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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 331
A hedge fund manager uses 'Renaissance Technologies'-style quantitative strategies. Which of the following BEST describes such an approach?
Select an option first.
Correct answer: C — Systematic, data-driven trading strategies using mathematical models, statistical analysis, and large datasets to identify short-lived market inefficiencies
Explanation: Quant funds like Renaissance use complex mathematical models on vast historical data to identify predictive patterns. These are systematic (no human discretion on individual trades), often high-frequency, and target small recurring edges. A and B are fundamental approaches. D is passive.
Question 332
A hedge fund that employs 'risk parity' allocates capital such that:
Select an option first.
Correct answer: C — Each asset class contributes equally to portfolio risk — typically resulting in larger bond allocations and leverage on low-vol assets
Explanation: Risk parity (Bridgewater's All Weather) allocates based on risk contribution rather than capital. Bonds have low vol, so they receive large allocations (often leveraged); equities have high vol, so they receive smaller allocations. A and B ignore risk weighting. D is wrong.
Question 333
'Capacity' constraints in hedge fund strategies mean:
Select an option first.
Correct answer: B — The strategy has a finite profit pool — as more capital is deployed, returns diminish because the fund moves markets or the mispricing is arbitraged away
Explanation: Many alpha-generating strategies are capacity-constrained: small inefficiencies that yield good risk-adjusted returns on $100M may generate much lower returns on $10B because the fund's own trades move prices. A, C, D are wrong.
Question 334
A hedge fund's 'notional exposure' exceeds its 'net asset value' when the fund uses:
Select an option first.
Correct answer: B — Leverage — borrowing allows controlling more assets than equity invested
Explanation: Leverage allows a fund to control positions exceeding its NAV. A 2x leveraged fund with $100M NAV controls $200M in assets. Notional exposure > NAV whenever leverage is employed. A, C, D describe non-leveraged approaches.
Question 335
A hedge fund uses prime brokerage services primarily to access:
Select an option first.
Correct answer: C — Leverage, short-selling facilitation, custody, securities lending, and operational infrastructure from a large investment bank
Explanation: Prime brokers provide hedge funds with: margin lending (leverage), securities lending (to short), custody, clearing, risk management tools, and capital introduction. These services are essential to most hedge fund strategies. A, B, D are wrong.
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Question 336
The term 'two and twenty' has become less standard in hedge funds in recent years because:
Select an option first.
Correct answer: C — Increased competition, institutional investor pressure, and widespread underperformance vs. benchmarks have led many funds to accept lower fees
Explanation: Fee compression in hedge funds: large institutional investors (pensions) demanded lower fees; passive investing alternatives made fee-sensitive investors pickier; persistent underperformance vs. cheaper benchmarks reduced willingness to pay '2 and 20.' B and D are wrong. A is incorrect.
Question 337
Bitcoin is often described as 'digital gold' primarily because:
Select an option first.
Correct answer: C — Bitcoin has a fixed maximum supply (21 million coins), creating scarcity similar to gold — making it a potential store of value and inflation hedge
Explanation: Bitcoin's capped supply (21M coins) creates digital scarcity analogous to gold's limited supply. This makes it appealing as a store of value and inflation hedge to some investors. A is wrong — both generate no yield. B is wrong — they don't always correlate. D is wrong.
Question 338
Which of the following is an example of a 'real asset-backed' digital token?
Select an option first.
Correct answer: C — A tokenized real estate investment where each token represents a fractional ownership of a specific property
Explanation: Real asset-backed tokens represent digital claims on physical assets — real estate, commodities, or art. They differ from pure crypto assets by having underlying tangible value. A and B are pure cryptocurrencies. D is a governance/utility token.
Question 339
In the context of alternative investments, 'leverage' refers to:
Select an option first.
Correct answer: B — Using borrowed capital to amplify investment returns (and risk)
Explanation: Financial leverage means using debt alongside equity — allowing control of more assets than equity alone. Returns (and losses) are amplified. In hedge funds, leverage is typically obtained through prime brokerage. A is operational control. C is diversification. D is fees.
Question 340
The 'market impact' of a large hedge fund trade is:
Select an option first.
