Alternative Investments Overview

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Questions and Answers

Which of the following is NOT a reason why investors would include alternative investments in their portfolio?

  • To diversify the portfolio
  • To increase absolute returns
  • To add alpha
  • To access stable cash flows (correct)

What is a primary characteristic of timberland investments that makes them attractive?

  • High correlation with stock market performance
  • High volatility in investment returns
  • Guaranteed long-term appreciation
  • Low correlation with other asset classes (correct)

Which type of investment is NOT typically associated with private equity?

  • Publicly traded corporations (correct)
  • Venture capital
  • Buyouts
  • Mezzanine financing

How does diversification affect portfolio risk according to the investment principles discussed?

<p>Decreases risk at a faster rate than returns (C)</p> Signup and view all the answers

Which of the following investments would most likely provide a method for accessing timber assets?

<p>Timber investment management organizations (TIMOs) (A)</p> Signup and view all the answers

What significant change occurred regarding the regulation of commodity pools in Canada on January 3, 2019?

<p>Commodity pools automatically became alternative mutual funds. (B)</p> Signup and view all the answers

What are alternative mutual funds informally referred to as?

<p>Liquid alternatives (D)</p> Signup and view all the answers

Which of the following statements about alternative mutual funds is true?

<p>They cannot short sell non-derivative related securities. (C)</p> Signup and view all the answers

What was a primary goal of the CSA's modernization of Investment Product Regulation?

<p>To enhance access to alternative investment strategies for retail investors. (C)</p> Signup and view all the answers

Which of the following restrictions remains for alternative mutual funds?

<p>Restrictions on illiquid investments similar to conventional mutual funds. (C)</p> Signup and view all the answers

Which category includes the differences between conventional mutual funds and alternative funds?

<p>Liquidity and redemption policies (A)</p> Signup and view all the answers

What characterizes hedge funds compared to liquid alternative funds?

<p>Higher after-fee returns and higher risk (C)</p> Signup and view all the answers

During times of market distress, the differences in returns between hedge funds and liquid alternatives tend to?

<p>Narrow as liquidity becomes more valuable (A)</p> Signup and view all the answers

In what way do alternative mutual funds differ from traditional hedge funds?

<p>Stricter investment strategies and limitations (D)</p> Signup and view all the answers

Which aspect is NOT typically a difference between conventional mutual funds and alternative funds?

<p>Total number of investment assets (A)</p> Signup and view all the answers

What does Portfolio X demonstrate in relation to Portfolio A?

<p>It offers a better risk-return tradeoff than Portfolio A. (D)</p> Signup and view all the answers

What is the primary reason Portfolio X has a higher expected return than Portfolio A?

<p>The stock component of Portfolio X raises the expected portfolio return. (A)</p> Signup and view all the answers

Why are points below the efficient frontier considered inefficient?

<p>They indicate portfolios that can achieve lower risk for the same return or higher returns for the same risk. (D)</p> Signup and view all the answers

What happens if a portfolio contains more than 20% stocks?

<p>The benefits of diversification are overwhelmed by increased risk. (D)</p> Signup and view all the answers

Which portfolio represents the lowest expected return and the lowest risk?

<p>Portfolio A, which is 100% bonds. (B)</p> Signup and view all the answers

Flashcards

Diversification in Alternative Investments

Including alternative investments in a portfolio can help manage risk by reducing correlation with traditional investments.

Alpha in Alternative Investments

Alternative investments can potentially generate higher returns compared to traditional investments, even after adjusting for risk.

Absolute Returns in Alternative Investments

Alternative investments can provide more stable returns, even during market downturns, protecting capital from erosion.

What is Private Equity?

Private equity investments involve ownership in companies not publicly traded, offering potential higher returns but with increased risk.

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Why is Timberland an Alternative Investment?

Timberland has become a popular alternative investment option due to its potential for stable returns, low correlation with other assets, and high demand.

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Efficient Frontier

A graph illustrating all possible combinations of assets that maximize expected return for a given level of risk.

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Inefficient Portfolio

A portfolio that lies below the efficient frontier, meaning it does not offer the highest possible expected return for its level of risk.

