Alternative Investments: Practice Pack

1. [Introduction to Commodities and Commodity Derivatives] When applying a stock and

flow approach, central bank monetary policy is a primary influencer of the flow of:
A. grains.
B. precious metals.
C. softs (cash crops).

2. [Introduction to Commodities and Commodity Derivatives] For an investor that

estimates the impact of flows on commodity prices, geopolitical events primarily
influence the flow of:
A. energy commodities.
B. livestock commodities.
C. base material commodities.

3. [Introduction to Commodities and Commodity Derivatives] When estimating the

impact of stocks and flows on commodity prices, seasonality primarily influences the:
A. flow of grain commodities.
B. flow of energy commodities.
C. stock of base material commodities.

4. [Introduction to Commodities and Commodity Derivatives] A commodity investor

wishing to exploit seasonal variability in demand is most likely to trade in:
A. grains.
B. energy.
C. livestock.

5. [Introduction to Commodities and Commodity Derivatives] The flexibility in industrial

metals life cycle is due to the ability to:
A. change the amount of ore extracted.
B. store metals for long periods of time.
C. increase or decrease smelting and purification.

6. [Introduction to Commodities and Commodity Derivatives] When valuing a commodity

contract, is the settlement method likely to affect whether the law of one price will
be enforced by arbitrageurs?
A. No
B. Yes, it is more likely to be enforced if the contract settles in cash
C. Yes, it is more likely to be enforced if the contract settles using physical delivery
 EdZeb Institute

7. [Introduction to Commodities and Commodity Derivatives] In contrast to equities and

bonds, commodity futures are primarily valued on the basis of:
A. future profitability.
B. supply and demand for the physical item.
C. cash flows generated while the commodity is held.

8. [Introduction to Commodities and Commodity Derivatives] The value of a commodity

futures contract is most likely to increase as the result of an increase in:
A. storage costs.
B. forecasted profitability.
C. periodic income received.

9. [Introduction to Commodities and Commodity Derivatives] A commodity investor's

strategy is to provide insurance to hedgers in return for an expected profit. This
investor is best described as a(n):
A. arbitrageur.
B. liquidity provider.
C. informed investor.

10. [Introduction to Commodities and Commodity Derivatives] A market participant

whose main objective is to capitalize on the mispricing between the commodity and
the futures price is best described as a(n):
A. hedger.
B. arbitrageur.
C. index investor.

11. [Introduction to Commodities and Commodity Derivatives] A short position in a gold

futures contract is most appropriate for a:
A. gold mining company.
B. speculator expecting gold prices to rise.
C. jewelry manufacturer buying gold for manufacturing.

12. [Introduction to Commodities and Commodity Derivatives] When futures contracts

are in contango:
A. their value tends to erode over time.
B. they have a positive calendar spread.
C. they must be settled by physical delivery.

13. [Introduction to Commodities and Commodity Derivatives] Which of the

following most likely occurs when commodity futures prices are in contango?
A. The calendar spread is positive

Alternative Investments Page 2 of 26

 EdZeb Institute

B. The commodity forward curve is downward sloping

C. The futures contract value tends to erode over time

14. [Introduction to Commodities and Commodity Derivatives] If the calendar spread in

the futures market is positive, then the:
A. spot price is above the price of the near-term futures contract.
B. spot price is above the price of the longer-term futures contract.
C. price of the near-term futures contract is above the price of the longer-term
futures contract.

15. [Introduction to Commodities and Commodity Derivatives] Which theory of

commodities futures returns fails to explain contango?
A. Insurance theory
B. Theory of storage
C. Hedging pressure hypothesis

16. [Introduction to Commodities and Commodity Derivatives] According to the theory

of storage, which of the following changes will cause the greatest increase in a
futures contract price?
A. A decrease in storage costs and a decrease in convenience yield
B. An increase in storage costs and a decrease in convenience yield
C. An increase in storage costs and an increase in convenience yield

17. [Introduction to Commodities and Commodity Derivatives] A commodity investor

bought fully collateralized April contracts in a commodity on 1 March with the intent
to roll them into May contracts on 1 April. The details of the trade are presented
below.

The investor's total return for March was closest to:

A. 3.40%.
B. 5.07%.
C. 6.33%.

18. [Introduction to Commodities and Commodity Derivatives] An analyst gathers the

following information about a position in a March futures contract that will roll over
50% into a June contract on 1 March:

Alternative Investments Page 3 of 26

 EdZeb Institute

The net roll return for February is closest to:

A. –3.09%.
B. –1.40%.
C. 3.30%.

19. [Introduction to Commodities and Commodity Derivatives] An investor enters a

futures contract on a commodity at a price of $100. At the end of the month, the
futures price is $99. If the roll yield is 0.8% and the collateral return is 0.5%, the
total return for the month is closest to:
A. –2.3%.
B. 0.3%.
C. 3.6%.

20. [Introduction to Commodities and Commodity Derivatives] To maintain the same

exposure in the futures markets when in contango, rolling forward the expiring
futures contracts requires buying:
A. a lower number of futures contracts.
B. the same number of futures contracts.
C. a higher number of futures contracts.

21. [Introduction to Commodities and Commodity Derivatives] When a futures market is

in contango, the roll return on a long position will be:
A. negative.
B. zero.
C. positive.

22. [Introduction to Commodities and Commodity Derivatives] If contracts in a futures

market are in backwardation, the roll return is:
A. negative and the investor will need to buy more contracts to maintain the same
exposure.
B. positive and the investor will need to buy more contracts to maintain the same
exposure.
C. positive and the investor will need to buy fewer contracts to maintain the same
exposure.