Correct answer: B — The effect of the trade on the market price — a large buy order can push up prices, making execution more expensive than anticipated
Explanation: Large institutional trades move markets. A large buy order increases prices (market impact), so execution cost exceeds the pre-trade price. This is transaction cost analysis (TCA) territory. A, C, D are wrong.
Question 341
A hedge fund with a 'soft lock-up' of 1 year means:
Select an option first.
Correct answer: B — Investors may redeem before 1 year but will incur a penalty fee (e.g., 3% of redemption amount)
Explanation: Soft lock-ups permit early redemption with a financial penalty (redemption fee), unlike hard lock-ups which prohibit redemption entirely. This gives the manager some stability while giving investors a (costly) exit option. A is hard lock-up. C and D are wrong.
Question 342
The 'carry trade' in global macro hedge funds involves:
Select an option first.
Correct answer: C — Borrowing in low-interest-rate currencies and investing in higher-yielding currencies to profit from the interest rate differential
Explanation: Currency carry trade: borrow in USD/JPY at low rates, invest in high-yield currencies (AUD, BRL). Profit = interest differential. Risk: sudden currency moves can wipe out the carry. A, B, D are wrong.
Question 343
Hedge funds face 'headline risk' primarily because:
Select an option first.
Correct answer: B — High-profile failures or scandals (Madoff, Amaranth) attract negative media attention that can trigger investor redemptions across the industry
Explanation: Headline risk is reputational contagion — a major hedge fund fraud or collapse (even at a different fund) can cause investors to question the entire sector and redeem broadly. A, C, D are wrong.
Question 344
A hedge fund with gross exposure of 200% (100% long + 100% short) and net exposure of 0% is BEST described as:
Select an option first.
Correct answer: B — Leveraged and market neutral
Explanation: Gross exposure 200% = 2x leverage (borrowing funds to run both long and short books). Net exposure 0% = market neutral (long = short). So: leveraged AND market neutral. A is unleveraged (gross=100%). C is directional (net ≠ 0). D is wrong.
Question 345
The use of 'high-frequency trading' (HFT) algorithms in hedge funds is primarily associated with:
Select an option first.
Correct answer: C — Ultra-short holding periods (milliseconds to seconds), exploiting tiny price discrepancies and market microstructure inefficiencies at very high speed
Explanation: HFT strategies hold positions for fractions of a second, exploiting bid-ask spreads, order flow patterns, and latency advantages. Returns per trade are tiny but volume is massive. A, B, D are inconsistent with HFT. C is correct.
Question 346
In alternative investment due diligence, 'operational due diligence' (ODD) focuses on:
Select an option first.
Correct answer: C — Assessing the fund manager's operational processes — including legal structure, compliance, IT systems, accounting, and risk management infrastructure
Explanation: ODD complements investment DD by evaluating the operational robustness of the manager: legal/compliance functions, fund administration, technology systems, trade execution, and key-person dependencies. A and B are investment DD. D is macroeconomic analysis.
Question 347
A hedge fund charges 2% management fee on $100M AUM and earns 20% performance fee on $15M profit. Total fees are:
Select an option first.
Correct answer: A — $5M
Explanation: Management fee = 2% × $100M = $2M. Performance fee = 20% × $15M = $3M. Total fees = $2M + $3M = $5M. B is performance fee only. C and D are wrong.
Question 348
Alternative investments are BEST distinguished from traditional investments by:
Select an option first.
Correct answer: B — Lower liquidity, less regulation, limited transparency, and unique risk-return profiles
Explanation: Alternative investments differ from traditional stocks and bonds through their structural characteristics: limited liquidity, lighter regulation, less price transparency, and access to risk premiums unavailable in public markets. A is not guaranteed. C is wrong. D is wrong.
Question 349
Which of the following is NOT typically classified as a private capital investment?
Select an option first.
Correct answer: C — Listed shares of a large technology company
Explanation: Private capital encompasses privately held equity (venture capital, buyouts) and private debt instruments. Publicly listed shares trade on exchanges — they are traditional (public) equity, not private capital. A, B, D are all private capital categories.
Question 350
Venture capital primarily targets:
Select an option first.
Correct answer: C — Early-stage or start-up companies with high growth potential
Explanation: Venture capital provides capital to young, high-growth-potential companies — often technology or life sciences — that cannot access public markets or traditional bank loans. A and B describe buyout/distressed strategies. D is infrastructure investing.
