CAIA REVIEW EXAM ACTUAL UPDATED
QUESTIONS AND ANSWERS SURE A+
✔✔List the three primary categories of single-strategy event-driven hedge funds. - ✔✔1)
Activist Hedge Funds
2) Merger Arbitrage Funds
3) Distressed Securities Funds
✔✔Why are event-driven hedge funds often characterized as selling insurance? -
✔✔Event-driven hedge funds are often characterized as selling insurance because they
purchase shares during the period near an event (such as a proposed merger
announcement) and the eventual resolution of uncertainty regarding the event. This act
may be viewed as providing event risk insurance to the equity market.
✔✔Why would activist hedge fund managers need to understand corporage
governance? - ✔✔Corporate governance is central to the activist hedge fund's
investment strategy as it is the means to assert change or threat of change into the
management of the target corporation.
✔✔List the five dimensions of shareholder activists - ✔✔1) Financial versus social
activists
2) Activists versus pacifists
3) Imitators versus followers
4) Friendly versus hostile activists
,5) Active activists versus passive activists
✔✔What is the economic term for a person or entity who allows others to pay initial
costs and then benefits from those expenditures? - ✔✔A free rider
✔✔Is Form 13F a U.S.-required form that is targeted towards activist hedge funds? -
✔✔No, Form 13F is a required quarterly filing of all long positions by all U.S. asset
managers who over $100m in assets under management, including hedge funds and
mutual funds, among other investors.
✔✔What is the difference between a spin-off and a split-off? - ✔✔1) A spin-off occurs
when a publicly traded firm splits into two publicly traded firms, with shareholders in the
original firm automatically becoming shareholders in the new firm.
2) A split-off occurs when Company A splits off (divests) Company B and the investors
in Company A have the choice to retain their ownership in Company A or exchange
their shares in A for shares in the newly created firm (Company B)
✔✔What are the positions utilized in a traditional merger arbitrage strategy? -
✔✔Traditional merger arbitrage generally uses leverage to buy the stock of the firm that
is to be acquired and sell short the stock of the firm that is to be the acquirer in a stock-
for-stock merger.
✔✔What is the financing risk in the context of an event-driven investment strategy? -
✔✔Financing risk is the economic dispersion caused by failure or potential failure of an
entity, such as an acquiring firm, to secure the funding necessary to consummate a plan
such as an acquisition.
✔✔How is short selling of equity in a distressed firm similar to an option position? -
✔✔Shares in highly leveraged firms resemble call options, therefore short-selling
distressed equities is analogous to writing naked call options on the firm's assets and
generates a negatively skewed return distribution. An investor has a naked option
position when the investor is short an option position for which the investor does not
also have a hedged position.
✔✔Describe the positions utilized in a classic convertible bond arbitrage trade. - ✔✔The
classic convertible bond arbitrage trade is to purchase a convertible bond that is
believed to be undervalued and to hedge its risk using a short position in the underlying
equity.
✔✔What are the three terms used to describe convertible bonds differentiated by
whether the implicit option in the bond is in-the-money, at-the-money, or out-of-the-
money? - ✔✔Equity-like convertible, hybrid convertibles, busted convertibles,
respectively.
,✔✔What is the difference between delta and theta in measuring the price sensitivity of
an option? - ✔✔Delta is the change in the value of the option with respect to a change
in the value of the underlying asset, whereas theta is the change in the value of the
option with respect to the time to expiration of the option (i.e., passage of time).
✔✔What is the term that describes when additional equity is issued at below market
values causing the per share value of the holdings of existing shareholders to be
diminished? - ✔✔Dilution
✔✔List the components of the returns of a traditional convertible arbitrage straegy. -
✔✔1) Convertible Bond Arbitrage Income:
-(Bond Interest - Stock Dividends + Short Stock Rebate - Financing Expenses)
2) Convertible Bond and Stock Net Capital Gains and Losses:
-(Capital Gains on Stock and Bond - Capital Losses on Stock and Bond)
✔✔What is the key difference between a volatility swap and a variance swap? -
✔✔Variance swaps are forward contracts wherein one party agrees to make a cash
payment to the other party linearly based on the realized variance of a price or rate in
exchange for receiving a predetermined cash flow. A volatility swap mirrors a variance
swap except that the payoff of the contract is linearly based on the standard deviation of
a return series rather than the variance.