23. [Introduction to Commodities and Commodity Derivatives] For a portfolio manager

seeking to change their allocation to commodities, it would be most appropriate to
enter:

Alternative Investments Page 4 of 26

 EdZeb Institute

A. a basis swap.
B. a total return swap.
C. an excess return swap.

24. [Introduction to Commodities and Commodity Derivatives] An investor hedges

exposure to a commodity that is illiquid by using a swap contract based on another
correlated commodity that is liquid. This best describes a commodity:
A. basis swap.
B. variance swap.
C. total return swap.

25. [Introduction to Commodities and Commodity Derivatives] An airline hedging against

rising fuel prices would most appropriately enter:
A. a basis swap.
B. a total return swap.
C. an excess return swap.

26. [Introduction to Commodities and Commodity Derivatives] An investor believes that

commodity prices tend to trend and wants to invest in a commodity index that is not
dominated by any one commodity. It would be most appropriate for this investor to
choose an index that is:
A. equal-weighted and rebalanced annually.
B. production-weighted and rebalanced monthly.
C. production-weighted and rebalanced annually.

27. [Introduction to Commodities and Commodity Derivatives] In a trending market,

which of the following index characteristics most likely leads to higher returns?
A. Using a floating weighting scheme rather than a fixed weighting
B. Rebalancing at an increased frequency rather than a lower frequency
C. Including a large weight of commodities that typically trade in contango rather
than in backwardation

28. [Introduction to Commodities and Commodity Derivatives] Which of the following

rolling methods with respect to commodity indexes would most likely result in the
highest return?
A. Most liquid contract
B. Maximizing contango
C. Maximizing backwardation

Alternative Investments Page 5 of 26

 EdZeb Institute

29. [Investments in Real Estate through Publicly Traded Securities] For an investor who
wants to gain publicly traded exposure to companies that develop real estate
properties for sale, which of the following is the most appropriate investment
vehicle?
A. REIT
B. An MBS
C. A real estate operating company

30. [Investments in Real Estate through Publicly Traded Securities] An analyst gathers
the following information about three publicly traded real estate securities:

Which of the following real estate securities most likely qualifies as a tax-
advantaged REIT?
A. Security 1
B. Security 2
C. Security 3

31. [Investments in Real Estate through Publicly Traded Securities] The best reason to
use NAV per share rather than book value per share when valuing a REIT is that the
NAV per share is a superior measure of:
A. its net worth.
B. whether the REIT is fairly valued.
C. the investments made in the properties.

32. [Investments in Real Estate through Publicly Traded Securities] An analyst gathers
the following information about a REIT:

The REIT's NAV per share is closest to:

A. $55.17.

Alternative Investments Page 6 of 26

 EdZeb Institute

B. $76.28.
C. $77.67.

33. [Investments in Real Estate through Publicly Traded Securities] When valuing
publicly traded real estate securities, net asset value per share:
A. refers to depreciated real estate value.
B. includes the value of non-real-estate assets.
C. provides an indication of the manager's performance relative to benchmarks.

34. [Investments in Real Estate through Publicly Traded Securities] Compared to

adjusted funds from operations (AFFO) used in REIT valuation, funds from
operations (FFO) is:
A. open to less error in estimation.
B. a superior measure of economic income.
C. more reflective of a REIT’s dividend-paying ability.

35. [Investments in Real Estate through Publicly Traded Securities] For an investor
interested in evaluating a REIT's dividend-paying capacity, it is most appropriate to
use:
A. net income.
B. funds from operations.
C. adjusted funds from operations.

36. [Investments in Real Estate through Publicly Traded Securities] All else being equal,
as REIT leverage increases, an investor should expect a(n):
A. increase in EBITDA.
B. decrease in the P/FFO multiple.
C. decrease in the investor's required return.

37. [Investments in Real Estate through Publicly Traded Securities] An analyst gathers
the following information about a REIT for the year just ended:

If the REIT's price-to-adjusted-FFO multiple is 12x, the forecast REIT share price
is closest to:
A. $30.
B. $36.
C. $48.

Alternative Investments Page 7 of 26

 EdZeb Institute

38. [Investments in Real Estate through Publicly Traded Securities] An analyst gathers
the following information about a REIT for the year just ended:

If dividends per share are $1.00 for the year, the dividend payout ratio on adjusted
FFO is closest to:
A. 29%.
B. 38%.
C. 45%.

39. [Investments in Real Estate through Publicly Traded Securities] An analyst gathers
the following information (in € millions) about three REITs with the same share price
and number of shares outstanding:

Which REIT has the lowest price-to-FFO ratio?

A. REIT 1
B. REIT 2
C. REIT 3

40. [Investments in Real Estate through Publicly Traded Securities] Assuming similar
expected return and risk, distributions from which of the following investments will
attract the most favorable tax treatment for US investors?
A. Equity REITs
B. Real estate operating companies
C. Direct commercial property investments

41. [Investments in Real Estate through Publicly Traded Securities] Which of the
following investments is least likely to offer exposure to real estate development
activity?
A. REITs
B. Private real estate investments
C. Real estate operating companies

Alternative Investments Page 8 of 26

 EdZeb Institute

42. [Investments in Real Estate through Publicly Traded Securities] Compared to private
real estate vehicles, REITs most likely provide greater:
A. transparency.
B. pricing stability.
C. control over the underlying properties.

