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Free Questions › CFA › Alternative Investments
Free CFA Alternative Investments Practice Questions & Answers
550 exam-style Alternative Investments questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 301
Which of the following hedge fund strategies is most likely to be negatively correlated with equity markets during a financial crisis?
Select an option first.
Correct answer: C — Short-biased equity fund
Explanation: A short-biased fund holds net short equity positions — it profits when markets fall. During crises, it typically gains while other strategies lose. A, B, D are net long in risk assets and would suffer. C benefits from market declines.
Question 302
NFT (Non-Fungible Token) markets have suffered from which risk that traditional art markets also face?
Select an option first.
Correct answer: C — Illiquidity and price discovery challenges — NFTs can be difficult to value and trade due to their unique, one-of-a-kind nature
Explanation: Like rare art, NFTs are unique — no two are the same, making price discovery difficult. Markets can be illiquid (few buyers for specific NFTs). Prices can collapse dramatically. A is wrong. B affects tech but not specifically NFT market structure. D is wrong.
Question 303
A hedge fund has $200M AUM. After a 30% gross return ($60M profit), the fund charges 2% management fee and 20% performance fee (no hurdle, no HWM). Net return to investors is approximately:
Select an option first.
Correct answer: B — 23.2%
Explanation: Management fee = 2% × $200M = $4M. Profit after mgmt fee = $60M − $4M = $56M. Performance fee = 20% × $56M = $11.2M. Net profit = $56M − $11.2M = $44.8M. Net return = $44.8M / $200M = 22.4% ≈ 22-23%. Closest to B (23.2%). Note: some calculate mgmt fee on beginning NAV and performance fee on net profit. Slight variations are possible.
Question 304
Digital assets are characterized by which of the following return features?
Select an option first.
Correct answer: C — Extremely high volatility, potential for large drawdowns, and limited track record
Explanation: Crypto assets have experienced drawdowns of 80%+ (Bitcoin from 2017-18 peak), extreme volatility, and unclear long-term return drivers. Their limited history makes risk assessment difficult. A and D are wrong. B is wrong.
Question 305
A fund charging '0 and 30' fees would be charging:
Select an option first.
Correct answer: B — Zero management fee and a 30% performance fee
Explanation: '0 and 30': 0% management fee, 30% performance fee. This is a high-watermark-only structure used by some quant/high-frequency funds to align interests — no base fee, but large performance share. A reverses. C is wrong. D is wrong.
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Question 306
In hedge fund analysis, 'drawdown' refers to:
Select an option first.
Correct answer: B — The peak-to-trough decline in NAV — measuring the largest loss from a high point before a new high is reached
Explanation: Maximum drawdown captures the worst-case loss scenario — from peak NAV to subsequent trough. It is a key risk metric for hedge funds. A is redemption. C and D are wrong.
Question 307
Why might a fund-of-hedge-funds be preferred by a smaller institutional investor?
Select an option first.
Correct answer: C — It provides access to top hedge fund managers with lower minimums and diversification across strategies, which would otherwise be inaccessible
Explanation: FoHFs aggregate capital to meet high hedge fund minimums, diversify across managers, and provide due diligence. Smaller investors gain access they couldn't achieve individually. A is wrong. B is wrong — FoHF adds a fee layer. D is wrong.
Question 308
The primary reason alternative investment returns are difficult to compare to traditional investment returns is:
Select an option first.
Correct answer: C — Differences in liquidity, fee structures, leverage, return smoothing from appraisal-based valuations, and survivorship bias make direct comparisons unreliable
Explanation: Multiple factors complicate comparisons: illiquidity premiums embedded in returns, smoothed valuations, leverage amplification, reporting biases, and higher fees. Adjusting for these is complex. A, B, D are wrong.
Question 309
A hedge fund's 'sharpe ratio' of 1.5 means:
Select an option first.
Correct answer: C — The fund earned 1.5 units of excess return per unit of total risk — indicating strong risk-adjusted performance
Explanation: Sharpe ratio = (Fund return − Rf) / σ. SR of 1.5 means 1.5% excess return for each 1% of standard deviation. Above 1.0 is generally considered good. A uses 'times market.' B is wrong sign. D is beta.
Question 310
'Alpha decay' in a quantitative hedge fund strategy refers to:
Select an option first.