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Diversification

The ability to reduce overall portfolio risk by combining assets that have low correlation with each other.

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100% Bond Portfolio

A portfolio that is composed solely of bonds, representing a low-risk, low-return strategy.

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Mixed Portfolio (Stocks & Bonds)

A portfolio that includes both stocks and bonds, aiming to balance risk and return.

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Alternative Mutual Fund (Liquid Alt)

A type of investment fund that allows managers to use derivatives, leverage, and short-selling to a greater extent than traditional mutual funds, but with limitations.

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Liquid Alternatives (Liquid Alts)

A type of investment fund that allows investors to gain exposure to alternative investment strategies, such as hedge funds, private equity, and real estate.

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Commodity Pool

A type of investment fund that used to allow managers to use derivatives and leverage, but with limitations.

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Alternative Investment

A type of investment that aims to provide returns that are not correlated with the broader market, typically seeking absolute returns.

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Absolute Return

The ability of an investment to maintain its value during market downturns, providing stability and protecting capital.

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Alternative Mutual Funds

Alternative mutual funds are regulated like traditional mutual funds but invest in a wider array of assets, including some typically found in hedge funds.

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Hedge Funds

Hedge funds are private investment funds with less regulatory oversight compared to traditional mutual funds, allowing for more flexible investment strategies and potentially higher returns.

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Higher Risk - Higher Return

The potential for higher returns in hedge funds comes with increased risk, as they can use more complex strategies.

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Liquidity in Hedge Funds

While hedge funds aim for higher returns, they typically have lower liquidity than traditional funds, meaning investors may find it more difficult to cash out their investments quickly.

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Liquidity in Alternative Mutual Funds

Alternative mutual funds are generally more liquid compared to hedge funds, offering investors greater flexibility to redeem their investments.

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Study Notes

Alternative Investments: Benefits, Risks, and Structure

  • Alternative investments include hedge funds and alternative mutual funds
  • Alternative investments differ from conventional mutual funds in terms of benefits, risks, and structure
  • Learning objectives include explaining alternative investments, identifying categories, discussing benefits, describing risks, and outlining structural features of different investment types
  • Alternative investments can be categorized by strategy and structure, such as exempt market alternative funds (hedge funds), alternative mutual funds, exchange-traded funds (ETFs), and closed-end funds
  • Alternative investments are assets different from traditional stocks, bonds, and cash
  • Alternative investments are categorized into alternative strategy funds, real assets (commodities, real estate, collectibles), and private equity
  • Relative value strategies aim to exploit discrepancies in related assets' prices
  • Event-driven strategies target companies involved in corporate actions (mergers, etc.)
  • Directional strategies profit from anticipated market movements
  • Commodities include agricultural products, precious metals, and energy products
  • Real estate encompasses commercial, industrial, and residential property
  • Collectibles encompass fine art, classic cars, rare stamps, and coins among other items
  • Infrastructure includes roads, ports, and water works
  • Natural resources include timberland and farmland
  • Private equity entails investments in companies not publicly traded
  • Benefits of alternative investments include diversification, alpha enhancement, and increased absolute returns
  • Diversification minimizes risk by distributing investments across different assets
  • Alpha adds value beyond expected returns based on market conditions
  • Increasing absolute return creates more resilience against market declines
  • Alternative investments have risks like diversification, alpha, and heightened risk
  • Incentive fees for hedge fund managers are often performance-based, calculated after deducting management fees and expenses, based on the manager's performance
  • High water marks ensure managers are paid incentives only on net new profits
  • Hurdle rates are a minimum return requirement before incentive fees are paid
  • Hedge funds involve unique features, like incentive fees, high-water marks, and hurdle rates.
  • Hedge funds have reduced volatility and professional management, access to hedge funds, and ability to diversify with a smaller investment.
  • Hedge funds can encounter issues regarding manager and business risk, additional costs, no guarantees of positive returns, and diversification.
  • Alternative mutual funds offer limitations, restrictions, and protections
  • Alternative funds compare to conventional funds based on considerations like disclosures, liquidity, fees, and regulatory oversight

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