Ai tutorial solution 1 15 day 38

Mangalayatan University
PGCFR (Batch: August 2012)
Alternate Investment
Max Marks: 45 Marks Date: 3.11.2012
Duration: 1 Hrs
All questions are compulsory
1. The limitation in which the disclosure of past performance of all the funds managed vests with
the fund manager is termed as:
A. Back-filling bias
B. Survivorship bias
C. Self-selection Bias
Solution: C.
When the index only includes surviving funds and not the discontinued ones, its called
survivorship bias. Hence B is incorrect. Hedge fund index includes mostly those managers who
have strong track record is called back-filled bias. Hence A is incorrect. However the funds to
be disclosed voluntarily at the discretion of the fund manager leads to Self-selection bias,
hence C is correct.
2. An investor is considering the purchase of a commercial real estate and provided following
information:
• Gross potential rental income 175,000
• Vacancy & collection loss rate 8%
• Insurance 15,000
• Taxes 12,000
• Utilities and maintenance 25,000
Calculate the appraisal value of the property if market cap rate is 10%?
A. 1,210,000
B. 1,090,000
C. 1,230,000
Solution: B.
©Neev Knowledge Management Pvt. Ltd. Page 1

The correct answer is 1,090,000
NOI= 175000*(1-8%)- 25000 – 15000- 12000= 109,000
Appraisal value= 109,000/10%= 1090,000
3. An investor wishes to invest in Becker fund Ltd and the details are given as below:
Land: 2,000,000
Investments: 75,000,000
Liabilities: 17,000,000
Accrued Expenses: 500,000
Front end load: 2%
Outstanding units: 1,000,000
Calculate NAV
A. 59.5
B. 60
C. 58.31
Solution: A.
The formula for calculating NAV is (Assets-Liabilities-Accrued expenses)/Outstanding units
= (2m+75m-17m-0.5m)/1m= 59.5, Hence A is correct. The information on front end load is not
required to calculate NAV.
4. A UK Global macro fund manager wants to invest his funds. Which of the following scenarios
are least likely suitable for him for investing purposes?
A. Steep fall in the US dollar.
B. An acquisition of a distressed firm by another foreign company on expectations of synergy
benefits.
C. Low volatility in the Japanese stock markets.
Solution: B.
Is correct. An event driven fund manager would be looking for investment in the distressed
firm's acquisition.
5. Compared to other asset classes, real estate as an asset:
A. Has high liquidity

B. Has high transaction cost
C. Has easily determinable market value.
Solution: B.
Compared to other asset classes, real estate as an asset is somewhat illiquid, has high
transaction costs and management fees. Also it is difficult to determine the true asset value of a
real estate.
6. Which of the following does not represent an advantage of investing in Exchange traded funds
(ETFs) over open end funds?
A. ETFs can be traded right throughout the day with continuously updated prices, whereas
traditional open end funds trade once a day
B. Decreased capital gains tax liability for ETF shareholders compared to traditional open-end
fund investors.
C. Dividends can be reinvested in ETFs
Solution: C.
Dividends can be reinvested in open end funds but not in ETFs
7. Which of the following stages of venture capital investing helps a company to fund a major
expansion?
A. Mezzanine Financing
B. Bridge Financing
C. Third Stage
Solution: C.
Third Stage of venture capital investing provides major funds for expansion whereas
Mezzanine/Bridge Financing helps a company in preparing for an IPO.
8. An investor is considering investing $4,000,000 in a new project .The expected payoff is
$19,200,000 at the end of five years. The cost of equity for the investor is 12%. Estimated
probability of failure at each stage is given by
Year Probability
1 15%
2 15%
3 18%
4 20%
5 18%
The NPV of the project is closest to:
A. $248,892.3
B. -$238,972.8