43. [Hedge Fund Strategies] Which of the following indexes would be

the most appropriate benchmark for a small, long/short equity hedge fund open to
new investment?
A. The HFRI Index
B. The HFRX Index
C. The Credit Suisse Hedge Fund Index

44. [Hedge Fund Strategies] A hedge fund strategy focused on mergers and acquisitions
arbitrage is best classified as a(n):
A. specialist strategy.
B. event-driven strategy.
C. equity-related strategy.

45. [Hedge Fund Strategies] Which of the following hedge fund strategies most
likely has the highest liquidity risks?
A. Managed futures
B. Long/short equity
C. Convertible bond arbitrage

46. [Hedge Fund Strategies] The skill of long/short equity managers in delivering alpha
derives mainly from:
A. beta tilts.
B. market timing.
C. stock selection.

47. [Hedge Fund Strategies] Long/short equity hedge fund strategies typically have:
A. a net long exposure of 40%–60%.
B. gross short exposure that is more than double gross long exposure.
C. a standard deviation of returns that is more than double that of a long-only fund.

48. [Hedge Fund Strategies] A hedge fund manager is reviewing the following securities:
• Common stock of Company 1
• Non-voting stock of Company 1
• Common stock of Company 2 (a subsidiary of Company 1)
The equity market-neutral trading strategy known as 'stub trading' most
likely involves buying the common stock of Company 1 and selling:

Alternative Investments Page 9 of 26

 EdZeb Institute

A. the common stock of Company 2.

B. the non-voting stock of Company 1.
C. both the common stock of Company 2 and the non-voting stock of Company 1.

49. [Hedge Fund Strategies] Investors with lower risk tolerance should prefer event-
driven hedge funds that:
A. employ soft-catalyst investing.
B. undertake a hard-catalyst approach.
C. make investments in anticipation of the announcement of a corporate event.

50. [Hedge Fund Strategies] With respect to a merger arbitrage hedge fund strategy,
which of the following situations is most likely to be classified as a soft-catalyst
event-driven investment? The purchase of stock in a company involved in a merger
where the merger:
A. has been completed.
B. has been announced but not completed.
C. is anticipated by investors but has not been announced.

51. [Hedge Fund Strategies] The payoff profile for a merger arbitrage strategy
resembles that of a riskless bond and:
A. a short put option.
B. a short call option.
C. a short put option and a short call option.

52. [Hedge Fund Strategies] In order to profit from expected mean reversion in the
yield curve, a fixed-income arbitrage fund can take long and short positions in:
A. the same issuer, but not different issuers within the same industry.
B. different issuers within the same industry, but not the same issuer.
C. either the same issuer or different issuers within the same industry.

53. [Hedge Fund Strategies] The manager of a convertible bond arbitrage strategy buys
a convertible bond and takes a short position in the underlying stock. As the price of
the underlying stock increases, the delta of this position will:
A. decrease.
B. remain the same.
C. increase.

Alternative Investments Page 10 of 26

 EdZeb Institute

54. [Hedge Fund Strategies] A convertible arbitrage hedge fund manager observes the
following information about a convertible bond and the underlying stock:

The manager buys the bond and sells the stock short. If the stock price falls by 10%
over one year, the per-share profit of this strategy is closest to:
A. –$3.38.
B. $2.88.
C. $3.50.

55. [Hedge Fund Strategies] When considering managed futures strategies, which of the
following will most likely result in exposure that is market neutral?
A. Time-series momentum strategies only
B. Cross-sectional momentum strategies only
C. Both time-series momentum strategies and cross-sectional momentum strategies

56. [Hedge Fund Strategies] A managed futures manager is considering a portfolio

allocation across three different assets with similar return expectations. The
historical standard deviation of returns is 10% for Asset 1 and Asset 2, and 15% for
Asset 3. The manager compiles the following correlation matrix for the assets'
returns:

If the manager wishes to maximize risk-adjusted returns, the largest portfolio

position is most likely to be in:
A. Asset 1.
B. Asset 2.
C. Asset 3.

57. [Hedge Fund Strategies] A hedge fund implementing an equity volatility position
trade and seeking maximum liquidity is most likely to employ:
A. VIX Index futures.

Alternative Investments Page 11 of 26

 EdZeb Institute

B. over-the-counter VIX Index options.

C. long-term exchange-traded VIX Index options.

58. [Hedge Fund Strategies] A volatility trading hedge fund strategy sells an at-the-
money put option. Between the sale date of the option and its expiration date, the
price of the underlying asset is unchanged and implied volatility increases. At option
expiration, the profit on the trade is:
A. negative.
B. zero.
C. positive.

59. [Hedge Fund Strategies] A third-party broker has purchased life insurance contracts
from the original policyholders. The broker now offers to sell these contracts to a
hedge fund. An analyst notes the following characteristics of these contracts:
Characteristic I: The surrender value offered to the insured individuals is high
compared to other similar policies.
Characteristic II: Premiums payable on the policies are low compared to the relatively
high risks of terminal illness faced by many policyholders.
Which of these characteristics would most likely be attractive to the hedge fund?
A. Characteristic I only
B. Characteristic II only
C. Both Characteristic I and Characteristic II

60. [Hedge Fund Strategies] Multi-strategy funds have typically:

A. outperformed funds-of-funds.
B. experienced lower volatility than funds-of-funds.
C. provided better redemption provisions than funds-of-funds.

61. [Hedge Fund Strategies] A fund-of-funds (FoF) invests equal amounts of capital in
the following hedge funds, where incentive fees are calculated on returns net of
management fees:

If the FoF also charges a base fee of 1.0% and an incentive fee of 10.0%, the net
annual return to FoF investors is closest to:
A. 0.93%.
B. 1.17%.
C. 3.23%.

