Event-driven strategies: merger arbitrage, distressed securities — MCQs

Northbridge Pension Plan is reviewing three mature private equity funds and the proposed commitment to a new buyout fund. Investment analyst Elena Patel is responsible for reconciling the managers' reported performance with the cash-flow records maintained by the plan's custodian. Patel notes that private capital fund performance is commonly assessed using both money-weighted returns and investment multiples. She explains to the investment committee that an internal rate of return incorporates the timing of contributions and distributions, whereas a multiple such as total value to paid-in capital does not reflect how long capital has been invested. She also cautions that a fund with a high residual value may report an attractive total value multiple even though relatively little cash has been returned to investors. The custodian provides the information in Exhibit 1. All cash flows occur on the dates stated, values are reported after portfolio-company operating expenses, and no subscription credit facilities were used. Fund Alpha remains active, Fund Gamma has fully liquidated, and Fund Delta is completing its final distribution. Fund Gamma made its only capital call at inception and returned all proceeds exactly two years later. For Fund Delta, Patel reviews the limited partnership agreement summarized in Exhibit 2. The waterfall is calculated at the total-fund level rather than on a deal-by-deal basis. Consequently, the general partner cannot receive carried interest until limited partners have recovered all contributed capital. The liquidation proceeds shown in Exhibit 1 are before carried interest but after portfolio-level expenses. Management fees have been settled separately, so they must not be deducted again when calculating carried interest. Finally, Patel evaluates the proposed buyout fund's projected pattern of returns. The manager expects negative net returns during the first two years, even if portfolio companies initially perform in line with their business plans. The manager attributes this pattern to organizational expenses, management fees, and the practice of initially carrying investments near acquisition cost. Realizations and valuation gains are expected to occur later as operating improvements are implemented and portfolio companies are sold. Patel tells the committee that this pattern is common but does not eliminate the need to evaluate the manager's investment discipline, valuation policies, and use of leverage.

Atlas Diversifying Strategies manages a multi-strategy hedge fund for institutional investors. One portfolio team trades announced corporate acquisitions. In a pending share-for-share acquisition, the team purchases shares of the target company and sells short the number of acquirer shares expected to be received when the transaction closes. The expected profit is primarily the difference between the target's current market value and the value implied by the announced exchange ratio. The principal risks are deal failure, revised terms, and a longer-than-expected closing period. The fund charges both management and incentive fees. Incentive fees are subject to a perpetual high-water mark, and the partnership agreement specifies that the management fee is deducted before determining the incentive-fee base. There is no hurdle rate or general-partner catch-up. Exhibit 1 provides the complete fee information for the current year. No subscriptions, redemptions, or distributions occur during the year. Atlas is also evaluating a fully collateralized long commodity-futures position. The portfolio manager decomposes the position's total return into spot return, roll return, and collateral return. At expiration, the futures price converges to the spot price. For this analysis, each return component is measured relative to the initial spot price, as directed in Exhibit 2. Transaction costs, margin variation, taxes, and contract multipliers can be ignored. A separate team proposes holding digital assets directly rather than through a regulated investment vehicle. The assets would be maintained in self-custody wallets, meaning Atlas would control the private keys rather than delegate custody to an exchange or specialist custodian. The team argues that the distributed ledger provides an immutable record of validated transactions and that direct custody avoids counterparty exposure to a centralized trading venue. The operational-risk officer responds that immutable settlement can make erroneous transfers difficult to reverse and that possession and secure backup of private keys are critical to continued access. The investment committee asks analysts to classify the acquisition trade, calculate the fee-adjusted year-end NAV, decompose the commodity return, and identify the operational risk most directly associated with the proposed digital-asset custody method.

Ardent Foundation is evaluating diversifying strategies for a USD 500 million portfolio. Its consultant reviews three hedge fund allocations, a commodity futures position, and a proposed direct digital-asset holding. The foundation is willing to accept moderate leverage but wants the sources of return and operational risk described accurately. The first hedge fund maintains USD 120 million of long equity positions and USD 110 million of short equity positions against USD 100 million of net asset value. The manager seeks to neutralise broad equity-market sensitivity while profiting from security selection. For exposure reporting, long positions are entered as positive amounts, short positions as negative amounts, gross exposure uses the absolute values of both legs, and net exposure offsets the short positions against the long positions. A second manager buys convertible bonds judged to be undervalued relative to the issuers' common shares. The manager shorts the corresponding shares in amounts intended to hedge the convertibles' equity sensitivity and seeks to profit as the pricing relationship normalises. The trade is not associated with a merger, bankruptcy, restructuring, or other announced corporate event. A third fund follows a discretionary directional macro strategy, but no calculation concerning that fund is required. For its commodity allocation, Ardent enters a fully collateralised long futures contract at a futures price of USD 98 per unit when the commodity's spot price is USD 103. At contract expiration three months later, the spot price is unchanged at USD 103. The contract settles against the exchange's specified final settlement index, which is calculated from a designated reference basket and expiration-day fixing procedure rather than directly from cash-market spot quotes, and that index-based settlement price is USD 100. For the requested return calculation, use the change in the futures price divided by the initial futures price. The collateral earns zero interest, and transaction costs, margin variation, taxes, and management fees are ignored. Ardent is also considering direct ownership of a token recorded on a permissionless blockchain. The token would be held in a self-custodied wallet, and only Ardent would control the private key. The network does not provide chargebacks, the token has no central issuer capable of resetting credentials, and Ardent has not retained a third-party custodian or recovery service. The operational risk team considers the consequence of permanently losing every copy of the private key. All percentage exposure calculations use the stated USD 100 million hedge fund net asset value.

An investor requires exchange trading, observable market prices, and no responsibility for property operations. The most appropriate real estate exposure is:

An adviser seeking continuing subscriptions and periodic investor redemptions should most likely select:

A hedge fund begins with NAV of USD 100 million and ends before fees at USD 125 million. It charges a 2% fee on beginning NAV and 20% incentive fee above a USD 105 million high-water mark, calculated after the management fee. The investor's net return is closest to:

A REIT reports USD 120 million of net income, USD 30 million of depreciation, and USD 10 million of gains on property sales. With USD 2.8 billion market capitalisation, its price-to-FFO yield is closest to:

A private equity fund invests USD 10.0 million today and receives a single USD 14.0 million distribution two years later. The calculated annual IRR is closest to: