CSC Alternative Investments 2 — Questions and Answers
Question 1: What is the 'high-water mark' provision in a hedge fund?
- The maximum leverage ratio the fund is permitted to use
- A rule that prevents the fund from collecting performance fees until previous losses are recovered (Correct answer)
- The highest NAV reached since the fund's inception
- A liquidity threshold requiring a cash buffer
Correct answer: A rule that prevents the fund from collecting performance fees until previous losses are recovered
The high-water mark ensures managers only collect performance fees on net new profits, not on gains that simply recover prior losses.
Question 2: Real estate investment trusts (REITs) traded on the TSX are best described as:
- Private equity vehicles restricted to institutional investors
- Liquid real estate investments that trade like stocks and distribute income (Correct answer)
- Futures contracts based on real estate price indices
- Unlisted partnerships requiring a 10-year lock-up
Correct answer: Liquid real estate investments that trade like stocks and distribute income
Publicly traded REITs allow retail investors to access real estate returns with daily liquidity, and they are required to distribute most of their taxable income.
Question 3: Which alternative investment strategy seeks to profit from price discrepancies in a company's securities around a merger or acquisition?
- Global macro
- Managed futures
- Merger arbitrage (Correct answer)
- Distressed debt
Correct answer: Merger arbitrage
Merger arbitrage (risk arbitrage) involves buying the target company's shares after a deal announcement and often shorting the acquirer, profiting from the spread between market price and deal price.
Question 4: Commodity investments are often included in a portfolio because they tend to:
- Provide guaranteed income through regular dividends
- Offer tax-exempt returns under Canadian tax law
- Have low correlation with stocks and bonds and hedge against inflation (Correct answer)
- Outperform equities in all market environments
Correct answer: Have low correlation with stocks and bonds and hedge against inflation
Commodities historically have low correlation to traditional asset classes and often rise in price during inflationary periods, providing portfolio diversification.
Question 5: A 'global macro' hedge fund strategy involves:
- Investing only in large-cap global equities
- Making bets on macroeconomic trends across currencies, interest rates, and commodities worldwide (Correct answer)
- Replicating a global benchmark with minimum tracking error
- Arbitraging pricing differences in international stock markets
Correct answer: Making bets on macroeconomic trends across currencies, interest rates, and commodities worldwide
Global macro managers take positions in currencies, bonds, equities, and commodities based on their forecasts of broad macroeconomic trends and policy changes.
Question 6: 'Distressed debt' investing involves purchasing:
- Short-duration government bonds during recessions
- Securities of companies near or in bankruptcy at a significant discount (Correct answer)
- High-yield bonds with a credit rating of BB or higher
- Convertible debentures of growth-stage technology companies
Correct answer: Securities of companies near or in bankruptcy at a significant discount
Distressed debt investors buy the bonds or loans of financially troubled companies at steep discounts, hoping to profit from restructuring, recovery, or liquidation.
CSC Alternative Investments 2
What is the 'high-water mark' provision in a hedge fund?