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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 241
Hedge funds are BEST described as:
Select an option first.
Correct answer: B — Privately organized investment vehicles that use flexible strategies including leverage, short selling, and derivatives to achieve absolute returns
Explanation: Hedge funds are lightly regulated pooled vehicles for sophisticated investors. They use diverse strategies — long/short equity, macro, arbitrage — with leverage, derivatives, and short selling. They target absolute returns (positive in all markets). A, C, D are wrong.
Question 242
A 'long/short equity' hedge fund strategy involves:
Select an option first.
Correct answer: B — Simultaneously buying undervalued stocks (long) and short-selling overvalued stocks to reduce market exposure while profiting from relative performance
Explanation: Long/short equity exploits relative value between stocks — going long expected winners and short expected losers. Net market exposure varies from fully hedged (market neutral) to net long or net short. A and C are only half the strategy. D is a different strategy.
Question 243
A 'market neutral' hedge fund strategy aims to:
Select an option first.
Correct answer: C — Maintain near-zero net market exposure (beta ≈ 0), profiting from security selection rather than market direction
Explanation: Market neutral strategies construct offsetting long and short positions to neutralize market (beta) exposure. Returns come from alpha (security selection skill) not market direction. A is opposite. B is too extreme. D is not a hedge fund strategy.
Question 244
Event-driven hedge fund strategies seek to profit from:
Select an option first.
Correct answer: C — Corporate events such as mergers, acquisitions, bankruptcies, spin-offs, and restructurings
Explanation: Event-driven strategies focus on corporate catalysts: merger arbitrage profits from deal spreads, distressed investing from restructurings, special situations from spin-offs or delistings. A is global macro. B is high-frequency trading. D is commodity arbitrage.
Question 245
Merger arbitrage (risk arbitrage) typically involves:
Select an option first.
Correct answer: A — Short-selling the acquirer and going long the target company stock after a deal is announced
Explanation: In a typical cash acquisition: the acquirer pays a premium over market. Post-announcement, the target trades below the offer price (spread). Arbitrageurs buy the target (capture the spread) and may short the acquirer (hedge deal failure/equity risk). B loses money on both. C is wrong. D is too narrow.
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Question 246
A 'global macro' hedge fund strategy bases its investments on:
Select an option first.
Correct answer: B — Large-scale bets on macroeconomic trends — interest rates, currencies, commodities, and equity indices across countries
Explanation: Global macro funds take directional positions in currencies, rates, commodities, and equity indices based on macro analysis (economic cycles, political events, central bank policy). A is bottom-up stock selection. C is quantitative arbitrage. D is event-driven.
Question 247
'Relative value' hedge fund strategies aim to profit from:
Select an option first.
Correct answer: B — Price discrepancies between related securities that are expected to converge
Explanation: Relative value strategies exploit mispricings between related instruments — fixed income arbitrage (yield curve), convertible arbitrage (bond vs. equity), or statistical arbitrage (pairs trading). Returns depend on convergence, not market direction. A is directional. C is PE. D is macro.
Question 248
Convertible bond arbitrage involves:
Select an option first.
Correct answer: B — Buying undervalued convertible bonds and short-selling the underlying equity to capture the mispricing between them
Explanation: Convertible arbitrage buys the convertible bond (which has embedded equity option value) and shorts the underlying stock to hedge equity risk. Profits from the bond being mispriced relative to its theoretical value. A, C, D are wrong.
Question 249
A '1.5 and 15' hedge fund fee structure means:
Select an option first.
Correct answer: B — 1.5% annual management fee on AUM and 15% performance fee on net new profits
Explanation: Standard hedge fund fees: the first number = annual management fee as % of AUM; the second = performance fee (incentive fee) as % of profits above the hurdle. 1.5% management + 15% incentive. A and D reverse. C is wrong.
Question 250
A 'high-water mark' provision in a hedge fund protects investors by:
Select an option first.
Correct answer: B — Ensuring the manager only earns performance fees on profits that exceed the fund's previous peak NAV — so investors don't pay twice for recovering prior losses
Explanation: The high-water mark ensures that if a fund loses value, the manager must recover those losses before earning new performance fees. Investors don't pay performance fees for regaining what was already lost. A is a guarantee (wrong). C and D are unrelated.
Question 251
Which of the following hedge fund structures allows investors to invest in a diversified portfolio of multiple hedge fund managers?