C. $238,972.8
Solution: A.
The probability that the project will survive for 5 years
= (1-0.15) x (1-0.15) x (1-0.18)x(1-0.2)x(1-0.2) = 0.39
Present value of payoff from success of the project = -$4,000,000 + $19,200,000/1.12^5
=$6894595.63
Present value of Payoff if the project fails = -$4,000,000
Net Present Value of the project = 0.38x $6894595.63 -0.62x$4,000,000
= $248,892.30
9. Which of the following is not a benefit of Fund of funds?
A. Enable investors with limited capital to invest in a portfolio of hedge funds.
B. Provides access to hedge funds which are closed due to limitation on the number of
investors.
C. Lower fees as compared to other hedge funds
Solution: C.
The benefit of Fund of funds is that it enables investors with limited capital to invest in a
portfolio of hedge funds and provides access to hedge funds which might otherwise be closed
due to limitation on the number of investors. However Fund of funds manager charge a
management fees in addition to those fees already charged by the hedge fund manager.
10. The market value of the assets held in a hedge fund tends to be stable over time most likely
because:
A. Managers may be unwilling to disclose poor performance.
B. Most of the assets held in a hedge fund are infrequently traded
C. Fee structures and gaming entice managers to big risks.
Solution: B.
Most of the assets held in a hedge fund are infrequently traded , hence their values are not
based on actual transactions .Hence broker-dealers estimate market value which has low
volatility.
11. Establishing collateralized commodities futures position requires simultaneously:
A. Purchasing a specific futures contract and purchasing government securities with a market
value equal to the contract value of the futures contract.
B. Selling a specific futures contract and purchasing government securities with a market
C. Purchasing a specific futures contract and selling government securities with a market

Solution: A.
Collateralized commodities futures position requires simultaneously Purchasing a specific
futures contract and purchasing government securities with a market value equal to the
contract value of the futures contract.
12. Which of the following is not a reason behind investing in a collateralized futures position?
A. Diversification
B. Hedging against long term inflation
C. Earning speculative profits
Solution: C.
Passive investors who hold commodities as an asset class for diversification or those who hold
commodities as a long term inflation hedge are most likely to invest in a collateralized futures
position.
13. Hedge fund as compared to traditional equity investments
A. Has lower risk profile
B. Has lower Sharpe ratio
C. Are legally required to disclose performance to public.
Solution: A.
Hedge funds have lower risk profile and higher Sharpe ratio, which is reward-to-risk ratio, than
for most equity investments. However hedge funds are not legally required to disclose
performance to public.
14. In case of a commodity investment the gain or loss due to changes in the spot price is known
as:
A. Roll yield
B. Collateral yield
C. Price return
Solution: C.
The return on the collateral posted to satisfy margin requirement is known as Collateral yield.
The gain or loss resulting from re-establishing positions as contracts expire is known as roll
yield. The gain or loss due to changes in the spot price is known as price return.
15. The hedge funds used to invest in a distressed company or in a potential merger and
acquisition situation is known as:
A. Long/Short funds
B. Global macro funds
C. Event-driven funds

Solution: C.
Event – driven funds strive to capitalize on some unique opportunity in the market like investing
in a distressed company or a potential merger and acquisition situation. Global macro funds
make bets on the direction of a market, currency, interest rate or some other factors.
Long/Short funds take long and short common stock positions, use leverage, and are invested
in markets worldwide.
16. Which of the following is incorrect regarding income method of valuing real estates?
A. It uses a discounted cash flow model
B. It takes into account investor’s income tax implication.
C. Net Operating Income is divided by an estimated market required rate of return.
Solution: B.
Net income method uses a discounted cash flow model where the Net Operating Income (NOI)
is divided by an estimated market required rate of return. However it does not take investor’s
tax implication into account.
17. Which of the following is not a characteristic of open-end fund?
A. It stands ready to redeem shares at the closing value on any trading day.
B. The liquidity is determined in the open market.
C. The share price of an open end fund will always be equal to net asset value (NAV).
Solution: B.
Liquidity in open –end fund is provided by the investment company that manages it, whereas
the liquidity of a closed –end fund is determined in the open market.
18. Which of the following is not a characteristic of closed-end fund?
A. Its shares are traded in the secondary market.
B. Terms like “load” and “no-load” is not applicable.
C. The share price of a closed- end fund will always be equal to net asset value (NAV).
Solution: C.
The share price of a closed- end fund may or may not be equal to net asset value (NAV) since
the share price is determined in the secondary market.
19. An investor purchases a small residential building .The value of the property based on income
method using the following figures:
Annual Rental income: $400,000
Annual operating expenses: $250,000
Investor’s tax rate: 25%
Financing percentage: 90%
Holding period: 8 years
Market Capitalization rate: 20%

