Sample Questions
Question 1
Easy
An activist hedge fund seeks returns primarily by:
Solution
A is correct. Activist hedge funds build concentrated stakes in target companies and engage with boards or management, often publicly, to pursue value-unlocking changes such as cost cuts, asset divestitures, capital returns, board refreshment, or strategic reviews.
Question 2
Medium
Netting risk in a fund of hedge funds arises when:
Solution
D is correct.
Netting risk occurs because incentive fees at the underlying fund level are calculated individually. If Fund A earns $10 million and Fund B loses $10 million, the FoF has a net zero return, but the FoF investor still pays an incentive fee to Fund A's manager. This asymmetry in fee calculation is a structural disadvantage of the fund of funds model.
Netting risk occurs because incentive fees at the underlying fund level are calculated individually. If Fund A earns $10 million and Fund B loses $10 million, the FoF has a net zero return, but the FoF investor still pays an incentive fee to Fund A's manager. This asymmetry in fee calculation is a structural disadvantage of the fund of funds model.
Question 3
Hard
A PE FoF invested in 8 underlying buyout funds across 3 vintage years. The FoF reports a pooled IRR of 14% and a commitment-weighted average IRR of 11%. What does the divergence between these two metrics most likely indicate?
Solution
C is correct.
A pooled IRR aggregates all cash flows across all underlying funds and computes a single IRR, naturally giving more weight to larger cash flows. A commitment-weighted average IRR weights each fund's individual IRR by its commitment size. When the pooled IRR exceeds the commitment-weighted average, it indicates that larger or earlier cash flows came from higher-returning funds. This divergence most likely reflects successful allocation timing, where the FoF made larger commitments to vintage years or funds that performed better.
A pooled IRR aggregates all cash flows across all underlying funds and computes a single IRR, naturally giving more weight to larger cash flows. A commitment-weighted average IRR weights each fund's individual IRR by its commitment size. When the pooled IRR exceeds the commitment-weighted average, it indicates that larger or earlier cash flows came from higher-returning funds. This divergence most likely reflects successful allocation timing, where the FoF made larger commitments to vintage years or funds that performed better.
