CFA Level I Alternative Investments practice questions
25 exam-style questions from across Alternative Investments, which is 6–9% of the Level I exam (roughly 11–16 of the 180 questions). Pick an answer to see whether you were right, why each option is right or wrong, and the lesson to go back to.
Module 1 Alternative Investment Features, Methods and Structures
-
1Which of the following is least likely a typical feature of alternative investments?
Show the answer
The answer is B.
A. Typical. Valuing private cash flows and risks takes specialized skills.
B. Not typical. Alternatives tend to be illiquid, with long horizons and large capital outlays.
C. Typical. Low correlation with stocks and bonds is much of the diversification appeal. The trap
From the lesson What makes an investment alternative: features and categories
-
2An investor with limited alternative investment experience and a small team would most appropriately use:
Show the answer
The answer is A.
A. Fund investing outsources selection and management to the manager and suits limited resources and experience.
B. Co-investing suits investors that already have some fund experience and can assess individual deals. The trap
C. Direct investing is for the largest, most sophisticated investors with in-house teams.
From the lesson Fund investing vs co-investing vs direct investing
-
3In a limited partnership, the party with unlimited liability that manages the fund is the:
Show the answer
The answer is A.
A. The GP runs the fund and bears unlimited liability, in principle.
B. Limited partners are passive, and their liability is capped at what they invest. The trap
C. A side letter is a document, not a party to the partnership.
From the lesson Ownership structures: general and limited partners
-
4A fund returns 17% with a hard hurdle of 9% and a 20% performance fee (ignore management fees). The GP's share of return is closest to:
Show the answer
The answer is A.
A. 0.20 × (17% − 9%) = 1.6%. The fee applies only to the return above the hurdle.
B. 20% of the hurdle (0.20 × 9%). The fee is on the excess, not on the hurdle.
C. 20% of the whole return. That is the soft hurdle with catch-up outcome, not a hard hurdle. The trap
On your calculator- 17−9=×0.2= 1.6
- 17ENTER9−0.2× 1.6
ENTER enter (on the HP, puts the number on the stack)
From the lesson Fees and waterfalls: hurdle, catch-up, high-water mark, clawback
Module 2 Alternative Investment Performance and Returns
-
5In the early years of a private equity fund, returns are typically negative mainly because:
Show the answer
The answer is B.
A. Fees start immediately, from the capital commitment phase. That is part of why returns are negative. The trap
B. Fees and expenses are charged at once, while the assets generate little or no income until they are improved or sold. This is the J-curve.
C. Private equity holdings are not valued with Level 1 quoted prices.
From the lesson Why alternative investment performance is hard to judge
-
6A fund invests INR 2.5 billion and later another INR 0.5 billion in a company, and exits for INR 7.2 billion. The MOIC is closest to:
Show the answer
The answer is A.
A. Both investments count: 7.2 ÷ (2.5 + 0.5) = 2.40×.
B. Ignores the follow-on investment: 7.2 ÷ 2.5. The trap
C. Divides by the follow-on only: 7.2 ÷ 0.5.
On your calculator- 7.2÷(2.5+0.5)= 2.4
- 7.2ENTER2.5ENTER0.5+÷ 2.4
ENTER enter (on the HP, puts the number on the stack)
From the lesson IRR and multiple of invested capital (MOIC)
-
7A hedge fund has USD 200 million of equity, borrows USD 100 million at 5% and earns 9% on the total portfolio. The leveraged return on equity is closest to:
Show the answer
The answer is B.
A. Ignores leverage altogether.
B. 9% + (100 ÷ 200)(9% − 5%) = 11.0%.
C. Ignores the borrowing cost: 9% × 300 ÷ 200. The trap
On your calculator- 100÷200=×(9−5)+9= 11
- 100ENTER200÷9ENTER5−×9+ 11
ENTER enter (on the HP, puts the number on the stack)
From the lesson Leverage, redemptions, lockups and gates
-
8A fund starts at EUR 100 million and ends the year at EUR 125 million before fees. Fees are 2% of year-end AUM plus a 20% incentive fee, calculated net of the management fee. The investor's net return is closest to:
Show the answer
The answer is B.
