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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 361
Limited Partners (LPs) in a private equity fund are best described as:
Select an option first.
Correct answer: C — Passive investors who provide most of the capital and have liability limited to their committed amount
Explanation: LPs provide the bulk of capital (typically 99%) but are passive — they do not manage investments. Their loss is capped at their capital commitment (limited liability). They include pension funds, endowments, and sovereign wealth funds. A and B are wrong. D is wrong.
Question 362
The standard compensation structure in private equity is often described as '2 and 20'. This refers to:
Select an option first.
Correct answer: B — 2% annual management fee on committed capital and 20% carried interest (profit share) above a hurdle rate
Explanation: The '2 and 20' structure means: 2% annual management fee (funds operations and salaries) and 20% carried interest (GP's share of profits above the hurdle rate). This aligns GP and LP incentives. A reverses the numbers. C and D are wrong.
Question 363
A 'hurdle rate' in private equity is:
Select an option first.
Correct answer: A — The minimum required return the GP must achieve before earning carried interest
Explanation: The hurdle rate (or preferred return) is the minimum annual return LPs must receive before the GP can take carried interest. Typical hurdle rates are 6-8%. This protects LPs from paying performance fees on mediocre returns. B, C, D are wrong.
Question 364
'Clawback' provisions in private equity protect LPs by:
Select an option first.
Correct answer: B — Requiring the GP to return previously paid carried interest if cumulative fund performance falls below the hurdle rate
Explanation: If a fund performs well early but later investments fail, the GP may have received excess carried interest. Clawback requires the GP to return the excess to LPs so total carried interest matches the agreed percentage of total fund profits. A, C, D are wrong.
Question 365
The 'lock-up period' in a private equity fund refers to:
Select an option first.
Correct answer: B — A restriction preventing LPs from withdrawing capital for a specified period
Explanation: The lock-up period restricts LP redemptions. In PE, this is typically the fund's full term (10 years) since investments are illiquid. Lock-ups are also common in hedge funds (shorter periods, 1-2 years). A is the investment period. C and D are wrong.
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Question 366
Which of the following best describes 'growth equity' as a private equity sub-category?
Select an option first.
Correct answer: C — Investing minority stakes in established, growing companies that need capital for expansion without a change in control
Explanation: Growth equity targets established (post-venture) companies that are profitable or near-profitable and need capital to accelerate expansion. It typically involves minority stakes without leverage-intensive buyouts. A is distressed. B is LBO. D is early-stage venture.
Question 367
Infrastructure as an investment asset class typically includes:
Select an option first.
Correct answer: C — Long-lived physical assets providing essential public services — such as toll roads, airports, pipelines, and utilities
Explanation: Infrastructure investments are in physical assets with long lives, essential public service characteristics, and often regulated or contracted revenue streams. These features provide stable, inflation-linked cash flows. A, B, D are not infrastructure.
Question 368
The Internal Rate of Return (IRR) in private equity is:
Select an option first.
Correct answer: A — The annual percentage return on invested capital over the fund's life, accounting for the timing of cash flows
Explanation: IRR is the discount rate that equates the present value of all cash inflows (distributions) to all cash outflows (capital calls). It accounts for cash flow timing. A high IRR is desired. B ignores timing. C is a separate measure (PME). D is not fund-level.
Question 369
The Multiple of Invested Capital (MOIC) measures:
Select an option first.
Correct answer: B — The ratio of total value (unrealized + realized) to total capital invested
Explanation: MOIC (also called TVPI — Total Value to Paid-In) = (Realized distributions + Unrealized NAV) / Total capital contributed. A MOIC of 2.0x means the fund returned twice the invested capital. A is IRR. C is real return. D is portfolio count.
Question 370
A PE fund called $100M over 4 years and distributed $160M over 5 years. The DPI (Distributions to Paid-In) multiple is:
Select an option first.
Correct answer: B — 1.6x
Explanation: DPI = Total distributions / Total paid-in capital = $160M / $100M = 1.6x. This measures realized (cash) return to investors. A inverts the ratio. C and D are wrong.
Question 371
The RVPI (Residual Value to Paid-In) multiple measures:
Select an option first.
Correct answer: B — The current unrealized value of remaining portfolio companies divided by capital invested
Explanation: RVPI = Current NAV of unrealized investments / Paid-in capital. It represents the portion of TVPI not yet realized. TVPI = DPI + RVPI. A is DPI. C is risk-adjusted return. D is wrong.
Question 372
Survivorship bias in alternative investment performance databases refers to:
Select an option first.
Correct answer: B — The overstatement of average performance because funds that failed or closed are removed from the database
Explanation: If failed funds are removed from databases, only surviving (generally better-performing) funds remain. Average reported performance is biased upward. This makes AI look more attractive than it actually is. A, C, D are not survivorship bias.
Question 373
Backfill bias (also called instant history bias) in hedge fund databases arises because:
Select an option first.
Correct answer: A — New funds include their entire track record only after achieving good early performance
Explanation: When a new hedge fund joins a database, it typically reports its historical returns going back to inception. Since only funds with good early performance tend to join databases, the added historical data is upward biased. B and C describe survivorship bias. D is stale pricing bias.
Question 374
Which of the following is a key challenge in comparing private equity performance to public market benchmarks?
Select an option first.
Correct answer: C — PE returns are based on irregular cash flows and appraised values rather than daily market prices, making direct comparison difficult
Explanation: PE uses IRR with irregular cash flow timing and subjective NAV appraisals, while public markets have daily mark-to-market prices. Direct comparison requires techniques like PME (Public Market Equivalent). A and B are wrong. D is wrong — PE typically has higher fees.
Question 375
The Public Market Equivalent (PME) is used in private equity to:
Select an option first.
Correct answer: B — Compare PE fund cash flows to a simulated investment in a public market index with the same timing
Explanation: PME replicates PE cash flows (calls and distributions) in a public index. If PME > 1 (or PME IRR > index IRR), the PE fund outperformed the equivalent public investment. A is alpha. C is IPO valuation. D is fee calculation.
Question 376
Stale pricing in alternative investments refers to:
Select an option first.
Correct answer: C — The use of appraisal-based or model-based valuations that lag true market values, creating artificially smooth returns
Explanation: Because private assets don't trade daily, valuations rely on appraisals or models updated infrequently. This makes reported returns appear smoother (less volatile) than true underlying value, understating risk and correlations with public markets. A partially describes it but C is more precise. B and D are wrong.
Question 377
Private equity funds typically have a term of approximately:
Select an option first.
Correct answer: C — 10-12 years
Explanation: Standard PE fund life is ~10 years: 5-year investment period + 5-year harvest/exit period, with possible 1-2 year extensions. This reflects the time needed to acquire, develop, and exit private portfolio companies. A and B are too short. D is too long.
Question 378
A PE fund called $50M and distributed $90M. MOIC is:
Select an option first.
Correct answer: B — 1.80x
Explanation: MOIC = Total distributions / Capital invested = $90M / $50M = 1.8x. A inverts. C and D are wrong.
Question 379
A PE fund called $80M. DPI=1.5x and RVPI=0.4x. What is the TVPI?
Select an option first.
Correct answer: C — 1.9x
Explanation: TVPI = DPI + RVPI = 1.5x + 0.4x = 1.9x. A subtracts. B is DPI only. D is wrong.
Question 380
A GP earns 20% carried interest on profits above an 8% hurdle. The fund returned $120M on $80M invested. Total profit = $40M. If the hurdle on $80M = $6.4M/year × assumed 5 years = $32M preferred return, profits above hurdle = $8M. Carried interest = 20% × $8M =
Select an option first.
Correct answer: A — $1.6M
Explanation: Profit above hurdle = $40M − $32M = $8M. GP carried interest = 20% × $8M = $1.6M. The remaining $6.4M goes to LPs. B is total above-hurdle profit. C is the preferred return. D is wrong.
Question 381
A venture capital fund invested $5M in a start-up and received $25M on exit 4 years later. The MOIC and approximate IRR are closest to:
Select an option first.