✔✔What is the primary term for financial arrangements that protect an investor's
portfolio from tail risk? - ✔✔Portfolio insurance
✔✔What are the differences between duration, modified duration and effective
duration? - ✔✔1) Duration is a measure of the sensitivity of a fixed income security to a
change in the general level of interest rates. Traditional duration may also be viewed as
a weighted average of the longevity of the cash flows of a fixed-income security.
2) Modified duration is equal to traditional duration divided by the quantity [1 + y/m],
where y is the stated annual yield, m is the number of compounding periods per year,
and y/m is the periodic yield. With continuous compounding periods per year, and y/m is
the periodic yield. With continuous compounding, m is infinity, and traditional duration
equals modified duration. Modified duration scales traditional duration to adjust for the
compounding assumption used in the interest rate computations.
3) Effective duration is a measure of the interest rate sensitivity of a position that
includes the effects of embedded option characteristics. As such it is not generally equal
to the weighted average longevity of the cash flows.
✔✔What is the primary term for financial arrangements that protect an investor's
portfolio from tail risk? - ✔✔Portfolio insurance
✔✔What is the key difference between a volatility swap and a variance swap? -
✔✔Variance swaps are forward contracts wherein one party agrees to make a cash
, payment to the other party linearly based on the realized variance of a price or rate in
exchange for receiving a predetermined cash flow. A volatility swap mirrors a variance
swap except that the payoff of the contract is linearly based on the standard deviation of
a return series rather than the variance.
✔✔What is the difference between a yield curve and a term structure of interest rates? -
✔✔The yield curve plots yields to maturity of coupon bonds, while the term structure of
interest rates generally is used to denote actual or hypothetical yields of zero-coupon
bonds.
✔✔For what type of interest rate shift is duration-neutral position best protected? - ✔✔A
duration-neutral position is protected from value changes due to shifts in the yield curve
that are small (infinitesimal), immediate (instantaneous), and parallel (additive).
✔✔Describe the role of a market maker in the context of taking and/or providing liquidity
in a market with anxious traders. - ✔✔A market maker is a market participant that offers
liquidity, typically both on the buy side and placing bid orders and on the sell side by
placing offer orders. A market maker meets imbalances in supply and demand for
shares caused by idiosyncratic trade orders from anxious traders. Typically, the market
maker's purpose for providing liquidity is to earn the spread between the bid and the
offer prices by buying at the bid price and selling at the offer price.
✔✔Why is an empirical test of informational market efficient a test of joint hypotheses? -
✔✔The test is a joint hypothesis of the appropriateness of the particular model of
returns (in determining what constitutes an abnormal return) and a test of whether a
particular investment has generated statistically significant abnormal returns.
✔✔Define standardized unexpected earnings, and describe how the measure is used. -
✔✔Standardized unexpected earnings (SUE) is a measure of earnings surprise, with
some measure of unexpected earnings in the numerator and some measure of earnings
volatility in the denominator.
✔✔What have empirical studies generally concluded bout the relationship between the
net stock issuance of a firm and the subsequent returns of the firm's shareholders? -
✔✔There is evidence that positive or negative net stock issuance is one of the most
profitable anomalies. Companies that issue large amounts of new shares, such as more
than 20% of the shares currently outstanding, frequently see their stock price
substantially underperform the market.