Correct answer: C — The erosion of a strategy's profitability over time as more capital exploits the same opportunity, narrowing the mispricing
Explanation: When a profitable quant strategy becomes widely known, many funds trade it simultaneously, arbitraging away the inefficiency. Alpha decays as competition erodes the edge. A and B are wrong. D is a risk but not alpha decay.
Question 311
The 'long volatility' hedge fund strategy profits when:
Select an option first.
Correct answer: C — Market volatility increases — through options or volatility derivatives that gain value during turbulent markets
Explanation: Long vol strategies (e.g., buying puts, VIX calls, or volatility swaps) profit from spikes in volatility. They often lose money slowly in calm markets but provide crisis insurance. A describes short vol. B and D are unrelated.
Question 312
A hedge fund that profits from the spread between a takeover offer price and the current trading price of the target company is employing:
Select an option first.
Correct answer: C — Merger (risk) arbitrage — buying the target stock at a discount to the announced deal price
Explanation: After a deal is announced, the target stock typically trades below the offer price (reflecting deal uncertainty). Merger arb buys the target to capture this spread. A is bonds-to-equity arb. B is yield curve. D is incomplete.
Question 313
'Multi-strategy' hedge funds allocate capital across:
Select an option first.
Correct answer: B — Several distinct strategy types within a single fund (e.g., equity L/S, fixed income arb, macro, event-driven)
Explanation: Multi-strategy funds run several different strategies under one roof, allocating dynamically to maximize risk-adjusted returns. This provides internal diversification and faster capital reallocation vs. a FoHF. A, C, D are wrong.
Question 314
The 'Sortino ratio' improves on the Sharpe ratio for hedge fund analysis by:
Select an option first.
Correct answer: C — Using only downside deviation (below a minimum acceptable return) rather than total standard deviation in the denominator
Explanation: Sortino ratio = (Return − MAR) / Downside deviation. It penalizes only bad volatility (below-target returns), not good volatility (above-target upswings). For hedge funds with asymmetric return distributions, this is more appropriate than Sharpe. A, B, D are wrong.
Question 315
Tokenization of a private equity fund's LP interests would primarily enable:
Select an option first.
Correct answer: C — Fractional ownership, secondary market trading, and improved liquidity for what is traditionally an illiquid investment
Explanation: Tokenizing LP interests creates digital ownership records on a blockchain, enabling fractional sales, 24/7 trading, and broader investor access. This could address one of PE's biggest drawbacks — illiquidity. A and B are unrelated. D is a fund administration feature.
Question 316
A hedge fund with a Sharpe ratio of 0.3 and annualized standard deviation of 15% has an annualized excess return above the risk-free rate of approximately:
Select an option first.
Correct answer: B — 4.5%
Explanation: Excess return = Sharpe × σ = 0.3 × 15% = 4.5%. A would need Sharpe=0.2. C is σ itself. D is Sharpe alone.
Question 317
Which of the following characteristics makes hedge funds more complex to value than mutual funds?
Select an option first.
Correct answer: C — Hedge funds often hold illiquid, OTC, or hard-to-value positions (derivatives, private securities, distressed debt) without daily market prices
Explanation: Valuation complexity in hedge funds stems from illiquid holdings, OTC derivatives priced by models, distressed positions, and private company stakes — none of which have readily observable market prices. A is wrong. B is wrong. D is wrong.
Question 318
Which of the following digital assets is designed to maintain a stable value?
Select an option first.
Correct answer: C — USD Coin (USDC) — a stablecoin pegged to the US dollar
Explanation: USDC is a stablecoin backed 1:1 by USD-denominated assets, maintaining a $1 peg. Bitcoin (A) and Ether (B) are highly volatile. Dogecoin (D) is also volatile. C is the stablecoin designed for stability.
Question 319
The primary economic role of a blockchain's 'miner' or 'validator' is:
Select an option first.
Correct answer: C — To verify and record transactions on the blockchain, maintaining ledger integrity and earning newly issued coins as compensation
Explanation: Miners (PoW) and validators (PoS) verify transactions, prevent double-spending, and add new blocks to the chain. They are economically compensated through block rewards and transaction fees. A, B, D are other roles.
Question 320
A 'hard fork' in a blockchain occurs when:
Select an option first.
Correct answer: B — The blockchain splits into two incompatible versions due to a protocol disagreement among participants
Explanation: Hard forks occur when a portion of the network adopts new rules incompatible with the old protocol, creating two separate chains (e.g., Bitcoin/Bitcoin Cash). A is market price movement. C is mining reward. D is a 'soft fork' (backward-compatible upgrade).