A. $ 750,000
B. $ 600,000
C. $ 562,500
Solution: A.
Net Operating Income = Annual Rental income – Annual operating expenses = $150,000
Appraised value of the property = NOI/Market Capitalization rate = $150,000/0.2 = $750,000
20. Which of the following costs is least likely associated with closed end funds?
A. Issuance cost
B. Redemption cost
C. Load and no-load
Solution: C.
Load and no-load are not applicable to closed end funds.
21. An investor wants to estimate the value of a piece of land using hedonic price model. The
following data pertains to the sale of comparable real estate properties.
Characteristic Units Estimated Effect on Property Value in $ per
unit
Proximity to market Kms -20,000
Vacancy Rate Percent -12,000
Building Size Square feet 70
The land is 5Kms away from the market, has a vacancy rate of 6% and its size is 25,000
square feet.
The estimated appraised value of the land is closest to:
A. $1,578,000
B. $3,470,000
C. $1,758,000
Solution: A.
Using hedonic price model the estimated appraised value = (-20,000 x 5) + (-12,000x6) + (70 x
25,000) = $1,578,000
22. The term “balanced stage” in venture capital financing includes:

A. Formative Stage and Second Stage
B. Second Stage and Third Stage
C. Formative Stage and Later Stages
Solution: C.
Formative Stage includes:
• Seed Stage
• Early Stage
Later Stages includes
• Second Stage
• Third Stage
• Mezzanine/bridge financing
Balanced stage consists of all the stages from seed stage to Mezzanine/bridge financing
23. Which of the following is least likely a characteristic of Venture capital financing?
A. Illiquidity
B. Margin call
C. Difficulty in valuation
Solution: B.
In a venture capital financing the investor’s ability to cash out depends on successful IPO,
hence it involves illiquidity. Because of uniqueness of each investment and very few
comparable assets valuation is a problem. Margin call is a risk associated with hedge funds.
24. Which of the following is most likely a result of survivorship bias in hedge funds?
A. Higher returns and Higher risk
B. Higher returns and Lower risk
C. Higher return, no affect on risk
Solution: B.
As a result of survivorship bias, database includes only stable stocks with less volatility which
increases the return at the same time decreasing the risk.
25. An active investor as compared to a passive investor will most likely:
A. Invest in collateralized commodities future position
B. Invest in commodity futures to profit from economic growth
C. Invest directly in commodities
Solution: B.