Question 351
A leveraged buyout (LBO) transaction is characterized by:
Select an option first.
Correct answer: B — Acquiring a company using a large proportion of debt, with the acquired company's assets and cash flows as collateral
Explanation: LBOs use significant debt (leverage) to acquire a company, with the target's assets and cash flows securing the debt. The equity portion is relatively small. This amplifies returns but also risk. A is wrong. C is venture capital. D is unrelated.
Question 352
The 'J-curve effect' in private equity refers to:
Select an option first.
Correct answer: B — Negative cash flows and returns in early years followed by positive returns as investments mature and are exited
Explanation: In early years, PE funds draw capital (negative cash flow to LP) and expenses exceed gains. As companies mature and are sold, returns turn positive and eventually exceed the initial negative period — tracing a J-shape over time. A, C, D are wrong.
Question 353
A private equity fund's 'vintage year' refers to:
Select an option first.
Correct answer: B — The year the fund made its first investment or closed to new investors
Explanation: Vintage year identifies when a PE fund was launched (first close or first investment). It allows comparison of funds raised in similar economic environments and tracks return patterns across market cycles. A, C, D are wrong.
Question 354
Which of the following best describes 'mezzanine debt' in the context of private capital?
Select an option first.
Correct answer: B — Subordinated debt that ranks between senior debt and equity, often with equity-like features such as warrants
Explanation: Mezzanine debt sits in the capital structure between senior secured debt and equity. It bears more risk than senior debt (subordinated, unsecured) but compensates with higher yields and often equity participation through warrants or conversion rights. A is senior secured. C is equity. D is working capital credit.
Question 355
'Distressed debt' investing involves purchasing:
Select an option first.
Correct answer: B — The debt of companies in financial difficulty at a significant discount, with the goal of profit through restructuring or recovery
Explanation: Distressed debt investors buy bonds or loans of financially troubled companies at deep discounts. They may profit through debt restructuring, loan-to-own strategies, or simply price recovery. A, C, D are not distressed. B is correct.
Question 356
Direct lending as a private debt strategy involves:
Select an option first.
Correct answer: B — Non-bank lenders (typically private debt funds) providing loans directly to companies without a bank intermediary
Explanation: Direct lending fills the gap left by banks retreating from mid-market lending. Private debt funds lend directly, avoiding syndication, and typically earn higher yields than public bonds. A is traditional bank lending. C and D are traditional investments.
Question 357
The primary exit strategies for private equity investors include all of the following EXCEPT:
Select an option first.
Correct answer: D — Retaining the investment indefinitely with no exit
Explanation: PE funds have finite lives (typically 10 years) and MUST exit investments. Exit routes include IPO, trade sale, secondary sale (to another PE fund), or management buyout. Indefinite holding is not a viable PE exit strategy. A, B, C are all real exit mechanisms.
Question 358
Which of the following best describes 'fund-of-funds' as a method for accessing alternative investments?
Select an option first.
Correct answer: B — A pooled vehicle that invests in multiple underlying alternative investment funds, offering diversification and access
Explanation: A fund-of-funds (FoF) pools investor capital and allocates across multiple underlying funds (PE, hedge, etc.), providing diversification across managers, strategies, and vintages. The tradeoff is an additional layer of fees. A is co-investment. C is not typical. D is a direct fund.
Question 359
Co-investment in private equity allows investors to:
Select an option first.
Correct answer: B — Invest alongside the GP in a specific deal at reduced or no additional fees
Explanation: Co-investment rights allow LPs to invest directly in a specific portfolio company alongside the GP, typically without paying carried interest or management fees on that co-investment. This improves net returns. A, C, D are wrong.
Question 360
A General Partner (GP) in a private equity fund typically:
Select an option first.
Correct answer: B — Manages the fund's investments and operations, bears unlimited liability, and earns management fees and carried interest
Explanation: The GP manages the fund — sourcing deals, monitoring portfolio companies, and executing exits. GPs earn a management fee (typically 2% of committed capital) and carried interest (typically 20% of profits). They are the active decision-makers. A describes an LP. C is passive (LP). D is a lender.
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