Free CAIA Level I Hedge Funds Practice Questions
Hedge fund strategies on CAIA Level I cover global macro, managed futures (CTA), event-driven (merger arbitrage, distressed), relative value (convertible arbitrage, fixed income), and equity hedge strategies, along with hedge fund index construction.
Sample Questions
Question 1
Easy
A hedge fund's lock-up period is best described as:
Solution
A is correct. A hedge fund lock-up is the contractually defined period that begins at the date of an investor's subscription during which redemptions are restricted (or carry a redemption-fee penalty). Lock-ups allow managers to hold less liquid positions without exposure to forced selling, which would otherwise damage all remaining investors.
Question 2
Medium
A dispersion trading strategy typically involves:
Solution
A is correct.
Dispersion trading exploits the tendency for implied correlation among index constituents to be overpriced. The strategy involves buying options (volatility) on individual stocks and selling options (volatility) on the index. If the implied correlation embedded in index option prices exceeds the actual realized correlation among individual stocks, the portfolio of single-stock options outperforms the index option, generating a profit.
Dispersion trading exploits the tendency for implied correlation among index constituents to be overpriced. The strategy involves buying options (volatility) on individual stocks and selling options (volatility) on the index. If the implied correlation embedded in index option prices exceeds the actual realized correlation among individual stocks, the portfolio of single-stock options outperforms the index option, generating a profit.
Question 3
Hard
A convertible bond arbitrageur holds a delta-neutral position. The delta hedge must be rebalanced most frequently when the underlying stock price is:
Solution
D is correct.
When the stock price is near the conversion price, the embedded equity option is approximately at-the-money and gamma is at its highest. High gamma means the delta changes rapidly with small stock price movements, requiring more frequent rebalancing of the equity short position to maintain delta neutrality.
When the stock price is near the conversion price, the embedded equity option is approximately at-the-money and gamma is at its highest. High gamma means the delta changes rapidly with small stock price movements, requiring more frequent rebalancing of the equity short position to maintain delta neutrality.