Correct answer: A — MOIC=5x, IRR≈50%
Explanation: MOIC = $25M/$5M = 5x. IRR: (1+r)^4 = 5 → r = 5^0.25 − 1 = 1.495 − 1 = 49.5% ≈ 50%. B has wrong IRR. C has wrong MOIC. D has wrong IRR.
Question 382
An LP commits $10M to a PE fund with a 2% annual management fee on committed capital. Annual management fee is:
Select an option first.
Correct answer: A — $200,000
Explanation: Fee = 2% × $10M = $200,000 per year. B confuses 2% with 20%. C uses 1%. D is wrong.
Question 383
A PE fund's IRR over 6 years is 18%. The risk-free rate is 4%. The PME IRR (equivalent public market return) is 14%. The fund's alpha over public markets is approximately:
Select an option first.
Correct answer: C — 4%
Explanation: Alpha = Fund IRR − PME IRR = 18% − 14% = 4%. This 4% represents excess return over what a similar public investment would have earned. A is fund IRR. B is PME. D is wrong.
Question 384
Which of the following is a key characteristic of most alternative investments that makes due diligence more challenging?
Select an option first.
Correct answer: C — Limited transparency, complex structures, and less standardized reporting compared to public markets
Explanation: Alternative investments typically offer less transparency (private information, complex structures, proprietary strategies), non-standardized reporting, and complex legal structures. This makes due diligence more demanding than for public securities. A and D are wrong. B is wrong.
Question 385
The term 'dry powder' in private equity refers to:
Select an option first.
Correct answer: B — Capital committed by LPs but not yet called and deployed by the GP — available for future investments
Explanation: Dry powder is committed-but-uncalled capital. When LPs commit to a PE fund, the GP draws down capital over the investment period. Uncalled commitments represent dry powder — available to fund future acquisitions. A, C, D are wrong.
Question 386
The 'investment period' in a PE fund refers to:
Select an option first.
Correct answer: B — The period during which the GP actively makes new investments (typically the first 4-5 years)
Explanation: The investment period (typically years 1-5) is when the GP deploys committed capital into new portfolio companies. After this period, no new investments are made — the GP focuses on managing and exiting existing positions. A is the full fund life. C and D are wrong.
Question 387
Which of the following BEST describes the role of an alternative investment in a traditional 60/40 portfolio?
Select an option first.
Correct answer: C — To improve risk-adjusted returns through diversification, access to illiquidity premiums, and exposure to return streams with low correlation to stocks and bonds
Explanation: Alternatives add diversification (low correlation), capture illiquidity premiums, and provide access to private market opportunities unavailable in public markets. Combined, these can improve the portfolio's risk-return profile. A, B, D are too extreme.
Question 388
Private debt investments offer which of the following advantages over publicly traded bonds?
Select an option first.
Correct answer: C — Higher yields and customized terms as compensation for illiquidity and lower marketability
Explanation: Private debt commands a premium over comparable public bonds due to illiquidity, complexity, and the borrower's inability to access public markets. Lenders customize covenants, collateral, and terms. A is the opposite. B is wrong. D is not a general advantage.
Question 389
'Waterfalling' of distributions in a PE fund refers to:
Select an option first.
Correct answer: B — The sequential priority in which profits are distributed — typically: return of capital → preferred return to LPs → catch-up to GP → carried interest split
Explanation: The distribution waterfall defines the order of distributions: (1) return all capital to LPs, (2) pay preferred return (hurdle), (3) GP catch-up, (4) remaining profits split per carried interest agreement. B is correct. A is capital calls. C and D are wrong.
Question 390
The term 'carried interest' in private equity refers to:
Select an option first.
Correct answer: C — The GP's share of profits (typically 20%) above the hurdle rate — a form of performance compensation
Explanation: Carried interest (or 'carry') aligns the GP's interests with LPs. The GP earns 20% of profits above the hurdle rate, incentivizing them to maximize returns. A is the management fee. B is investment income. D is wrong.
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