Alternative Investments Page 12 of 26

 EdZeb Institute

62. [Hedge Fund Strategies] An analyst gathers the following information about multi-
strategy hedge fund returns:

Which fund is most likely to be running strategies using less liquid instruments?
A. Fund 1
B. Fund 2
C. Fund 3

63. [Hedge Fund Strategies] Adding a 20% hedge fund allocation to a traditional
stock/bond portfolio would most likely result in a(n):
A. increase in total portfolio standard deviation.
B. increase in the Sortino ratio for the total portfolio.
C. decrease in the Sharpe ratio for the total portfolio.

64. [Hedge Fund Strategies] An analyst gathers the following information about a
traditional stock/bond portfolio and blended portfolios that combine this traditional
portfolio with an equal allocation to one of three different hedge funds:

If all three hedge funds have similar risk–return profiles, which fund is most likely to
mitigate the risk of the traditional portfolio?
A. Hedge Fund 1
B. Hedge Fund 2
C. Hedge Fund 3

65. [Overview of Types of Real Estate Investment] An investor seeks a liquid equity
exposure to real estate. The investment structure should own, manage, and develop
properties. The most appropriate investment structure is a:
A. real estate partnership.
B. real estate investment trust.

Alternative Investments Page 13 of 26

 EdZeb Institute

C. real estate operating company.

66. [Overview of Types of Real Estate Investment] For all real estate property types,
the most important factor that affects the performance outlook is:
A. GDP growth.
B. business confidence.
C. consumer confidence.

67. [Overview of Types of Real Estate Investment] Under the terms of a gross lease, a
property's operating expenses are:
A. paid by the owner.
B. paid by the tenant.
C. shared by the owner and the tenant.

68. [Overview of Types of Real Estate Investment] A primary purpose of due diligence
for an equity investment in real estate is to:
A. verify audited financial statements.
B. identify problems not disclosed by the seller.
C. verify the funding sources for the purchase of the property.

69. [Overview of Types of Real Estate Investment] Appraisal-based real estate indexes
tend to:
A. overestimate the volatility of real estate returns.
B. lead transaction-based indexes in a falling market.
C. lead to overestimation of the diversification benefits from private real estate.

Solutions
1. B is Correct because precious metals can be described as certain metals that act as
monetary stores of value (as well as industrial uses). Primary commodities include
gold, silver, and platinum. The primary influencers of the flow of precious metals
include central bank monetary policy, geopolitics, economic (GDP) growth. With the
lack of annual seasonality in the production of metals and ease of storage without
spoilage, much of time variability comes from the demand side of the equation (e.g.,
construction and economic growth).

2. A is Correct because adverse weather (cold, hurricanes) drives the change in flows
resulting from changes in season or the time of year. Primary influences for energy
commodities include: pipeline and tanker reliability, seasonality (summer/winter),
adverse weather (cold, hurricanes), automobile/truck sales, geopolitical instability,
environmental requirements, economic (GDP) growth.

Alternative Investments Page 14 of 26

 EdZeb Institute

3. B is Correct because seasonality drives the change in stocks and flows resulting from
changes in season or the time of year. The demand or consumption of energy depends
upon the season (increase consumption in the winter for heating, summer for cooling).
Primary influences for energy commodities include: pipeline and tanker reliability,
seasonality (summer/winter), adverse weather (cold, hurricanes), automobile/truck
sales, geopolitical instability, environmental requirements, economic (GDP) growth.

4. B is Correct because the products from crude oil and metal ore have seasonal
demands depending on weather (e.g., gasoline demand in the summer and heating oil
demand in the winter) that affect the life cycle and usage of the underlying
commodity.

5. B is Correct because the life cycle of both precious and industrial metals is probably
the most flexible because the ore, as well as the finished products, can be stored for
months (if not years) given the relative resistance to spoilage of metals (assuming
proper storage).

6. B is Correct because some commodity contracts require actual delivery of the

physical commodity at the end of the contract versus settlement in a cash payment
(based on the difference between the contract futures price and the spot price
prevailing at the time of contract expiration). The force of arbitrage—which reflects
the law of one price—may not be entirely enforced by arbitrageurs because some
participants do not have the ability to make or take delivery of the physical
commodity. In these situations, the relationships that link spot and futures prices
are not an equality but are a range that only indicates the limit or boundary of value
differences that can occur.

7. B is Correct because the valuation of commodities is based not on the estimation of

future profitability and cash flows but on a discounted forecast of future possible
prices based on such factors as the supply and demand of the physical item or the
expected volatility of future prices.

8. A is Correct because owning a commodity incurs transportation and storage costs.

These ongoing expenditures affect the shape of the forward price curve of the
commodity derivative contracts with different expiration dates. If storage and
transportation costs are substantial, the prices for a commodity futures contract will
likely be incrementally higher as one looks farther into the future. The theory of
storage states that futures prices can be written this way: Futures price= Spot price
of the physical commodity + Direct storage costs (such as rent and insurance) −
Convenience yield.

Alternative Investments Page 15 of 26

 EdZeb Institute

9. B is Correct because a speculator may be willing to act as a liquidity provider, knowing

that producers and consumers may not be in the market at the same time. By buying
when the producer wants to sell and selling when the consumer is ready to buy,
speculators may be able to make a profit. In this sense, speculators are willing to step
in, under the right pricing circumstances, to provide insurance to hedgers in return
for an expected (albeit not guaranteed) profit.

10. B is Correct because arbitrageurs who have the ability to inventory physical
commodities can attempt to capitalize on mispricing between the commodity (along
with related storage and financing cost) and the futures price. They may own the
storage facilities (bonded warehouses, grain silos, feedlots) and work to manage that
inventory in conjunction with the futures prices to attempt to make arbitrage-style
profits.

11. A is Correct because a gold mining company, expecting to produce and sell gold in the
future, would take a short position in a futures contract to lock in a selling price and
hedge against the potential decline in gold prices.

12. A is Correct because as a long owner of a futures contract in contango, value will
erode over time as the contract pricing moves closer to the spot price, assuming all
else is unchanged.

13. C is Correct because as a long owner of a futures contract in contango, value will
erode over time as the contract pricing moves closer to the spot price, assuming all
else is unchanged.

14. C is Correct because backwardation and contango are also used to describe the
relationship between two futures contracts of the same commodity. When the near-
term (i.e., closer to expiration) futures contract price is higher than the longer-term
futures contract price, the futures market for the commodity is in backwardation.
In contrast, when the near-term futures contract price is lower than the longer-term
futures contract price, the futures market for the commodity is in contango. The
price difference (whether in backwardation or contango) is called the calendar
spread. A positive calendar spread is associated with futures markets that are in
backwardation. Backwardation occurs when the near-term (i.e., closer to expiration)
futures contract price is higher than the longer-term futures contract price.

15. A is Correct because with respect to the insurance theory, Keynes (1930), the noted
economist and market speculator, proposed one of the earliest known theories on the
shape of a commodity futures price curve. Also known as his theory of normal
backwardation, this theory posits that the futures price has to be lower than the
current spot price as a form of payment or remuneration to the speculator who takes

Alternative Investments Page 16 of 26

 EdZeb Institute

on the price risk and provides price insurance to the commodity seller. But, markets
failed to match Keynes’s hypothesis a more sophisticated view developed to explain
futures markets in contango (i.e., when the shape of the futures price curve is upward
sloping with more distant contract dates), recognizing that certain commodity
futures markets often show persistently higher prices in the future as opposed to
the backwardation outlined by Keynes.

16. B is Correct because the theory of storage specifies the futures price as the spot
rate + direct storage costs – convenience yield. Thus, if storages costs increase and
the convenience yield decreases, there will be an increase in the futures price.

17. C is Correct because Total return = Spot yield + Roll yield + Collateral yield.
The price yield or Price return = (Current price − Previous price) / Previous price. In
this case, (15.20 – 14.70) / 14.70 ≈ 0.0340.
The roll return = [(Near-term futures contract closing price − Farther-term futures
contract closing price)/Near-term futures contract closing price] × Percentage of
the position in the futures contract being rolled. In this case, [(15.20 – 14.80) / 15.20]
× 1 ≈ 0.0263.
The collateral return is the one-month return on government bonds, or 0.036/12 =
0.003.
Accordingly, 0.0340 + 0.0263 + 0.003 ≈ 0.0633 ≈ 6.33%.

18. B is Correct because the roll yield or net roll return = [(closing price of near-term
contract – closing price of farther-term contract) / closing price of near-term
contract] × rollover portion = [(501 – 515) / 501] × 50% = –2.7944% × 50% = –1.3972%
≈ –1.40%.

19. B is Correct because Total return on a commodity futures position is expressed as

Total return = Price return + Roll return + Collateral return. Price return = (Current
price − Previous price) / Previous price = ($99 – $100) / $100 = –1%; and Total return
(monthly) = Price return + Roll return + Collateral return = –1% + 0.8% + 0.5% = 0.3%.

20. A is Correct because if the futures price curve shape is being driven by contango—
with a higher futures price in the far contract—this scenario will require the
purchase of fewer commodity contracts than in the near position.

21. A is Correct because in a contango market, futures prices are higher than expected
future spot prices. Therefore, when rolling over a long futures position, an investor
would be selling a cheaper contract and buying a more expensive one, resulting in a
negative roll return. The roll return is effectively the accounting difference (in
percentage terms) between the near-term commodity futures contract price and the
farther-term commodity futures contract price. When the spot price exceeds the

Alternative Investments Page 17 of 26

 EdZeb Institute

futures price, the situation is called backwardation, and the opposite case is called
contango.

22. B is Correct because in backwardation, the longer-term futures contract has a lower
price than the near-term futures contract so that the roll return is positive when the
investor sells the near-term contract and purchases the longer-term contract. In
addition, the investor will need to buy more of the (cheaper) longer-term contract to
maintain the same exposure (in value).

23. B is Correct because a total return swap is generally used by large institutional
investors (e.g., pension plans) as opposed to commodity producers or buyers. With a
total return swap, the investor seeks exposure to commodity returns, often because
of the low return correlation of commodities with other asset classes (e.g., stocks or
bonds) or as a reflection of the view that commodities provide a valuable inflation
hedge for asset/ liability matching (ALM). Therefore, such investors would engage in
a total return swap that provides them with long exposure to the future returns from
a commodity index that is used as the reference price.

24. A is Correct because a basis swap's cash flows are based on the values of two related
commodity reference prices that are not perfectly correlated. These swaps are often
used to adjust for the difference (called the basis) between a highly liquid futures
contract in a commodity and an illiquid but related material.

25. C is Correct because given that oil prices are subject to many events beyond a
company’s control, a company looking to protect itself from financing risk may find
that a swap can be a valuable tool. There are many types of swaps available in the
marketplace because they are not standardized, exchange-traded contracts like
futures. In an excess return swap, the payments to either party are driven primarily
by the changes in price of each of the futures contracts that make up the index. The
net change in the prices of the underlying futures contracts is defined as the
“excess” return, and the excess return is multiplied by the contract’s notional amount
to determine the payments between buyer and seller.

