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IKOS Interview Questions with Answers on Hedge Funds
Posted on :28-04-2016
Q1. What is a hedge fund?
It is a private, unregistered investment pool encompassing all types of investment funds, companies, and private partnerships that can use a variety of investment techniques such as borrowing money through leverage, selling short, and derivatives for directional investing and options.
Q2. What makes hedge funds different from mutual funds?
The main distinguishing characteristics are that hedge funds use derivatives, can short sell, and have the ability to use leverage.
Q3. What is convertible arbitrage?
It is an investment strategy that seeks to exploit pricing inefficiencies between a convertible bond and the underlying stock. Managers will typically long the convertible bond and short the underlying stock.
Q4. What are the Structural Advantages of Hedge Funds?
1. Lack of Regulation2. Lack of Transparency3. Lack of Investment Constraints4. Illiquidity5. High Fees/Complex Incentive Structures
Q5. What are the Structural Disadvantages of Hedge Funds?
1. Lack of Regulation – Hedge funds are often less regulated than many other structures, and this lack of oversight is a common complaint
2. Lack of Transparency – Hedge funds are notoriously opaque
3. Lack of Investment Constraints – Hedge funds pose a greater risk of strategy and style drift
4. Illiquidity – Hedge funds do not typically offer daily or even monthly liquidity to investors, with long notice periods and the potential for fund gating
5. High Fees/Complex Incentive Structures – Hedge fund fee structures can provide an asymmetric payout to the manager, and can induce excessive risk taking to regain fund high water marks or attempt to generate greater performance fees
Q6. What is diversification?
Diversification is allocating your funds into different types of assets. It may be a portion of your money going into stocks while another portion goes into bonds. You are looking to vary your long term and short term returns so that you have a continual income coming in from your assets. This is where having an asset management firm to control your financial portfolio comes in handy.
Q7. What is passive management?
Passive management is one of the styles of management for controlling and influencing your assets. He or she will interfere with your portfolio as little as possible in order to keep fees down to a minimum. The stocks, bonds or other assets being managed will more than likely be long-term investments that do not require daily monitoring.
Q8. What are the types Of Hedge Funds?
There are 4 main kinds of hedge fund:
• Directional• Global Macro• Event Driven• Relative Value
Q9. What is meant by Directional Hedge Fund?
These are probably the most algorithmic orientated hedge funds. Their basic aim is to determine current market trends and to trade on them, i.e. if the market is going up, they will go long etc. If the hedge fund is large enough it can actually influence the market to continue to trend, and this gives it a lot of power.
Directional hedge funds have the most exposure to the global markets and can either be immensely profitable or hit very hard by sudden volatile fluctuations in the markets.
These types of hedge funds will usually invest in any kind of asset, as long as it is trending strongly and they can make a profit out of it.
Q10. What is meant by Global Macro Hedge Fund?
Hedge funds which operate on a global macro strategy will trade according to events in the global economy, usually in currency, bond and equity markets. They will trade on information such as government fiscal & monetary policy, geopolitical events and much more.
Global macro funds attempt to seek out global imbalances and investment opportunities and to take advantage of these inefficiencies.
Due to the fact that their investments are spread throughout the world, they are susceptible to events in localities such as banking collapses, political risk etc, exchange rates etc.
Q11. What is meant by Event Driven Hedge Fund?
Event Driven funds invest based on the likelihood of some given event occurring and then profiting out of it. For example, an event driven fund speculating on the future of the Eurozone would invest in European government bonds and a currency pair involving the Euro.
A well known example of Event driven hedge funds are those which did not buy into the hype over CDOs in the mid 2000s and instead bought CDSs on those CDOs and profited massively when they defaulted, i.e. Paulson & Co. Event driven funds will invest in all kinds of events such as IPOs, scandals, mergers, wars, political turmoil etc.
Q12. What is meant by Relative Value Hedge Fund?
Relative Value funds are perhaps the easiest to understand and the least risky to operate. They essential engage in value investing based on fundamental analysis, i.e. buying securities which are valued incorrectly in the market and then taking their profit when the prices correct themselves.
The difference between hedge funds and mutual funds when it comes to value investing is that hedge funds can also short assets that are overvalued and be more speculative through the use of derivatives, as well as investing in a far broader range of assets (i.e. real estate).