Long Quiz

1. When the futures price of a commodity exceeds the spot price, the commodity market is most
likely in:
A. contango.
B. backwardation.
C. carry.

Solution
A is correct. When a commodity market is in contango, futures prices are higher than spot prices. When
spot prices are higher than the futures price, the market is said to be in backwardation.

2. Which of the following statements concerning the historical record of alternative investments
is most likelycorrect?
A. The exclusion of returns of funds that have been liquidated leads to an upward bias in
index performance.

B. The use of appraised values instead of market prices leads to an upward bias in volatility.

C. The inclusion of previous return data for funds that enter the index leads to a downward
bias in index performance.

Solution
A is correct. The exclusion of returns of funds that have been liquidated is called survivorship bias. It is
most likely that only poor performers are eliminated and thus reported returns are artificially inflated.

3. An investor who has positions in multiple long–short equity hedge funds and is concerned about
whether these positions are sufficiently diversified will mostly likely be concerned about the lack
of:
A. transparency in reported positions.
B. frequent independent valuations.
C. liquidity in the underlying assets.

Solution
A is correct. Long–short hedge funds invest in liquid, publicly traded equity (taking long and short
positions); therefore, the underlying positions can be reversed easily and there is no need for independent
valuations because current market prices are available. The investor will have difficulty in determining if
the different funds are holding diverse or concentrated positions (both within each fund and between
funds) because hedge funds generally do not reveal their holdings.

4. Compared to traditional investments, alternative investments least likely demonstrate which of the
following characteristics?
A. Narrow manager specialization
B. Underlying investments that are illiquid
C. A high degree of regulation

C is correct. Alternative investments are less regulated and transparent than traditional investments such
as equity and debt securities.

5. With regard to venture capital, which of the following statements is most likely true regarding
venture capital?
A. Investments typically are in later stage and more established companies.
B. Investors tend to have short time horizons.
C. Investors require a higher return than investors in publicly traded equity.
 C is correct. The historical standard deviations of annual return for venture capital are higher
than that of common stocks. Investors should therefore require a higher return in exchange for
accepting this higher risk, along with the illiquidity of venture capital investing.

6. Categories of alternative investments would least likely be described by which of the following?
A. Fine wine and other tangibles
B. Schools and other long-lived real assets
C. Cash and other liquid investments

C is correct. Cash and other short-term liquid investments would not generally be
considered alternative investments. Alternative investments fall outside of the definition of
long-only publicly traded investments in stocks, bonds, and cash (often referred to as
traditional investments). In other words, these investments are alternatives to long-only
positions in stocks, bonds, and cash.

Initial investment capital $100 million

Return at the end of one year 12%

Management fee based on assets under management 1%

Incentive fee based on the return net of the management fee 10%
7. Assume management fees are calculated using end-of-period valuation. The investor’s net return
given this fee structure is closest to:
A. 10.88%.
B. 9.79%.
C. 9.68%.

8. A hedge fund with an initial value of $100 million has a management fee of 2% and an incentive
fee of 20%. Management and incentive fees are calculated independently using end-of-period
valuation. The value must reach the previous high-water mark before incentive fees are paid. The
table below provides end-of-period fund values over the next three years.

Fund Value ($ millions)

Year Before After Fees

Fees

1 120 113.6
 Fund Value ($ millions)

2 110 107.8

3 125 ?
The total amount of fees earned by the hedge fund in Year 3 is closest to:
A. $4.8 million.
B. $5.5 million.
C. $5.9 million.

9. A real estate investor looking for equity exposure in the public market is most likely to invest in:
A. real estate limited partnerships.
B. shares of real estate investment trusts.
C. collateralized mortgage obligations.

B is correct. Shares in real estate investment trusts are publicly traded and represent an equity
investment in real estate.

10. Which of the following characteristics of a target company is likely the least attractive for a
leveraged buyout?
A. Substantial amount of physical assets
B. Strong and sustainable cash flow
C. High leverage

C is correct. Low leverage is an attractive feature of a target company in a leveraged buyout. This
characteristic makes it easier for an acquirer to use debt to finance a large portion of the purchase price.

11. Commodity futures prices are most likely in backwardation when:

A. interest rates are high.
B. storage costs are high.
C. the convenience yield is high.

C is correct. In backwardation, futures prices are lower than spot prices, that is, the commodity forward
curve is downward sloping. This scenario occurs when the convenience yield is high. Futures price ≈ Spot
price (1 + r) + Storage costs − Convenience yield.

12. If the level of broad inflation indexes is largely determined by commodity prices, the average real
yield on direct commodity investments is most likely:
A. less than zero.
 B. equal to zero.
C. greater than zero.