26. A is Correct because trending markets favor less-frequent rebalancing and equal-
weight indexes have more diverse holdings than production weighted indexes, which
are dominated by energy. More frequent mean reversions should favor (monthly
rebalancing), but a longer-term trend will more likely favor the annually rebalancing
indexes. In a world production value-weighting scheme that gives the largest weight
to the most valuable commodity on the basis of physical trade value energy has the
highest sector weight (historically as high as 80%).

Alternative Investments Page 18 of 26

 EdZeb Institute

27. A is Correct because if an index uses a floating weighting scheme, such as production
value (fully or partially), then the higher (lower) futures prices usually coincide with
higher (lower) physical prices. Therefore, with this kind of approach, the magnitude
of rebalancing weights is generally lower than for a fixed-weight scheme because the
post-rebalance weights will generally drift in line with the current portfolio weights.
As a result, the S&P GSCI and BCOM indexes (using a floating weighting scheme)
typically have lower rebalancing costs and—in a trending market—have an opportunity
to outperform their fixed-weight index counterparts, particularly those that have a
relatively frequent rebalance period.

28. C is Correct because maximizing backwardation in the rolling of futures contracts of

commodities will maximize the roll return, increasing the return of the index. Using
the most liquid contract to roll forward will be using a contract that may be in
contango (negative roll yield) or not be one with the highest roll yield. Indexes that
choose (perhaps inadvertently) contracts that more commonly trade in backwardation
may appear to improve forward-looking performance (because this generates a
positive roll return), whereas those that more commonly trade in contango may hurt
performance.

29. C is Correct because businesses are organized as REOCs, as opposed to REITs, if they
engage to a large extent in the development of for-sale real estate properties.

30. A is Correct because real estate investment trusts are companies that own, finance,
and—to a limited extent—develop income-producing real estate across a range of
property sectors. Most REITs are required to distribute 90%–100% of their taxable
income to shareholders. Also, in most countries, REITs are required to distribute
90%–100% of their otherwise taxable earnings [Security 1 and Security 2], invest at
least 75% of their assets in real estate [Security 1 and Security 3], and derive at
least 75% of income from real estate rental income or interest on mortgages
[Security 1]. Security 1 is best qualified as a tax-advantaged REIT.

31. A is Correct because NAVPS is a superior measure of a company’s net worth compared
with historical book value per share.

32. A is Correct because NAV per share is calculated as follows:

Value of operating assets = NOI/Cap rate = 346,000/0.072 = 4,805,556.
To this is added the cash, undeveloped property and accounts receivable to arrive at
gross asset value: 4,805,556 + 43,000 + 38,000 + 29,000 = 4,915,556.
From this debt is subtracted: 4,915,556 – 1,440,000 = 3,475,556
Which is divided by shares outstanding to arrive at NAV per share:
3,475,556/63,000 ≈ 55.17

Alternative Investments Page 19 of 26

 EdZeb Institute

33. B is Correct because NAVPS should also include the following: the value of non–real
estate assets, including cash.

34. A is Correct because AFFO is superior to FFO as a measure of economic income and
thus economic return because it considers the capital expenditures necessary to
maintain the economic income of a property portfolio. AFFO is also more reflective
of a REIT’s dividend-paying ability than FFO. It is open to more variation and error
in estimation than FFO (funds from operations). Thus FFO is open to less error in
estimation than AFFO.

35. C is Correct because AFFO better approximates a company’s sustainable dividend-

paying capacity. Adjusted funds from operations (AFFO) subtracts from FFO
recurring capital expenditure and the difference between reported rents and cash
rents: AFFO = (FFO – Non-cash rent – Recurring capex).

36. B is Correct because, if we assume price stays the same, the P/FFO multiple will
decrease. FFO and AFFO are based on net income available to equity and thus
represent levered income. P/FFO multiples are generally lower for companies with
higher leverage, all things equal.
In addition, the perceived risk of the firm increases, causing investors to demand a
higher return. The higher required return is reflected in a lower P/FFO multiple. As
financial leverage increases, equities' FFO and AFFO multiples decrease because
required return increases as risk increases.

37. A is Correct because AFFO (adjusted FFO) is most often defined as FFO adjusted
to remove any non-cash rent and to subtract maintenance-type capital expenditures
and leasing costs (including leasing agents' commissions and tenants' improvement
allowances).
AFFO = FFO ($65,000) – Non-cash rent ($5,000) – Recurring capital expenditures
($10,000) = $50,000
AFFO/share = $50,000/20,000 = $2.50
Share price = $2.50 × 12 = $30

38. C is Correct because AFFO [adjusted FFO] is most often defined as FFO adjusted to
remove any non-cash rent and to subtract maintenance-type capital expenditures and
leasing costs (including leasing agents’ commissions and tenants’ improvement
allowances).
AFFO = FFO ($70,000) – Non-cash rent ($5,000) – Recurring capital expenditures
($10,000) = $55,000
AFFO/share = $55,000/25,000 = $2.20
Dividend payout ratio on AFFO = $1.00/$2.20 = 0.454545 ≈ 45%

Alternative Investments Page 20 of 26

 EdZeb Institute

39. B is Correct because the REIT with the highest FFO (and therefore the lowest price-
to-FFO ratio) is REIT 2 (i.e., if share price is €100, price-to-FFO ratio is €100/€325
≈ 0.308 for REIT 1, €100/€330 ≈ 0.303 for REIT 2, and €100/€325 ≈ 0.308 for
REIT 3).
FFO is derived in the following table (FFO = Net income + Depreciation &
amortization).