An active investor as compared to a passive investor will invest in commodity futures to profit
from economic growth. Passive investors will invest in collateralized commodities future
position for diversification and hedging against inflation.
26. Which of the following is least likely a characteristic of hedge funds?
A. They are constrained to perform relative to some specific benchmark
B. They strive for absolute returns
C. They are subjected to limited regulations.
Solution: A.
Hedge funds are not constrained to perform relative to some specific benchmark but it strives
for absolute returns.
27. An investor is considering investing $5,000,000 in a new project .The expected payoff is
$18,000,000 at the end of five years. The cost of equity for the investor is 10%. Estimated
probability of failure at each stage is given by
Year Probability
1 20%
2 15%
3 18%
4 15%
5 18%
The investor should most likely:
A. Accept the project as it has a positive NPV of $641,132
B. Accept the project as it has a positive NPV of $ 614,132
C. Reject the project as it has a negative NPV of $ 641,132
Solution: C.
The probability that the project will survive for 5 years
= (1-0.20)x(1-0.15) x(1-0.18)x(1-0.15)x(1-0.2) = 0.39
Present value of payoff from success of the project = -$5,000,000 + $18,000,000/(1.1)^5
=$6,176,583.82
Present value of Payoff if the project fails = -$5,000,000
Net Present Value of the project = 0.39x $6,176,583.82 -0.61x$5,000,000
= -$641,132.3
28. An investor purchase shares of a fund that has an NAV of $28.50, given the current market
price is $29.50.The fund is most likely:
A. Open –end fund

B. Closed –end fund
C. Issued with a front end load
Solution: B.
Since the NAV is different from the market price, hence it is a closed –end fund. No terms like
load and no load is associated with closed-end funds.
29. What is the most likely motive of creating a collateralized commodities futures position?
A. To earn a return equal to gain on futures position plus the interest on treasury securities like
T bills.
B. To buy more T bills, when the futures contract prices fall.
C. To sell more T bills, when the futures contract prices fall
Solution A: Collateralized commodities futures position is created by going long on
commodities futures and buying treasury securities worth the contract value of the futures
contract. If futures fall, it results in margin calls as long on futures loses, which can be honored
by selling T bills, hence C is correct. B is incorrect as T bills are bought when futures prices
increase as investor is long.
30. Which of the following conclusions regarding hedge funds is least likely to be correct?
A. Hedge funds have higher risk profile than equity investments measured by standard
deviation
B. Sharpe ratio for hedge funds has been consistently higher than most equity investments
C. There is low correlation between hedge fund performance and conventional asset class
Solution: A. The correct answer is Hedge funds have higher risk profile than equity
investments measured by standard deviation
31. Which of these are not the risks involved in ETFs?
A. High liquidity may lead to larger bid ask spreads in ETF prices.
B. Some ETFs resort to taking positions in options and forward markets for hedging purposes,
leading to credit risks.
C. An investor is exposed to country and currency risks for investing in international ETFs.
Solution: A. Is correct. Low liquidity may lead to larger bid ask spreads in ETF prices. OTC
derivatives like forwards and options involve counterparty/credit risks.
32. In which of the following types of hedge funds, fund invests in a distressed company or in a
potential merger & acquisition situation?
A. Long / short funds

B. Event driven funds
C. Market neutral funds
Solution: B. The correct answer is Event driven funds
33. Which of the following statements are least likely correct?
A. Commodity prices are more volatile when compared to the prices of finished goods.
B. Commodity prices and GDP growth are negatively correlated.
C. Investment in commodities is often made with the view of attaining a hedge against
inflation.
Solution: B.
When an economy experiences growth, commodity prices increase and vice versa hence
commodities are positively correlated with the GDP growth.
34. Which of the following is least likely to be the benefits of investing in fund of funds?
A. Diversification among hedge funds will reduce investors’ risk as well as returns
B. Enables investors with limited capital to invest in a hedge fund
C. Fund of funds manager have expertise to choose right hedge funds
Solution: A.
The correct answer is Diversification among hedge funds will reduce investors’ risk as well as
returns
35. Which of these features are least associated with closed end funds?
A. An open end fund manager may charge a fee on purchase of fund by the investor.
B. The secondary market provides liquidity to the open end fund.
C. The open end fund can be redeemed at the closing value of it as on the previous day.
Solution: B.
Since the open end funds are not traded in the secondary markets, unlike the closed end
funds, not the secondary market but the investment company provides liquidity to the open end
fund.

