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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 391
Which of the following statements about private equity performance is most accurate?
Select an option first.
Correct answer: C — Top-quartile PE managers tend to show more return persistence than top-quartile public fund managers
Explanation: Research shows PE manager performance has more persistence than in public markets — top managers tend to remain top managers across funds. This persistence justifies the effort of manager selection. A is wrong — dispersion is high. B is wrong — wide dispersion. D is wrong.
Question 392
A Limited Partner agreement's 'key man' clause provides that:
Select an option first.
Correct answer: B — If a specified key person leaves the fund, LPs may have the right to suspend the investment period or dissolve the fund
Explanation: Key man provisions protect LPs from the fund continuing without the talent that made them invest. If the named manager(s) depart, LPs can potentially halt new commitments or exit. A, C, D are wrong.
Question 393
Which of the following is a typical characteristic that differentiates alternative investments from traditional investments?
Select an option first.
Correct answer: C — Use of leverage, short selling, and derivatives not commonly available in traditional funds
Explanation: Alternatives frequently employ leverage, short selling, and derivatives to enhance returns or reduce risk. These tools are restricted or unavailable in most traditional investment vehicles. A is wrong (alternatives often have high minimums). B is wrong (illiquid). D is wrong (lighter regulation).
Question 394
Seed capital or angel investing refers to:
Select an option first.
Correct answer: C — The earliest stage of equity financing — funding provided to an entrepreneur to develop a concept or prototype
Explanation: Seed/angel capital is the first external funding — often pre-revenue, pre-product. It carries the highest risk among equity stages but offers the highest potential return. A is early-stage VC. B is PE buyout. D is distressed.
Question 395
Series A, B, C rounds of venture capital funding represent:
Select an option first.
Correct answer: B — Sequential rounds of equity funding as a start-up grows — each round typically at higher valuations and larger amounts
Explanation: VC rounds follow the company's growth: Series A (product-market fit), Series B (scaling), Series C (expansion/pre-IPO). Each round typically brings a higher valuation and more capital. A is PE. C and D are unrelated.
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Question 396
The primary reason PE funds use leverage in leveraged buyouts is:
Select an option first.
Correct answer: C — To amplify equity returns — debt is cheaper than equity, and if the target generates returns above the cost of debt, equity holders benefit disproportionately
Explanation: Leverage amplifies returns: if a company earns 12% ROIC and debt costs 6%, equity earns more than 12%. The smaller the equity stake, the greater the ROE. A is wrong. B is a byproduct not the primary reason. D is often the opposite effect.
Question 397
Which of the following EXIT strategies in PE typically yields the highest valuation for the portfolio company?
Select an option first.
Correct answer: C — Initial public offering (IPO) — accessing public market valuations and liquidity
Explanation: IPOs often achieve the highest valuations by accessing broad public market liquidity and investor base. PE firms time IPOs to favorable market conditions. Secondary sales (A) are common but often lower value. MBOs (B) are limited by management's financing capacity. D is worst case.
Question 398
The 'paid-in capital' in PE fund reporting equals:
Select an option first.
Correct answer: B — The total capital actually called and received from LPs to date
Explanation: Paid-in capital (or contributed capital) is what has actually been drawn from LPs — not the full commitment. Early in the fund, paid-in < committed because not all capital is called at once. A is committed capital. C is distributions. D is unrealized value.
Question 399
A PE fund reports TVPI=2.1x, DPI=1.3x. What does this tell an investor?
Select an option first.
Correct answer: B — The fund has returned 1.3x in cash distributions and holds unrealized value worth 0.8x of invested capital
Explanation: TVPI = DPI + RVPI → 2.1 = 1.3 + RVPI → RVPI = 0.8x. The fund returned 1.3x cash and holds unrealized NAV worth 0.8x. A is wrong. C is wrong. D cannot be determined without a benchmark.
Question 400
Why is IRR a potentially misleading performance metric for PE funds in isolation?
Select an option first.
Correct answer: B — IRR assumes all intermediate cash flows are reinvested at the IRR rate, which may not be realistic
Explanation: IRR implicitly assumes distributions are reinvested at the same IRR. A fund with a very high early IRR from a quick exit may not be as strong as it appears if later capital cannot earn the same rate. A, C, D are wrong.