Question 321
Digital asset custody solutions address which investment risk?
Select an option first.
Correct answer: C — Secure storage and access to private keys — preventing theft, loss, or unauthorized access to digital assets
Explanation: Custody is critical for digital assets because private key loss = permanent loss of assets. Institutional custodians (Coinbase Custody, Fidelity Digital Assets) provide secure cold storage. A is market risk. B is regulatory risk. D is liquidity risk.
Question 322
Which of the following describes an 'Exchange-Traded Product' (ETP) providing digital asset exposure?
Select an option first.
Correct answer: C — A listed financial instrument (e.g., a Bitcoin ETF or ETC) that tracks digital asset prices and trades on traditional exchanges
Explanation: ETPs (including ETFs, ETNs, ETCs) let traditional investors gain crypto exposure through regulated, exchange-listed instruments without directly managing wallets and keys. A is direct custody. B is DeFi. D is exchange account.
Question 323
The primary disadvantage of a fund-of-hedge-funds (FoHF) compared to direct hedge fund investing is:
Select an option first.
Correct answer: C — An additional layer of fees that significantly reduces net returns to investors
Explanation: FoHF adds 1%+10% on top of underlying hedge fund fees (2%+20%), significantly compressing net returns. For institutional investors who can access hedge funds directly, this fee drag often eliminates the benefit. A is reversed. B is an advantage. D is also reversed.
Question 324
A hedge fund strategy that exploits price discrepancies between a stock's price across different exchanges or venues is called:
Select an option first.
Correct answer: C — Cross-market (or inter-market) arbitrage
Explanation: Inter-market arbitrage exploits temporary price differences for the same security trading in different venues or as equivalent instruments. With algorithmic trading, these opportunities are tiny and rapidly arbitraged away. A is macro. B is statistical model-based. D is bond/equity mispricing.
Question 325
Which of the following hedge fund strategies has the HIGHEST expected correlation with equity markets?
Select an option first.
Correct answer: B — Equity long/short (net long 70%)
Explanation: A net 70% long equity L/S fund retains substantial equity market exposure. Its returns will be heavily influenced by equity market direction. A, C, D use diverse strategies with lower net equity exposure.
Question 326
Which of the following is a key challenge in digital asset regulation regarding investor protection?
Select an option first.
Correct answer: B — Many digital assets are issued without prospectuses, are unregistered, lack investor protection disclosures, and operate across jurisdictions that have inconsistent rules
Explanation: Digital assets lack the consumer protection infrastructure of traditional securities — no mandatory disclosures, no SIPC-like protection, cross-border regulatory gaps, and ambiguous classification. A, C, D are wrong.
Question 327
A hedge fund that has a 'hard lock-up' of 2 years means:
Select an option first.
Correct answer: B — Investors absolutely cannot redeem capital for 2 years — no exceptions permitted
Explanation: A hard lock-up is a strict restriction — no redemptions under any circumstances during the lock-up period. A soft lock-up permits early redemption with a penalty fee. A, C, D are wrong.
Question 328
A hedge fund's 'net exposure' of -20% means:
Select an option first.
Correct answer: B — Short positions exceed long positions by 20% of NAV — net short overall
Explanation: Net exposure = Long % − Short %. −20% means the fund is net short — shorts are 20% larger than longs. The fund benefits from falling markets. A is return. C and D are wrong.
Question 329
A 'decentralized exchange' (DEX) in cryptocurrency markets differs from a centralized exchange by:
Select an option first.
Correct answer: C — Operating via smart contracts without a central intermediary — users trade directly from their wallets without depositing funds to an exchange
Explanation: DEXs (Uniswap, Curve) use automated market maker smart contracts for peer-to-peer trading directly from wallets. No central custodian holds funds. Centralized exchanges (Coinbase, Binance) custody assets and match orders. A, B, D are wrong.
Question 330
Hedge funds are primarily marketed to which type of investor?
Select an option first.
Correct answer: C — Accredited investors, qualified purchasers, and institutional investors — typically subject to minimum investment thresholds and suitability requirements
Explanation: Due to limited regulation, hedge funds restrict access to sophisticated investors who can assess risk — accredited investors ($1M+ net worth) or qualified purchasers ($5M+ investments). High minimums ($1M+) further restrict access. A, B, D are wrong.
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