B is correct. As the price increases of commodities are mirrored in higher price indexes, the
nominal return is equal to inflation and thus the real return is zero.

13. Relative to traditional investments, alternative investments are most likely to be characterized by
higher:
A. fees.
B. liquidity.
C. transparency.

A is correct. Alternative investments are often characterized by high fees.

14. The value at risk of an alternative investment is best described as the:

A. probability of losing a fixed amount of money over a given time period.
B. minimum amount of loss expected over a given time period at a given probability level.
C. time period during which a fixed amount is lost at a given probability level.

B is correct. Value at risk is defined as the minimum amount of loss expected over a given time period at
a given probability level.

15. A manager is compensated with a management fee based on committed capital plus an incentive
fee based on fund performance. This scenario best describes the fee structure of a:
A. private equity fund.
B. hedge fund.
C. mutual fund.

A is correct. A private equity manager is compensated through a management fee based on committed
capital plus an incentive fee.
 16. Capital provided for companies moving toward operation but before commercial manufacturing
and sales have occurred best describes which stage in venture capital investing?
A. Later stage
B. Seed stage
C. Early stage

C is correct. Early-stage financing is capital provided for companies moving toward operation but
before commercial manufacturing and sales have occurred.

17. The primary motivation of activist shareholders is to promote:

A. improved shareholder value.
B. environmentally sustainable business practices.
C. consideration of human rights in employee relations.

A is correct. The primary motivation of activist shareholders is to increase shareholder value. If they feel
management or the board has failed to act in the best interests of shareholders, they may attempt to force
changes by gaining control of the board.

18. Which of the following scenarios can best be described as offering superior protection of
shareholder interests?
A. When common law is practiced
B. When CEO duality is common
C. When stakeholder theory prevails

A is correct. Unlike civil law systems, common law systems provide judges with the ability to
create law by setting precedents that are followed in subsequent cases. Shareholders are
viewed as better protected under common law because judges may rule against
management actions in situations that are not specifically addressed by statutes.

19. A company’s management team is proposing to sell a major division because of low future growth
prospects in that industry. To which committee of the board is the proposal most likely to be
presented?
A. Risk
B. Audit
C. Investment

C is correct. Management is most likely to present the proposed sale to the investment committee,
whose main role is to review the viability of material investment opportunities proposed by management.

20. Recent trends in corporate governance most likely include:

A. focusing on the corporate governance system’s responsibility to maximize shareholder value.
B. expanding the scope to consider the interests of employees, customers, and suppliers.
C. increasing the diversity of corporate governance systems tailored to specific jurisdictions.

B is correct. A significant majority of OECD member countries have ratified the influential
“Principles of Corporate Governance.” Most recently updated in 2015, the principles call for an
expanded scope of stakeholders to be considered as part of a prudent corporate governance
system. Regulators and practitioners have responded by moving toward a more effective balance
of stakeholder interests.

21. In an acquisition, the interests of minority shareholders are best protected through the use of:
A. sell-out rights.
B. clawback provisions.
 C. covenants within indentures.

A is correct. Sell-out rights protect minority shareholders in acquisition situations by forcing acquirers to
buy out minority shareholders at a fair price, even if those shareholders initially voted against the
acquirer’s offer.

22. A mining company has received government approval for the development of a mining property
and has also consulted with members of the local community near the development site
throughout the project assessment process. The latter action is best described as an example of:
A. principal–agent conflict mitigation.
B. stakeholder management.
C. regulatory compliance.

B is correct. Stakeholder theory broadens a company’s focus beyond the interests of only its
shareholders to those of its customers, suppliers, employees, and others who have an interest in the
company. The local community is likely a stakeholder in the company’s development plans. By identifying
the community and understanding its interests, the company is engaging in stakeholder management.

23. The post-audit performed as part of the capital budgeting process is least likely to include the:
A. provision of future investment ideas.
B. rescheduling and prioritizing of projects.
C. indication of systematic errors.

B is correct. Rescheduling and prioritizing projects is part of the planning stage of the capital budgeting
process, not the post-audit. The post-audit’s purpose is to explain any differences between the actual and
predicted results of a capital budgeting project. This process can aid in indicating systematic errors,
improve business operations, and provide concrete ideas for future investment opportunities. A and C are
incorrect because rescheduling and prioritizing projects is part of the planning stage of the capital
budgeting process, not the post-audit. The post-audit’s purpose is to explain any differences between the
actual and predicted results of a capital budgeting project. This process can aid in indicating systematic
errors, improve business operations, and provide concrete ideas for future investment opportunities.