40. C is Correct because one of the advantages of investing in private real estate (direct
investment) is that there are tax benefits (e.g., accelerated depreciation, deferred
taxes in some markets when sales are reinvested in other real estate).
The US tax structure allows the deduction of interest and depreciation from
property-level cash flows, prior to the calculation of income tax. These non-cash
adjustments have the effect of eliminating or deferring otherwise payable income
tax.
Further, US investors are able to defer capital gains taxes on disposition through a
special tax code provision (known as a '1031 exchange') where capital gains (profits
from sale) are not payable if the investor immediately purchases another investment
property for equal or greater value.

41. A is Correct because development requires equity capital. Lenders require equity
capital to be invested in the land or construction before they fund any debt.
Therefore, a REIT would need to hold capital on its balance sheet to fund future
equity draws instead of paying out that capital. REIT laws typically stipulate that the
significant majority of a REIT's earned cash flow be paid out immediately to
investors. In contrast to REOCs, REITs face restrictions on the amount of income
and assets accounted for by activities other than collecting rent and interest
payments.

42. A is Correct because high transparency is an advantage of public real estate (such as
REITs) and low transparency is a disadvantage of private real estate.

43. A is Correct because the HFRI Index is the only one of the three answer choices
that tracks small hedge funds that are open for new investment. HFR produces its
HFRI index series, which tracks only hedge funds open to new investment.

Alternative Investments Page 21 of 26

 EdZeb Institute

44. B is Correct because event-driven hedge fund strategies focus on corporate events,
such as governance events, mergers and acquisitions, bankruptcy, and other key
events for corporations.

45. C is Correct because relative value hedge fund strategies focus on the relative
valuation between two or more securities. These strategies are often exposed to
credit and liquidity risks because the valuation differences from which these
strategies seek to benefit often are due to differences in credit quality and/or
liquidity across different securities. Also, liquidity issues surface for convertible
arbitrage strategies in two ways: 1) naturally less-liquid securities because of their
relatively small issue sizes and inherent complexities; 2) availability and cost to
borrow underlying equity for short selling.

46. C is Correct because stock selection defines manager skill for most long/short equity
managers—with market-timing ability being an additive, but generally secondary,
consideration. Manager skill derives mainly from stock selection. Further, some
managers are able to add alpha via market timing of portfolio beta tilt, but evidence
suggests that most long/short managers do this poorly.

47. A is Correct because long/short strategies typically have average exposures of 40%–
60% net long, composed of gross exposures of 70%–90% long, vs. 20%–50% short,
but they can vary widely.

48. A is Correct because stub trading entails buying and selling stock of a parent company
and its subsidiaries, typically weighted by the percentage ownership of the parent
company in the subsidiaries.

49. B is Correct because event-driven hedge funds take one of two approaches. The hard-
catalyst approach is generally less volatile and less risky than soft-catalyst investing.
Either investments can be made proactively in anticipation of an event that has yet
to occur (i.e., a soft-catalyst event-driven approach), or investments can be made in
reaction to an already announced corporate event in which security prices related to
the event have yet to fully converge (i.e., a hard-catalyst event-driven approach).

50. C is Correct because investments can be made proactively in anticipation of an event

that has yet to occur (i.e., a soft-catalyst event-driven approach).

51. A is Correct because the payoff profile of the merger arbitrage strategy resembles
that of a riskless bond and a short put option.

52. C is Correct because profit can be generated given mispricings in either securities of
the same issuer or securities of different issuers within the same industry.

Alternative Investments Page 22 of 26

 EdZeb Institute

Considering yield curve trades, the prevalent calendar spread strategy involves taking
long and short positions at different points on the yield curve where the relative
mispricing of securities offers the best opportunities, such as in a curve flattening
or steepening. The positions can be in fixed-income securities of the same issuer; in
that case, most credit and liquidity risks would likely be hedged, making interest rate
risk the main concern. Alternatively, longs and shorts can be taken in the securities
of different issuers—but typically ones operating in the same industry or sector. In
this case, differences in credit quality, liquidity, volatility, and issue-specific
characteristics would likely drive the relative mispricing. In either case, the hedge
fund manager aims to profit as the mispricing reverses (mean reversion occurs) and
the longs rise and shorts fall in value within the targeted time frame.

53. C is Correct because the combination of a long convertible and short equity delta
exposure would create a situation where for small changes in the equity price, the
portfolio will remain essentially balanced. As the underlying stock price moves
further, however, the delta hedge of the convertible will change because the
convertible is an instrument with the natural positive convexity attributes of positive
gamma. That is, as the price of the underlying increases, the delta of the embedded
option in the convertible will also increase. Because stock gamma is always zero, the
convertible arbitrage strategy will leave the convertible arbitrageur “synthetically”
longer in total equity exposure as the underlying security price rises. This is because
the delta of the embedded option increases, which means the sensitivity of the
embedded option price to the price of the underlying stock is also increasing. This
means increasing equity exposure for the entire strategy as the price of the stock
increases. That is, the delta of the position will increase.

54. C is Correct because the bond value is $1,000,000 × 105/100 = $1,050,000. The
conversion price is $1,050,000/80,000 = $13.125. The profit on the long bond position
is Ending stock price – Conversion price = 0.9 × $20 – $13.125 = $4.875. This is
increased by the coupon receipt of 5% × $1,000,000 = $50,000 or $0.625 per share
(= $50,000/80,000).
The profit on the short stock position is –(Ending stock price – Starting stock price)
= –($18 – $20) = $2. This is reduced by the borrowing cost of $4 per share to a loss
of $2 per share.
Thus, the profit per share of this strategy is $4.875 + $0.625 – $2 = $3.50.

