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Chapter 6: Q20-6B (page 685)

With respect to hedge fund investing, the net return to an investor in a fund of funds would be lower than that earned from an individual hedge fund because of:

a. Both the extra layer of fees and the higher liquidity offered.

b. No reason; funds of funds earn returns that are equal to those of individual hedge funds.

c. The extra layer of fees only.

Short Answer

Expert verified

Option c.

Step by step solution

01

Definition of objectives of Hedge fund

The hedge funds attempt to seek absolute returns i.e. finding positive alpha which is above the required returns of the market exposure.

02

Explanation for correct option:

In the hedge, fund investing, the net return to an investor would be lower than the one earned from an individual hedge fund because of the extra layer of fees only. As it comes with a cost to maintain and manage the portfolio, a charge is levied to the investors. So, the investors would receive returns after the deduction of such charges..

Therefore the correct option is ‘c’.

03

Explanation for incorrect option:

a. Fund of fund investment in hedge funds will not provide lesser returns due to the presence of liquidity. So, option a cannot be acceptable.

b. Since management charges are required to be met by the investors, the returns would be lesser than the individually managed ones. Hence, it cannot be equal and so option b is incorrect.

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Most popular questions from this chapter

A plan sponsor with a portfolio manager who invests in small capitalization, high-growthstocks should have the plan sponsor’s performance measured against which one of thefollowing?

a. S&P 500 Index.

b. Wilshire 5000 Index.

c. Dow Jones Industrial Average.

d. Russell 2000 Index.

Return again to the previous problem. Now suppose that the manager misestimates thebeta of Waterworks stock, believing it to be .50 instead of .75. The standard deviation ofthe monthly market rate of return is 5%.

a. What is the standard deviation of the (now improperly) hedged portfolio?

b. What is the probability of incurring a loss over the next month if the monthly marketreturn has an expected value of 1% and a standard deviation of 5%? Compare youranswer to the probability you found in Problem 16.

c. What would be the probability of a loss using the data in the previous problem if themanager similarly misestimated beta as .50 instead of .75? Compare your answer tothe probability you found in the previous problem.

d. Why does the misestimation of beta matter somuch more for the 100-stock portfoliothan it does for the 1-stock portfolio?

Question: The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 Index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month.

a. If he holds a \(3 million portfolio of Waterworks stock and wishes to hedge market exposure for the next month using one-month maturity S&P 500 futures contracts, how many contracts should he enter? Should he buy or sell contracts? The S&P 500 currently is at 1,000 and the contract multiplier is \)250.

b. What is the standard deviation of the monthly return of the hedged portfolio?

c. Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month?

Assume the risk-free rate is .5% per month.

Suppose you could defer capital gains tax to the last year of your retirement (Spreadsheet 21.9). Would it be worthwhile given the progressivity of the tax code.

Give another example of adverse selection

Use the following information to answer Problems l2–16:

Primo Management Co. is looking at how best to evaluate the performance of its managers. Primo has been hearing more and more about benchmark portfolios and is interested in trying this approach. As such, the company hired Sally Jones, CFA, as a consultant to educate the managers on thebest methods for constructing a benchmark portfolio, how best to choose a benchmark, whether the style of the fund under management matters, and what they should do with their global funds in terms of benchmarking.

For the sake of discussion, Jones put together some comparative two-year performance numbers that relate to Primo’s current domestic funds under management and a potential benchmark.

As part of her analysis, Jones also takes a look at one of Primo’s global funds. In this particular portfolio, Primo is invested 75% in Dutch stocks and 25% in British stocks.

The benchmark invested 50% in each—Dutch and British stocks. On average, the British stocks outperformed the Dutch stocks. The euro appreciated 6% versus the U.S. dollar over the holding period, while the pound depreciated 2% versus the dollar. In terms of the local return, Primo outperformed the benchmark with the Dutch investments but underperformed the index with respect to the British stocks.

Question: Calculate the amount by which the Primo portfolio out- (or under-) performed the market over the period, as well as the contribution to performance of the pure sector allocation and security selection decisions.
See all solutions

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