"Alternative Investments":The volatility of returns
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Questions 1:
A hedge fund limited partnership agreement describes the general partner’s total fees for each year as follows: The general partner will measure the fair value of the fund’s assets at the beginning of the year (net of fees from the previous year) and the fair value of the fund’s assets at the end of the year. The general partner will receive 15% of any increase in fair value in excess of the 1-year US Treasury yield at the beginning of the year. This fee structure most likely includes a:
A、 hard hurdle rate.
B 、management fee.
C 、high-water mark provision.
Questions 2:
Alternative investments that rely on estimates rather than observable market prices for valuation purposes are most likely to report:
A 、returns that are understated.
B 、volatility of returns that is understated.
C 、correlations of returns with the returns of traditional assets that are overstated.
A is correct. In order for the general partner to earn its incentive fee, the return on the fund must exceed the Treasury yield (which is a hurdle rate), and the incentive fee is based only on the return in excess of the hurdle rate, so it is a hard hurdle rate. The general partner doesn’t earn any fee regardless of performance, so there is no management fee. There is no mention of the fund’s value needing to exceed its historical maximum value, so there is no high-water mark.
B is incorrect because there is no fixed management fee (one that does not depend on performance).
C is incorrect because there is no requirement that the fund’s value exceed its previous maximum.
B is correct. The use of estimates tends to smooth the return series. As a consequence, the volatility of returns will be understated.
A is incorrect. There is a tendency for returns to be overestimated or at least smoothed.
C is incorrect. Correlations of returns with the returns of traditional assets tend to be understated as a consequence of smoothing the return series.
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