Question 401
A PE fund with a hurdle rate of 8% and 'European waterfall' structure means:
Select an option first.
Correct answer: B — The GP only begins receiving carried interest after LPs have received back all capital plus the 8% preferred return on the entire fund
Explanation: European waterfall (whole-fund waterfall) requires full return of capital + preferred return on ALL investments before the GP earns any carry. This maximizes LP protection. American waterfall pays carry deal-by-deal, which can accelerate GP income. A is American waterfall. C and D are wrong.
Question 402
In private debt investing, 'unitranche' financing refers to:
Select an option first.
Correct answer: B — A combination of senior and subordinated debt blended into a single loan at a blended interest rate
Explanation: Unitranche combines senior and mezzanine debt into a single tranche with a blended rate. It simplifies the capital structure and documentation, popular in middle-market PE deals. A is traditional bank lending. C is convertible instrument. D is working capital.
Question 403
Which of the following describes 'venture debt'?
Select an option first.
Correct answer: C — Loans provided to venture-backed companies that complement equity financing, typically secured by IP or assets
Explanation: Venture debt provides non-dilutive capital to venture-backed companies between equity rounds. Typically secured by IP, inventory, or ARR. It extends runway without diluting founders. A, B, D are wrong.
Question 404
Private equity funds targeting 'special situations' typically focus on:
Select an option first.
Correct answer: B — Companies undergoing significant change — distress, turnarounds, spin-offs, regulatory restructurings — where complexity creates mispricing
Explanation: Special situations funds exploit corporate complexity and information asymmetry — companies undergoing change that creates mispricing opportunities. A is core PE. C is VC. D is RE.
Question 405
The main difference between a Primary fund investment and a Secondary fund investment in PE is:
Select an option first.
Correct answer: B — Primary investments are commitments to a new fund; secondary investments are purchases of existing LP interests in funds already deployed
Explanation: Primary: LP commits to a new fund at inception, participating from day one (J-curve exposure). Secondary: LP buys existing LP interests in an already-deployed fund, often at a discount, with shorter remaining term and reduced J-curve. A, C, D are wrong.
Question 406
Secondary PE investments typically trade at a discount to NAV primarily because:
Select an option first.
Correct answer: B — The seller urgently needs liquidity and buyers require a discount to compensate for information asymmetry and illiquidity of the remaining portfolio
Explanation: Sellers of PE secondaries often face liquidity needs (portfolio rebalancing, capital shortfalls). Buyers demand a discount to NAV for the risk and complexity. A is not necessarily true. C is wrong — secondaries are common. D is wrong.
Question 407
A MOIC of 3.5x over 7 years. Approximate IRR is closest to:
Select an option first.
Correct answer: A — 19.5%
Explanation: (1+r)^7 = 3.5 → r = 3.5^(1/7) − 1 = 1.1949 − 1 = 19.49% ≈ 19.5%. B, C, D are wrong.
Question 408
A fund called $200M (paid-in) and has distributed $160M to LPs (DPI=0.8x). Current NAV = $180M. TVPI =
Select an option first.
Correct answer: B — 1.7x
Explanation: TVPI = (Distributions + NAV) / Paid-in = ($160M + $180M) / $200M = $340M / $200M = 1.7x. A is DPI only. C uses wrong NAV. D is wrong.
Question 409
Management fee on $300M committed capital at 1.5% per year is:
Select an option first.
Correct answer: A — $4.5M
Explanation: Fee = 1.5% × $300M = $4.5M. B uses 15%. C uses 1%. D uses 0.5%.
Question 410
An LP commits $20M to a fund. After 5 years, distributions total $18M and remaining NAV = $10M. DPI, RVPI, and TVPI are:
Select an option first.
Correct answer: A — DPI=0.9x, RVPI=0.5x, TVPI=1.4x
Explanation: DPI=$18M/$20M=0.9x. RVPI=$10M/$20M=0.5x. TVPI=0.9+0.5=1.4x. A is correct.
Question 411
Which of the following BEST describes the alignment of interests created by carried interest in PE?
Select an option first.