Select an option first.
Correct answer: C — A fund-of-hedge-funds (FoHF)
Explanation: A fund-of-hedge-funds allocates across multiple underlying hedge fund managers and strategies, providing diversification of manager risk and strategy exposure. The cost is an additional fee layer. A is single-strategy. B is a direct separately managed account. D is a single-manager fund.
Question 252
The primary advantage of a 'managed account' (separately managed account) over a commingled hedge fund is:
Select an option first.
Correct answer: C — Greater transparency, customization, and liquidity — the investor directly owns the portfolio and can see all positions
Explanation: Managed accounts give the investor direct ownership of positions, full transparency, better liquidity terms, and the ability to customize. Commingled funds offer limited transparency. A, B, D are wrong — managed accounts don't guarantee these features.
Question 253
Distributed Ledger Technology (DLT) in the context of digital assets refers to:
Select an option first.
Correct answer: B — A decentralized record-keeping system where identical records are maintained and updated simultaneously across a network of participants
Explanation: DLT (blockchain is a type of DLT) distributes identical copies of transaction records across many nodes simultaneously. No single party controls it. Transactions are verified by consensus. A is centralized (traditional banking). C and D are wrong.
Question 254
Which of the following BEST describes a cryptocurrency?
Select an option first.
Correct answer: C — A digital medium of exchange secured by cryptography on a blockchain, operating independently of any central authority
Explanation: Cryptocurrencies (Bitcoin, Ethereum) are decentralized digital assets that use cryptographic proof (rather than a central authority) to secure transactions and control new unit creation. A is a commodity-backed digital token. B is a CBDC (Central Bank Digital Currency). D is wrong.
Question 255
'Proof of Work' as a blockchain consensus mechanism involves:
Select an option first.
Correct answer: B — Miners competing to solve complex mathematical puzzles to validate transactions and earn newly created cryptocurrency
Explanation: Proof of Work (used by Bitcoin) requires miners to expend computational energy solving cryptographic puzzles. The winner validates the block and earns the block reward. This makes the network secure but energy-intensive. A is Proof of Stake. C is centralized. D is governance voting.
Question 256
'Proof of Stake' differs from 'Proof of Work' primarily in that:
Select an option first.
Correct answer: B — It selects validators based on the amount of cryptocurrency they 'stake' as collateral, not computational effort
Explanation: Proof of Stake (used by Ethereum post-merge) chooses validators proportionally to their staked coins. It is far more energy-efficient than PoW. A describes PoW. C is wrong (Bitcoin uses PoW). D is wrong.
Question 257
A 'smart contract' on a blockchain is best described as:
Select an option first.
Correct answer: B — Self-executing code stored on a blockchain that automatically performs specified actions when predetermined conditions are met
Explanation: Smart contracts execute automatically when their coded conditions are met — no intermediary needed. They enable DeFi, NFTs, and tokenized assets. A is just a digital file. C is centralized. D is wrong.
Question 258
Non-Fungible Tokens (NFTs) differ from regular cryptocurrencies in that:
Select an option first.
Correct answer: C — NFTs are unique, indivisible digital tokens representing ownership of a specific asset (art, collectible, property rights) — unlike fungible currencies where each unit is identical
Explanation: Fungible = interchangeable (1 Bitcoin = 1 Bitcoin). Non-fungible = unique (each NFT is distinct). NFTs record unique ownership on a blockchain. A and B are wrong. D is wrong.
Question 259
Decentralized Finance (DeFi) refers to:
Select an option first.
Correct answer: C — Financial services built on blockchain smart contracts that operate without traditional financial intermediaries
Explanation: DeFi recreates financial services (lending, borrowing, trading, yield farming) using smart contracts on blockchains, removing banks and brokers as intermediaries. A and B are traditional finance. D is wrong.
Question 260
Which of the following is a DIRECT investment method in digital assets?
Select an option first.
Correct answer: B — Purchasing cryptocurrency through a digital asset exchange and holding in a wallet
Explanation: Direct investment means personally holding the digital asset — purchasing and storing cryptocurrency in a digital wallet. A is indirect (equity). C is traditional. D is lending (indirect).
Question 261
A major risk unique to digital asset investments compared to traditional assets is:
Select an option first.
