Sample Questions
Question 1
Easy
A hedge fund's lock-up period is best described as:
Solution
D is correct. A hedge fund lock-up is the contractually defined period that begins at the date of an investor's subscription during which redemptions are restricted (or carry a redemption-fee penalty). Lock-ups allow managers to hold less liquid positions without exposure to forced selling, which would otherwise damage all remaining investors.
Question 2
Medium
A dispersion trading strategy typically involves:
Solution
C is correct.
Dispersion trading exploits the tendency for implied correlation among index constituents to be overpriced. The strategy involves buying options (volatility) on individual stocks and selling options (volatility) on the index. If the implied correlation embedded in index option prices exceeds the actual realized correlation among individual stocks, the portfolio of single-stock options outperforms the index option, generating a profit.
Dispersion trading exploits the tendency for implied correlation among index constituents to be overpriced. The strategy involves buying options (volatility) on individual stocks and selling options (volatility) on the index. If the implied correlation embedded in index option prices exceeds the actual realized correlation among individual stocks, the portfolio of single-stock options outperforms the index option, generating a profit.
Question 3
Hard
The variance risk premium refers to the tendency for:
Solution
C is correct.
The variance risk premium is the well-documented tendency for implied volatility (the market's expectation of future volatility, as priced in options) to exceed the actual realized volatility on average. This premium compensates sellers of volatility for bearing the risk of large adverse moves.
The variance risk premium is the well-documented tendency for implied volatility (the market's expectation of future volatility, as priced in options) to exceed the actual realized volatility on average. This premium compensates sellers of volatility for bearing the risk of large adverse moves.
