparency and frequent reporting
Correct answer: Illiquidity, long lock-up periods, and potential for higher returns than public markets as compensation for illiquidity
Private equity investments are illiquid, often requiring capital commitments for 7–10 years, but they offer an illiquidity premium — the potential for higher returns than public market equivalents.
Question 4: A hedge fund using a market-neutral strategy aims to:
- Maximize beta exposure to the equity market
- Generate returns uncorrelated with the broad market by balancing long and short positions to offset market risk (Correct answer)
- Track the S&P 500 index closely
- Invest exclusively in government bonds
Correct answer: Generate returns uncorrelated with the broad market by balancing long and short positions to offset market risk
Market-neutral hedge funds combine long and short positions to neutralize overall market exposure (beta ≈ 0), seeking to profit purely from individual stock selection skill.
Question 5: Real estate investment trusts (REITs) provide investors with exposure to real estate while maintaining:
- The illiquidity of direct property ownership
- Daily liquidity, as REITs trade on public stock exchanges (Correct answer)
- Freedom from all market volatility
- Tax-exempt status on all income
Correct answer: Daily liquidity, as REITs trade on public stock exchanges
REITs allow investors to gain real estate exposure through publicly traded shares, providing daily liquidity that is absent in direct property investment.
Question 6: Commodities are included in a portfolio primarily to provide:
- High dividend income
- Inflation hedging and diversification, as commodity prices often rise with inflation (Correct answer)
- Guaranteed capital preservation
- Fixed income returns
Correct answer: Inflation hedging and diversification, as commodity prices often rise with inflation
Commodity prices tend to rise with inflation and have low correlation with stocks and bonds, making them effective inflation hedges and diversification tools.
CPM Alternative Investments in Portfolios 1
Which of the following is considered an alternative investment in a traditional portfolio context?