Correct answer: C — Key/custody risk — losing access to digital assets due to lost private keys, hacking, or exchange failure
Explanation: Digital assets can be permanently lost if private keys are lost or stolen. Exchange collapses (e.g., FTX) and smart contract exploits are also unique digital risks. A and D are traditional financial risks. B doesn't apply — most cryptos have no issuing government.
Question 262
Which of the following BEST describes 'tokenization' of real-world assets?
Select an option first.
Correct answer: C — Representing ownership of real-world assets (real estate, art, bonds) as digital tokens on a blockchain, enabling fractional ownership and improved liquidity
Explanation: Tokenization creates digital representations of real-world assets, enabling fractional ownership, 24/7 trading, and faster settlement. Real estate can be tokenized so small investors own fractions. A, B, D are wrong.
Question 263
The regulatory environment for digital assets is best characterized as:
Select an option first.
Correct answer: C — Fragmented, evolving, and inconsistent across jurisdictions — creating compliance risk for investors
Explanation: Different countries take different approaches — from banning crypto (some jurisdictions) to comprehensive frameworks (EU MiCA). Regulatory uncertainty is a key risk. A and B are too extreme. D is wrong.
Question 264
A 'closed-end fund' structure in alternative investments is characterized by:
Select an option first.
Correct answer: B — A fixed number of shares issued at inception, with investors buying/selling on the secondary market
Explanation: Closed-end funds raise a fixed amount at IPO, then shares trade on exchanges. Investors exit by selling to other investors, not redeeming from the fund. This suits illiquid underlying assets. A and D describe open-end mutual funds. C is open-end.
Question 265
Which of the following alternative investment features contributes MOST to their return premium over traditional assets?
Select an option first.
Correct answer: C — Illiquidity premium — investors demand extra return for accepting restricted access to capital
Explanation: The illiquidity premium is a primary source of alternative investment returns. Investors in PE, private debt, and direct real estate accept that they cannot exit easily and demand compensation in the form of higher expected returns. A, B, D are wrong.
Question 266
Which of the following describes 'managed futures' as a hedge fund strategy?
Select an option first.
Correct answer: C — Systematic trend-following strategies using futures contracts across asset classes (equities, bonds, currencies, commodities) — often using algorithmic trading models
Explanation: Managed futures (CTAs — Commodity Trading Advisors) use systematic models to trade futures across asset classes based on momentum/trend signals. They can go long or short. A is retail, not a hedge fund strategy. B is long-only. D is a specific fund type.
Question 267
Which hedge fund strategy tends to perform BEST during market crises when equities fall sharply?
Select an option first.
Correct answer: B — Global macro and managed futures (trend-following)
Explanation: Global macro and managed futures can take short positions in equities and long positions in safe-haven assets (bonds, gold). Trend-following models adapt to new trends including downtrends. Long-biased strategies (A, C for equity component, D) typically suffer in crises.
Question 268
'Side pockets' in hedge funds are used to:
Select an option first.
Correct answer: B — Segregate illiquid or hard-to-value investments from the main portfolio so other investors can redeem while illiquid assets are held separately
Explanation: Side pockets separate illiquid investments (like distressed securities or private equity stakes) from the main portfolio. This prevents a run on the fund where redeeming investors force liquidation of illiquid assets at distressed prices. A, C, D are wrong.
Question 269
The HFRI (Hedge Fund Research Index) or similar hedge fund indices suffer from which bias when used to evaluate hedge fund performance?
Select an option first.
Correct answer: B — Selection and survivorship biases — only surviving funds that voluntarily report are included, overstating average performance
Explanation: Hedge fund databases are voluntary. Only successful, surviving funds tend to report (survivorship bias). Backfill bias also inflates early returns. This makes index returns higher than what average investors actually earned. A, C, D are wrong.
Question 270
A hedge fund started the year at NAV $100. After management fee of 2%, NAV = $98. After a 15% gross return, NAV = $98 × 1.15 = $112.70. High-water mark = $100. Performance fee = 15% × ($112.70 − $100) =
Select an option first.
Correct answer: A — $1.91
Explanation: Gain above high-water mark = $112.70 − $100 = $12.70. Performance fee = 15% × $12.70 = $1.905 ≈ $1.91. Investor NAV after all fees = $112.70 − $1.91 = $110.79. B uses only the $18 gain. C and D are wrong.
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