Question

List four key legal documents necessary for establishing and managing a private fund.

What is a qualified majority?

Is the New York Stock Exchange a secondary or third market?

What are the three constraints against achieving alternative investment benefits through liquid products?

What is systemic risk?

Answer 1

1. The four key legal documents necessary for establishing and managing a private fund are:

i) Privat-placement memoranda (aka. the offering memorandum) - which includes the formal description of an investment opportunity that complies with security regulations

ii) a partnership agreement (aka. a limited partnership agreement), which is a formal written contract creating a partnership

iii) a subscription agreement, which is an application submitted by an investor who desires to join a limited partnership

iv) management company operating agreement, which is an agreement between members related to a limited liability company and the conduct of its business as it pertains to the law.

2. A qualified majority (eg. the decision to remove the GP without cause) is generally more than 75% of the LPs in contrast to the over 50% required for a simple majority.

3. The secondary market is an exchange between equity holders. For example, if one investor decides to sell the shares that he bought at the IPO, he might sell them to another investor. That would be an example of the secondary market. New York Stock Exchange is one of the largest secondary markets in the US.

4. The three constraints against achieving alternative investment benefits through liquid products are:

(a) Leverage - The hedge fund strategies often require substantial use of leverage, which is restricted within liquid products like US mutual funds by regulation. Specifically, there is a 300% asset coverage rule that requires a mutual fund to have assets totaling at least three times the total borrowings of the fund, thus limiting borrowing to 33% of assets. UCITS restrictions are even tighter.

(b) There are regulatory constraints on concentration (i.e. lack of diversification).

(c) There are illiquidity constrains (e.g. no more than 15% of a '40 Act fund or 10% of a UCITS fund can be invested in illiquid assets) that prevent substantial inclusion of private equity in open-end mutual funds.

5. Systemic risk is the potential for economy-wide losses attributable to failures or concerns over potential failures in financial markets, financial institutions, or major participants. For example, the collapse of a very large hedge fund may lead to a sequence of collapses and failures that disrupt the entire financial system and cause widespread economic losses from inability of the other market participants to trade and manage risks due to the uncertainty that is generated.