✔✔What is the name of the measure that describes managerial skill as the correlation
between managerial return predictions and realized return? - ✔✔The information
coefficient, which measures managerial skill as the correlation between managerial
return predictions and realized returns
QUESTIONS AND ANSWERS SURE A+
✔✔List the three primary categories of single-strategy event-driven hedge funds. - ✔✔1)
Activist Hedge Funds
2) Merger Arbitrage Funds
3) Distressed Securities Funds
✔✔Why are event-driven hedge funds often characterized as selling insurance? -
✔✔Event-driven hedge funds are often characterized as selling insurance because they
purchase shares during the period near an event (such as a proposed merger
announcement) and the eventual resolution of uncertainty regarding the event. This act
may be viewed as providing event risk insurance to the equity market.
✔✔Why would activist hedge fund managers need to understand corporage
governance? - ✔✔Corporate governance is central to the activist hedge fund's
investment strategy as it is the means to assert change or threat of change into the
management of the target corporation.
✔✔List the five dimensions of shareholder activists - ✔✔1) Financial versus social
activists
2) Activists versus pacifists
3) Imitators versus followers
4) Friendly versus hostile activists
,5) Active activists versus passive activists
✔✔What is the economic term for a person or entity who allows others to pay initial
costs and then benefits from those expenditures? - ✔✔A free rider
✔✔Is Form 13F a U.S.-required form that is targeted towards activist hedge funds? -
✔✔No, Form 13F is a required quarterly filing of all long positions by all U.S. asset
managers who over $100m in assets under management, including hedge funds and
mutual funds, among other investors.
✔✔What is the difference between a spin-off and a split-off? - ✔✔1) A spin-off occurs
when a publicly traded firm splits into two publicly traded firms, with shareholders in the
original firm automatically becoming shareholders in the new firm.
2) A split-off occurs when Company A splits off (divests) Company B and the investors
in Company A have the choice to retain their ownership in Company A or exchange
their shares in A for shares in the newly created firm (Company B)
✔✔What are the positions utilized in a traditional merger arbitrage strategy? -
✔✔Traditional merger arbitrage generally uses leverage to buy the stock of the firm that
is to be acquired and sell short the stock of the firm that is to be the acquirer in a stock-
for-stock merger.
✔✔What is the financing risk in the context of an event-driven investment strategy? -
✔✔Financing risk is the economic dispersion caused by failure or potential failure of an
entity, such as an acquiring firm, to secure the funding necessary to consummate a plan
such as an acquisition.
✔✔How is short selling of equity in a distressed firm similar to an option position? -
✔✔Shares in highly leveraged firms resemble call options, therefore short-selling
distressed equities is analogous to writing naked call options on the firm's assets and
generates a negatively skewed return distribution. An investor has a naked option
position when the investor is short an option position for which the investor does not
also have a hedged position.
✔✔Describe the positions utilized in a classic convertible bond arbitrage trade. - ✔✔The
classic convertible bond arbitrage trade is to purchase a convertible bond that is
believed to be undervalued and to hedge its risk using a short position in the underlying
equity.
✔✔What are the three terms used to describe convertible bonds differentiated by
whether the implicit option in the bond is in-the-money, at-the-money, or out-of-the-
money? - ✔✔Equity-like convertible, hybrid convertibles, busted convertibles,
respectively.
,✔✔What is the difference between delta and theta in measuring the price sensitivity of
an option? - ✔✔Delta is the change in the value of the option with respect to a change
in the value of the underlying asset, whereas theta is the change in the value of the
option with respect to the time to expiration of the option (i.e., passage of time).
✔✔What is the term that describes when additional equity is issued at below market
values causing the per share value of the holdings of existing shareholders to be
diminished? - ✔✔Dilution
✔✔List the components of the returns of a traditional convertible arbitrage straegy. -
✔✔1) Convertible Bond Arbitrage Income:
-(Bond Interest - Stock Dividends + Short Stock Rebate - Financing Expenses)
2) Convertible Bond and Stock Net Capital Gains and Losses:
-(Capital Gains on Stock and Bond - Capital Losses on Stock and Bond)
✔✔What is the key difference between a volatility swap and a variance swap? -
✔✔Variance swaps are forward contracts wherein one party agrees to make a cash
payment to the other party linearly based on the realized variance of a price or rate in
exchange for receiving a predetermined cash flow. A volatility swap mirrors a variance
swap except that the payoff of the contract is linearly based on the standard deviation of
a return series rather than the variance.