55. B is Correct because cross-sectional momentum (CSM) strategies generally result in

holding a net zero or market-neutral position.

56. A is Correct because Asset 1 is the least volatile and it has a negative correlation
with both Asset 2 and Asset 3. Many managed futures managers implement their
portfolios' relative position sizing by assessing both the volatility of each underlying

Alternative Investments Page 23 of 26

 EdZeb Institute

futures position as well as the correlation of their return behaviors against one
another. Generally, the greater the volatility of an asset, the smaller its portfolio
sizing; and the greater its correlation to other futures being positioned, the smaller
its portfolio sizing.

57. A is Correct because the need to maximize liquidity forces the fund to choose VIX
Index futures over over-the-counter or long-term exchange-traded VIX Index
options. In the United States, the most liquid volatility contracts are short-term VIX
Index futures contracts, which track the 30-day implied volatility of S&P 500 Index
options as traded on the Chicago Board Options Exchange (CBOE).

58. C is Correct because the short option position is left with a net gain due to the fact
that the unchanged value of the underlying asset has allowed the full option premium
to be retained.

59. B is Correct because the hedge fund would look for the following policy
characteristics: (1) the surrender value being offered to an insured individual is
relatively low; (2) the ongoing premium payments to keep the policy active are also
relatively low; and yet, (3) the probability is relatively high that the designated
insured person is indeed likely to die within a certain period of time (i.e., earlier than
predicted by standard actuarial methods).
Here, Characteristic II maps to points (2) and (3) above—premium payments are
relatively low while health risks are relatively high.

60. A is Correct because multi-strategy hedge funds typically outperform funds-of-

funds: They have higher mean returns (7.85%/TASS and 8.52%/CISDM) and among
the highest Sharpe ratios and Sortino ratios. Multi-strategy funds have higher Rho
(more than 20%) compared to FoFs, indicating relatively high serial autocorrelation.
This is reasonable because multi-strategy funds may be simultaneously running
strategies using less liquid instruments, such as convertible arbitrage, fixed-income
arbitrage, and other relative value strategies.

61. B is Correct because the net-of-fees return to Fund 1 is (4.5% – 1.8%) – 10% × (4.5%
– 1.8%) = 2.43%.
The net-of-fees return to Fund 2 is (3.6% – 1.2%) – 10% × (3.6% – 1.2%) = 2.16%.
Since the FoF exposure to the two funds is equally weighted, the FoF gross return is
(2.43% + 2.16%)/2 = 2.295% and the FoF net return is (2.295% – 1%) – 10% × (2.295%
– 1%) = 1.1655% ≈ 1.17%.

62. A is Correct because Fund 1 has the highest Rho, which indicates relatively high serial
autocorrelation. This is reasonable because multi-strategy funds may be
simultaneously running strategies using less liquid instruments, such as convertible
arbitrage, fixed-income arbitrage, and other relative value strategies. That is why,

Alternative Investments Page 24 of 26

 EdZeb Institute

unlike FoFs, they often impose investor-level or fund-level gates on maximum

quarterly redemptions. Also, high Rho signals smoothed returns and thus is an
indicator of potential liquidity issues (specifically, illiquidity and infrequent trading)
in the underlying securities.

63. B is Correct because adding a 20% allocation of any of the hedge fund strategies to
the traditional portfolio almost always decreases total portfolio standard deviation
while increasing Sharpe and Sortino ratios (and also decreasing maximum drawdown
in about one-third of the combined portfolios). These results demonstrate that hedge
funds act as both risk-adjusted return enhancers and diversifiers for the traditional
stock/bond portfolio.

64. C is Correct because the hedge fund strategy portfolios that generate the smallest
maximum drawdowns are the opportunistic strategies—specifically, global macro and
systematic futures as well as merger arbitrage and equity market-neutral strategies.
Types of strategies that provide risk mitigation for traditional assets are successful
in doing so because they are relatively opportunistic, and are liquid even during
periods of market stress.
Based on the information provided, adding Hedge Fund 3 reduces the maximum
drawdown, indicating opportunism on the part of the manager. Hedge Fund 3 also
reduces Rho, indicating a lower level of autocorrelation and therefore better liquidity
in the underlying investment strategies.

65. C is Correct because real estate operating companies (REOCs) are taxable
corporations that operate and manage commercial real estate with few corporate-
structure restrictions. They commonly own and often develop real estate. In addition,
REIT and REOC shares are typically liquid, and active trading results in prices that
are more likely to reflect market value.

66. A is Correct because several macro factors affect all major real estate sectors, but
GDP growth is generally the most important single economic factor affecting the
outlook for all property types.

67. A is Correct because a net lease requires the tenant to be responsible for paying
operating expenses, whereas a gross lease requires the owner to pay the operating
expenses.

68. B is Correct because the purpose of due diligence is to identify potential problems
that have not been disclosed by the seller that could negatively impact value.

69. C is Correct because appraisal lag tends to smooth the index, meaning that it has less
volatility. The smoothing effect will also overstate Sharpe ratios, which is

Alternative Investments Page 25 of 26

 EdZeb Institute

problematic if the index is used in asset allocation models to determine how much of
a portfolio should be allocated to real estate versus other asset classes. The
appropriate allocation to and benefits from private real estate would likely be
overestimated.

Alternative Investments Page 26 of 26