Investing in Hedge Funds and Closed-End Funds

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Questions and Answers

What is a primary characteristic of a closed-end fund?

It is exclusively composed of government bonds.

It issues and redeems units constantly.

It requires an annual minimum investment.

It has a fixed number of shares. (correct)

What is one advantage of closed-end funds compared to open-end mutual funds?

They can easily accommodate cash flow fluctuations.

They can engage in short selling or leverage. (correct)

They provide guaranteed returns.

They usually have higher management fees.

What type of funds can periodically buy back their outstanding shares?

Open-end mutual funds

Hedge funds

Interval funds (correct)

Exchange-traded funds

What is a consequence of the fixed number of shares in closed-end funds?

Ability for managers to concentrate on long-term strategies. Signup and view all the answers

What type of costs are typically lower for closed-end funds compared to mutual funds?

Marketing costs due to lower promotional activities. Signup and view all the answers

What must investors be aware of regarding currency risk in funds?

Some funds expose investors to currency risk and may or may not hedge it. Signup and view all the answers

Which of the following fees are associated with buying a mutual fund?

Front-end sales charge and ongoing trailer fees Signup and view all the answers

Why might management fees be lower in closed-end funds?

Lower portfolio turnover and marketing costs. Signup and view all the answers

What type of risk is primarily associated with the lack of transparency in hedge funds?

Light Regulatory Oversight Signup and view all the answers

Which risk involves the inability to quickly liquidate investments in hedge funds?

Liquidity Constraints Signup and view all the answers

What is the risk called that is associated with the direction of interest rates and equities in hedge funds?

Market Risk Signup and view all the answers

What responsibility do hedge fund investors have regarding investment risk?

To understand the investment strategies used Signup and view all the answers

What is another term for market risk in hedge funds?

First-order Risk Signup and view all the answers

Which of the following risks is NOT typically associated with hedge funds?

Market Saturation Risk Signup and view all the answers

Which of the following best describes investment strategy risk in hedge funds?

Methods may be difficult for investors to comprehend Signup and view all the answers

What can result from holding less-liquid investments in hedge funds?

Excess returns due to liquidity premium Signup and view all the answers

What is a significant risk associated with closed-end mutual funds?

Liquidity and trading risk Signup and view all the answers

How do capital gains and dividends get handled in a closed-end fund?

They are paid directly to investors. Signup and view all the answers

What typically contributes to lower management expense ratios (MERs) in closed-end funds?

Fixed number of units to be administered Signup and view all the answers

What is a common characteristic of the trading prices of closed-end funds in volatile markets?

They often trade at a discount to NAV. Signup and view all the answers

What does the term 'discount or premium' refer to when purchasing a closed-end fund?

The difference between market price and net asset value. Signup and view all the answers

What advantage do open-end funds offer over closed-end funds regarding liquidity?

They issue and redeem units at NAV. Signup and view all the answers

Which statement best describes the impact of bear markets on closed-end fund shareholders?

They may suffer as asset values decline and discounts widen. Signup and view all the answers

Why might investors find tracking the adjusted cost base in closed-end funds easier?

Since capital distributions are paid directly rather than reinvested. Signup and view all the answers

What is the maturity guarantee provided by the segregated fund when the market value is less than the invested amount?

The investor is paid the difference between invested amount and market value Signup and view all the answers

What effect does using the reset option have on the maturity guarantee of a segregated fund?

It resets the guarantee period for another ten years Signup and view all the answers

What typically happens when an investor passes away while holding a segregated fund?

The beneficiary receives at least the original guaranteed amount Signup and view all the answers

What is a significant feature associated with the death benefits of segregated funds?

They can sometimes be lower than the originally invested amount Signup and view all the answers

How do insurers add flexibility to segregated fund contracts?

By implementing more frequent reset dates for guarantees Signup and view all the answers

What is tracking error in relation to ETFs?

The discrepancy between ETF returns and the benchmark index Signup and view all the answers

How do ETFs differ from mutual funds regarding investment objective limitations?

ETFs are not subject to individual stock or sector exposure limits Signup and view all the answers

What is a significant cost consideration when investing in ETFs?

ETFs have lower management fees compared to most mutual funds Signup and view all the answers

In which situation might an ETF become subject to concentration risk?

When particular sectors experience large gains leading to high concentration Signup and view all the answers

What can be said about the fees associated with international ETFs compared to domestic ETFs?

International ETFs usually have higher fees Signup and view all the answers

What is the primary factor to consider before investing in an ETF?

The ETF's management costs and liquidity Signup and view all the answers

Which factor contributes to foreign currency risk in international investments?

Exchange rates affecting nominal returns in domestic currency Signup and view all the answers

Why might some ETFs not fully replicate the benchmark index?

The costs of matching the index perfectly are prohibitive Signup and view all the answers

Study Notes

Hedge Fund Risks

Light Regulatory Oversight: Hedge funds are less regulated than other investments, meaning investors may not have full transparency into how their money is being managed.
Market Risk: Hedge funds aim for positive returns regardless of market trends, exposing them to risks associated with interest rates, equities, currencies, and commodities.
Liquidity Constraints: Hedge funds typically have difficulty liquidating assets quickly, making it hard for investors to access their funds on short notice.
Investment Strategy Risk: Complex hedge fund strategies can be difficult for investors to understand, meaning they may not fully grasp the risks involved.

Closed-End Funds

Characteristics: Closed-end funds are traded on stock exchanges with a fixed number of shares, unlike open-end mutual funds.
Advantages: Offer opportunities for short-selling and leverage, managers can pursue long-term strategies without needing to reserve liquid assets for redemptions, and investors may benefit from lower management costs.
Risks: May trade at a discount to their net asset value, especially during volatile markets, have lower liquidity than open-end funds, and carry leverage risk due to the use of borrowed money.

Exchange-Traded Funds (ETFs)

Characteristics: Trade on stock exchanges, similar to individual stocks, and often track specific indexes or sectors.
Advantages: Offer diversification, liquidity, and lower costs compared to some mutual funds.
Risks: Possible tracking errors, concentration risk due to potential for overweighting of specific sectors or stocks, and higher fees for specialty ETFs.
Costs: Typically involve commission fees for buying and selling, along with management fees and operating expenses.

Segregated Funds

Guaranteed Maturity: Offer a guaranteed minimum payout at maturity, protecting against market losses.
Reset Options: Allow investors to lock in accrued value at certain intervals, protecting gains while resetting the guarantee period.
Death Benefits: Guarantee beneficiaries or estates will receive at least the original invested amount, even if the market value is lower.

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Description

This quiz explores the risks associated with hedge funds and the characteristics of closed-end funds. Learn about market risks, liquidity constraints, and the unique advantages of closed-end funds compared to traditional mutual funds.