Free CAIA Level I CAIA Ethical Principles Practice Questions

A is correct. The Bear Stearns High-Grade Structured Credit Strategies Fund and its Enhanced Leverage counterpart used significant leverage (up to 10:1 in the enhanced fund) to invest heavily in CDOs and other securities backed by subprime mortgages. When subprime defaults rose and these securities lost value, the leveraged losses quickly wiped out the funds' capital.
Choice D is incorrect because the funds' exposure was to U.S. subprime mortgage-backed securities, not emerging market bonds, and currency mismatch was not a factor in their collapse.
Choice B is incorrect because the funds collapsed due to investment losses from leveraged subprime exposure, not from regulatory penalties related to anti-money-laundering violations.
Choice C is incorrect because the ethical failures involved excessive risk-taking and misleading investors about portfolio risk, not unauthorized short selling of the parent company's stock.

B is correct. Archegos held total return swap positions with multiple prime brokers, none of whom had full visibility into the fund's aggregate exposure. When Archegos could not meet margin calls, the coordinated unwinding of positions caused billions in losses across multiple banks. The lesson is that prime brokers need better cross-counterparty exposure aggregation and more rigorous margining for concentrated swap positions.
Choice A is incorrect because total return swaps are legitimate financial instruments. The problem was not the instrument itself but the lack of transparency and inadequate risk management around concentrated positions.
Choice C is incorrect because total return swaps require initial and variation margin. The exchange-traded nature of the reference equity does not eliminate counterparty credit risk in a bilateral OTC derivative.
Choice D is incorrect because the Archegos collapse demonstrated that family offices can pose significant systemic risk. Despite managing only proprietary capital, the fund's concentrated positions and heavy use of leverage created losses exceeding \$10 billion across prime brokers.

B is correct. The GP's failure to disclose the side letter directly violates the principles of fair dealing and transparency. Fair dealing requires that all investors be treated equitably and that material differences in terms be disclosed. Transparency requires that LPs have access to information material to their investment, including whether other investors receive preferential economics or governance rights. The combination of economic advantage (reduced fees, co-investment) and information asymmetry (enhanced reporting) without disclosure creates a fundamentally unequal environment that undermines trust in the GP-LP relationship.
Choice A is incorrect because while the duty of loyalty is relevant to the GP's obligations, the duty of care relates to competence and diligence in analysis, not to the disclosure of preferential arrangements. The GP's failure here is not analytical incompetence but a deliberate choice to withhold material information from certain investors.
Choice C is incorrect because confidentiality protects client information from unauthorized disclosure, and market integrity concerns the fair functioning of public markets. Side letters are private contractual arrangements between fund parties, and the concern is about disclosure to existing LPs, not about leaks or public market distortion.
Choice D is incorrect because while professionalism encompasses ethical conduct broadly, the specific failure is not about documentation standards or due diligence. The GP presumably followed proper legal procedures in drafting the side letter. The violation is the deliberate nondisclosure to other LPs, which is a fair dealing and transparency issue.