A. Calculates the fees independently: 2.5 + 5.0 = 7.5, so (25 − 7.5) ÷ 100. The trap
B. Management fee 125 × 2% = 2.5. Incentive 20% × (125 − 2.5 − 100) = 4.5. Total 7.0, so (25 − 7.0) ÷ 100 = 18.0%.
C. Deducts only an incentive fee of 5.0 on the gross gain: (25 − 5) ÷ 100. The management fee is missing.
On your calculator- 125×0.02=STO1 2.5
- 125×0.98−100=×0.2=STO2 4.5
- 125−100−RCL1−RCL2=÷100= 0.18
STO store · RCL recall a stored number
- 125ENTER0.02×STO1 2.5
- 125ENTER0.98×100−0.2×STO2 4.5
- 125ENTER100−RCL1−RCL2−100÷ 0.18
ENTER enter (on the HP, puts the number on the stack) · STO store · RCL recall a stored number
From the lesson Calculating returns after fees: management, incentive, hurdle and high-water mark
Module 3 Private Capital: Private Equity and Private Debt
-
9A private equity fund buys a listed company using mostly debt, and a new management team replaces the existing one. This is best described as a:
Show the answer
The answer is B.
A. In a management buyout the current management team joins the buyers. Here it is replaced. The trap
B. A leveraged buyout in which the existing management is replaced by the acquiring team is a management buy-in.
C. A PIPE is a private sale of shares in a company that stays listed. Here the company is taken private.
From the lesson Private equity strategies: buyouts, venture capital and growth equity
-
10A private equity fund wants a quick, confidential exit, and a competitor has offered a premium for expected cost savings. The most appropriate exit is a:
Show the answer
The answer is A.
A. A strategic buyer pays a premium for synergies, and a private negotiation is fast, simple and confidential.
B. An IPO is slow, costly and requires heavy public disclosure. The trap
C. A recapitalization is not a true exit, so the fund would still own the company.
From the lesson How private equity exits: trade sale, IPO, SPAC and more
-
11Debt that ranks below senior secured loans but above equity, and often carries warrants, is best described as:
Show the answer
The answer is A.
A. Mezzanine debt is subordinated to senior secured debt and senior to equity. Warrants or conversion rights give lenders equity participation.
B. Direct senior lending ranks first, is secured and typically carries covenants, not warrants.
C. Venture debt lends to start-ups and early-stage companies. Its defining feature is the borrower, not a rank between senior debt and equity. The trap
From the lesson Private debt: direct lending, mezzanine, venture and distressed debt
-
12Which private capital category has the lowest expected risk and return?
Show the answer
The answer is C.
A. Mezzanine debt is junior and sits near the top of the debt part of the ladder.
B. Unitranche debt ranks between senior and subordinated debt, above senior lending. The trap
C. Infrastructure debt is at the bottom of the ladder: the most secured form of private debt.
From the lesson Private capital in a portfolio: risk, return, vintage years and diversification
Module 4 Real Estate and Infrastructure
-
13Which of the following is a disadvantage of owning real estate directly?
Show the answer
The answer is C.
A. Control is an advantage: only the owner decides when to buy or sell, how much to spend and whom to accept as tenants.
B. Depreciation and interest are deductible, which lowers taxable income. That is an advantage. The trap
C. A small investor can usually afford only one or a few properties, so a single building, tenant or local market dominates the result.
From the lesson Real estate: features and ways to invest (direct, REITs, funds)
-
14Which real estate strategy has the highest expected risk?
Show the answer
The answer is C.
A. Core-plus adds only minimal refurbishment to stable, income-producing property.
B. Value-add involves redevelopment and repositioning, but the most speculative work (new development, distress) is further along the spectrum. The trap
C. Opportunistic strategies, such as development and distressed property, carry the highest risk and the highest expected return.
From the lesson Real estate returns: core to opportunistic, leverage and diversification
-
15A privately financed hospital paid a fixed annual amount by the government for being ready to use is best described as social infrastructure with:
Show the answer
The answer is B.
A. Usage-based payments, such as tolls and fees, rise and fall with how much the asset is used. The hospital's payment does not. The trap
B. A fixed payment for keeping the facility available and maintained to standard is an availability payment.
C. Take-or-pay obliges a buyer to pay for a minimum volume of a product or service, typical of energy and utility contracts.
From the lesson Infrastructure: economic vs social, greenfield vs brownfield
-
16Which infrastructure investment most likely has the highest expected risk?
Show the answer
The answer is B.
A. A regulated utility has an operating record and regulated revenue, so it sits at the low end of the risk range.
B. A new toll road is greenfield (construction risk) and demand-based (traffic risk), which is the highest-risk combination.