✔✔What is the primary term for financial arrangements that protect an investor's
portfolio from tail risk? - ✔✔Portfolio insurance
✔✔What are the differences between duration, modified duration and effective
duration? - ✔✔1) Duration is a measure of the sensitivity of a fixed income security to a
change in the general level of interest rates. Traditional duration may also be viewed as
a weighted average of the longevity of the cash flows of a fixed-income security.
2) Modified duration is equal to traditional duration divided by the quantity [1 + y/m],
where y is the stated annual yield, m is the number of compounding periods per year,
and y/m is the periodic yield. With continuous compounding periods per year, and y/m is
the periodic yield. With continuous compounding, m is infinity, and traditional duration
equals modified duration. Modified duration scales traditional duration to adjust for the
compounding assumption used in the interest rate computations.
3) Effective duration is a measure of the interest rate sensitivity of a position that
includes the effects of embedded option characteristics. As such it is not generally equal
to the weighted average longevity of the cash flows.
✔✔What is the primary term for financial arrangements that protect an investor's
portfolio from tail risk? - ✔✔Portfolio insurance
✔✔What is the key difference between a volatility swap and a variance swap? -
✔✔Variance swaps are forward contracts wherein one party agrees to make a cash
, payment to the other party linearly based on the realized variance of a price or rate in
exchange for receiving a predetermined cash flow. A volatility swap mirrors a variance
swap except that the payoff of the contract is linearly based on the standard deviation of
a return series rather than the variance.
✔✔What is the difference between a yield curve and a term structure of interest rates? -
✔✔The yield curve plots yields to maturity of coupon bonds, while the term structure of
interest rates generally is used to denote actual or hypothetical yields of zero-coupon
bonds.
✔✔For what type of interest rate shift is duration-neutral position best protected? - ✔✔A
duration-neutral position is protected from value changes due to shifts in the yield curve
that are small (infinitesimal), immediate (instantaneous), and parallel (additive).
✔✔Describe the role of a market maker in the context of taking and/or providing liquidity
in a market with anxious traders. - ✔✔A market maker is a market participant that offers
liquidity, typically both on the buy side and placing bid orders and on the sell side by
placing offer orders. A market maker meets imbalances in supply and demand for
shares caused by idiosyncratic trade orders from anxious traders. Typically, the market
maker's purpose for providing liquidity is to earn the spread between the bid and the
offer prices by buying at the bid price and selling at the offer price.
✔✔Why is an empirical test of informational market efficient a test of joint hypotheses? -
✔✔The test is a joint hypothesis of the appropriateness of the particular model of
returns (in determining what constitutes an abnormal return) and a test of whether a
particular investment has generated statistically significant abnormal returns.
✔✔Define standardized unexpected earnings, and describe how the measure is used. -
✔✔Standardized unexpected earnings (SUE) is a measure of earnings surprise, with
some measure of unexpected earnings in the numerator and some measure of earnings
volatility in the denominator.
✔✔What have empirical studies generally concluded bout the relationship between the
net stock issuance of a firm and the subsequent returns of the firm's shareholders? -
✔✔There is evidence that positive or negative net stock issuance is one of the most
profitable anomalies. Companies that issue large amounts of new shares, such as more
than 20% of the shares currently outstanding, frequently see their stock price
substantially underperform the market.
✔✔What is the name of the measure that describes managerial skill as the correlation
between managerial return predictions and realized return? - ✔✔The information
coefficient, which measures managerial skill as the correlation between managerial
return predictions and realized returns