36. Which of the Real estate valuation approaches are most likely relative?
A. Income method.
B. Sales comparison method.
C. Discounted after tax cash flows
Solution: B.
Income method and Discounted after tax cash flows are absolute valuation approaches.
Real Estates are relatively valued in Sales comparison method, since this method takes sale
prices from comparable properties. Hence B is correct
37. Calculate the NOI. The information is as follows:
Rental income: $300,000
Vacancy Rate:5%
Insurance: $12,000
Taxes: $8000
Utilities: $7000
Maintenance: $18000
A. $220,000
B. $248,000
C. $282,000
Solution: B. NOI = 300,000 *(1-0.05) – 12,000 – 8,000 – 7,000 – 18,000 = $248,000
38. The fees charged by a mutual fund at the time of redemption is called
A. Distribution fee
B. Front-end load
C. Back-end load
Solution: C.
The fees charged by a mutual fund at the time of redemption is called back-end load.
39. The price of a unit of a closed-end fund is

A. Equal to market value of assets – liabilities divided by number of units outstanding.
B. Determined in the secondary market
C. Equal to book value of assets – liabilities divided by the number of units outstanding
Solution: A. The price of a unit of a closed-end fund is determined in the secondary market.
40. Moon-Life Fund is a stable-value fund. It would most likely
A. Mimic its benchmark index.
B. Invest in short-term government securities.
C. Invest in value stocks.
Solution: B. Invest in short-term government securities.
A stable-value fund invests in short-term government securities or other securities that offer
fixed-rate of return & timely repayment of principal.
41. Which of the following is not a primary advantage of ‘the in-kind’ redemption process of ETFs?
A. Provides more diversification.
B. Reduces tax bill
C. Keeps the market price of the shares of ETF close to NAV & avoids large premium or
discount.
Solution: A. Provides more diversification. The ‘in-kind’ redemption process does not affect the
diversification of the ETF.
42. A PE fund is planning to invest $1,500,000 in a new project that will pay $8,000,000 at the end
of four years, if successful. The required rate of return is 20%. Following are estimated
probabilities of failure of the project over the next four years. Each year’s probability represents
the probability of failure in that year, given the project survived till that year.
Year Probability of failure
1 25%
2 25%
3 20%
4 20%
Calculate the NPV of the project
A. $969,136

B. $234,489
C. -$111,111
Solution: C. -$111,111
The probability that the project survives for 4 years =
(1 – 0.25) (1 – 0.25) (1 – 0.20) (1 – 0.20) = 36%
The probability that the project fails = 1 – 0.36 = 64%
The NPV of the project, if successful = -$1,500,000 + 8,000,000/ (1.20)4
= $2,358,025
The NPV of the project, if it fails = -1,500,000
The expected NPV of the project is the probability-weighted average of the two scenarios.
= $2,358,025(0.36) + (-$1,500,000 X 0.64)
= $848,889 – $960,000
= -$111,111
43. The main advantage of Fund of funds over single hedge funds is
A. More Diversification
B. Higher Returns
C. Lower Management Fees

Solution: A. The main advantage of Fund of funds over a single hedge fund is more
diversification. However another layer of management fee is charged by the Fund of funds
manager in addition to those charged by the managers of hedge funds in which the Fund of
fund is investing. This most likely reduces the return.
44. Which of the following company would seek mezzanine financing?
A. A company which has completed the development of product & is seeking funds to
translate it to commercial production
B. A company preparing for an IPO
C. A company that has started producing & selling goods is seeking funds for further
expansion.
Solution: A. Mezzanine financing enables a company to go public.
45. Which of the following condition will result in a negative roll yield?
A. Backwardation
B. Future prices are higher than spot prices
C. Market is dominated by short hedgers.
Solution: B. If future prices are higher than spot prices; the market is in contango which will
result in a negative roll yield.
When the market is dominated by short hedgers, they will drive the future prices below the
current market price. This is backwardation situation which results in positive roll yield.

Ai tutorial solution 1 15 day 38

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