C. Availability payments are fixed for keeping the hospital ready, and the asset already operates, so risk is low. The trap
From the lesson Infrastructure risk, return and diversification
Module 5 Natural Resources: Land, Timber, Farmland and Commodities
-
17The three primary return drivers of timberland are biological growth, land prices and:
Show the answer
The answer is B.
A. Buildings are a real estate driver. Timberland value does not rest on physical improvements.
B. Timberland earns from the growth of the trees, the price of lumber they are sold at and changes in the price of the land.
C. Crop yields drive farmland, not timberland. The trap
From the lesson Raw land, timberland and farmland as investments
-
18A commodity's futures prices are below its spot price. This is best described as:
Show the answer
The answer is B.
A. Contango is the opposite: futures above spot, because carrying costs exceed the convenience yield. The trap
B. Futures below spot means the convenience yield exceeds the cost of carry. The curve is inverted.
C. There is no such thing as a convenience cost. Convenience yield is a benefit of holding the physical good.
From the lesson Commodities: sectors, ways to invest, contango and backwardation
-
19Among commodities, farmland and timberland, the asset class most closely linked to inflation is:
Show the answer
The answer is A.
A. Commodity prices (energy, food) feed directly into inflation, and commodity returns have the highest correlation with it.
B. Farmland returns show little correlation with inflation. They hold up across regimes rather than tracking it. The trap
C. Timberland also shows little correlation with inflation.
From the lesson Natural resources: risk, return, inflation hedging and diversification
Module 6 Hedge Funds
-
20Compared with mutual funds, hedge funds are most likely to:
Show the answer
The answer is B.
A. Daily redemption is a mutual fund feature. Hedge funds use periodic redemption, lockups and gates. The trap
B. Light regulation and flexible mandates let hedge funds short, borrow and use derivatives more freely.
C. Hedge funds usually add an incentive fee to the management fee.
From the lesson What a hedge fund is, and how it differs from other funds
-
21A fund buys a company's convertible bonds and sells short its common shares to exploit a pricing gap. The strategy is best described as:
Show the answer
The answer is A.
A. Long the convertible and short the same issuer's shares is the convertible bond arbitrage trade.
B. Merger arbitrage trades the target and acquirer around a takeover, not a convertible and its shares.
C. A short-biased fund is mainly short shares and does not buy the issuer's bonds. The trap
From the lesson Hedge fund strategies: equity, event-driven, relative value, opportunistic
-
22The part of a hedge fund's return that an investor could obtain cheaply through an index fund is:
Show the answer
The answer is A.
A. Market beta is exposure to the broad market, available at low cost from index funds and ETFs.
B. Strategy beta comes from the particular strategy applied across the market, which is harder to replicate cheaply. The trap
C. Alpha is manager-specific return from skill, which an index cannot supply.
From the lesson Hedge fund returns: market beta, strategy beta, alpha and diversification
Module 7 Digital Assets
-
23Which statement about proof of stake is most accurate?
Show the answer
The answer is B.
A. Solving costly puzzles is how proof of work chooses the next block, and it is what makes that protocol energy-hungry.
B. Proof of stake: a validator pledges (stakes) assets to vouch for a block, and a majority of other validators who have also staked must attest that it is valid.
C. Most of the computing power is the 51% threshold of proof of work. Under proof of stake, an attacker would need most of the staked assets. The trap
From the lesson Distributed ledgers and blockchain: how digital assets are recorded
-
24An analyst who values bonds by discounting their coupons tries the same method on a cryptocurrency. The main obstacle is that the cryptocurrency:
Show the answer
The answer is A.
A. A discounted cash flow model needs interest or dividends. Most digital assets pay neither, so there is no fundamental value to compute; price rests on expected scarcity and future use.
B. True, but where ownership is recorded does not stop you discounting cash flows. It is a difference in validation, not in valuation. The trap
C. Also true, but a bond is not legal tender either and can still be valued. This is the medium-of-exchange difference.
From the lesson How digital assets differ from stocks, bonds and currencies
-
25Which of the following is a direct investment in digital assets?
Show the answer
The answer is B.
A. A crypto-related stock is indirect: you own part of a company, whose price also depends on its own business and the stock market.
B. The new tokens go to the investor and are recorded on the blockchain, so an ICO is direct, even though it feels like funding a new venture.
C. Futures are an indirect route: a cash-settled contract on the price, so no coins change hands. The trap
From the lesson Ways to invest in digital assets: direct and indirect
Keep going
Study the topic module by module in the Alternative Investments lessons, look up a word in the Level I glossary, or run a timed practice set that tracks your score by topic.