Question

(a). Which would you prefer as an investor (circle one)? Why?

i An investment with a 20% return half the time and a -10% return half the time.

ii An investment with a 30% return half the time and a -25% return half the time.

(b) For a hedge fund with 2% management fees and a 20% performance fee benchmarked to the risk-free rate of 0%, what are the average fees they get (as a percent of assets under management) if their pre-fee returns are 20% half of the time and -10% half the time?

(c) For a hedge fund with 2% management fees and a 20% performance fee benchmarked to the risk-free rate of 0%, what are the average fees they get (as a percent of assets under management) if their pre-fee returns are 30% half of the time and -25% half the time?

(d) Which would you prefer as a hedge fund manager maximizing your expected fees (circle one)?

i An investment with a 20% return half the time and a -10% return half the time.

ii An investment with a 30% return half the time and a -25% return half the time.

Answer 1

a. An investment with 30% return half the time and 25% return half the time because overall return on investment is more.

b. They will get management fee @ 2% and performance fee at an average rate of 15% ,ie, (20% + 10%)/2 as they are the incremental returns on hedge fund against the benchmark of 0%.

c. They will get management fee @ 2% and performance fee at an average rate of 27.5%, as the hedge fund is earning 30% return half of the time and 25% return in remaining half.

d. An investment with a 30% return half the time and and a 25% return in the other half as it would increase the amount of performance fee.