Correct answer: B — The GP only earns significant compensation when LPs profit above the hurdle — incentivizing the GP to maximize fund returns
Explanation: Carried interest aligns GP incentives with LP outcomes. The GP earns 20% of profits ABOVE the hurdle, so maximizing fund value directly maximizes GP compensation. A describes the management fee. C and D are wrong.
Question 412
Which of the following statements about alternative investment diversification is most accurate?
Select an option first.
Correct answer: C — Low or negative correlations between alternatives and traditional assets can reduce portfolio-level volatility and improve risk-adjusted returns
Explanation: The diversification benefit of alternatives comes from their lower correlation with stocks and bonds. Different types have different correlations — real assets often low, hedge funds variable. A, B, D are wrong.
Question 413
The concept of 'illiquidity premium' in alternative investments means:
Select an option first.
Correct answer: C — Investors demand — and over long horizons, historically earn — a return premium above comparable liquid investments to compensate for the inability to sell quickly
Explanation: The illiquidity premium compensates investors for the risk of being unable to exit positions at will. It is a key driver of higher expected returns in PE, private debt, infrastructure, and direct real estate. A, B, D are wrong.
Question 414
A GP's 'catch-up' provision in the waterfall means:
Select an option first.
Correct answer: A — After LPs receive capital plus preferred return, the GP receives 100% of distributions until they have caught up to their carried interest percentage of total profits
Explanation: Once LPs receive all capital back plus the preferred return, the catch-up gives the GP a larger share of subsequent profits until the total GP/LP split equals the agreed carried interest ratio. Example: if GP earns 20% total, catch-up gets GP to 20% of cumulative profits. B, C, D are wrong.
Question 415
Which type of private equity fund would MOST likely target a company with stable cash flows, brand recognition, and potential for operational improvement through efficiency gains?
Select an option first.
Correct answer: C — Leveraged buyout (LBO) fund
Explanation: LBO funds target mature companies with stable, predictable cash flows (to service acquisition debt) and operational improvement opportunities. Strong brands and established markets reduce risk. A and D are early-stage. B buys financially troubled companies.
Question 416
The term 'vintage year diversification' in a PE portfolio context means:
Select an option first.
Correct answer: B — Spreading PE commitments across multiple fund vintage years to reduce exposure to a single economic cycle
Explanation: Committing to PE funds across multiple vintage years reduces the risk of all investments entering/exiting in the same economic environment. Different vintages are exposed to different market cycles. A, C, D are wrong.
Question 417
The average holding period for an LBO investment before exit is typically:
Select an option first.
Correct answer: B — 3-7 years
Explanation: PE buyout investments are typically held 3-7 years — enough time to implement operational improvements, reduce leverage, and achieve a favorable exit environment. A is too short. C and D are too long for a standard PE fund structure.
Question 418
In a private equity 'dual recourse' structure, LPs' liability extends to:
Select an option first.
Correct answer: C — Their committed capital only — losses beyond called capital have no recourse against LP's other assets
Explanation: LPs have limited liability. In a typical LP structure, an LP's maximum loss is their committed (and called) capital. 'Dual recourse' is a misstatement in the question context — LPs never owe beyond their commitment. C correctly states limited liability. A and D are wrong.
Question 419
What is a 'side letter' in the context of a PE fund?
Select an option first.
Correct answer: C — A separate agreement between the GP and a specific LP granting that LP preferential terms — such as reduced fees, co-investment rights, or earlier information
Explanation: Side letters are bilateral agreements between the GP and individual LPs offering negotiated preferential terms, usually to larger or earlier investors. They supplement the main LPA. A, B, D are wrong.
Question 420
Which of the following PE fund structures provides the MOST favorable tax treatment for US tax-exempt investors (pension funds, endowments)?
Select an option first.
Correct answer: D — Offshore feeder fund structure that prevents UBTI for tax-exempt investors
Explanation: Tax-exempt US investors (pensions, endowments) are exposed to UBTI (Unrelated Business Taxable Income) when invested in LPs that use leverage. Offshore feeder funds (e.g., Cayman Islands blockers) convert leveraged PE income into capital gains, avoiding UBTI. A, B, C create UBTI exposure.
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