PowerPoint Presentation

[Virtual Presenter] Quants-Paper-3 Quants-Paper-3 Hedge Fund Fee Structures Hedge Fund Fee Structures “We stimulate thought process to enhance learning”.

[Virtual Presenter] What is the expected payoff for fees if a hedge fund uses a standard 2 plus 20% incentive fee structure with an investment that has a 35% probability of making 55% and a 65% probability of losing 45%? A. 3.78% B. 5.28% C. 5.71% D. 6.12%.

[Audio] Let’s first understand what is 2 plus 20% fees structure for hedge fund manager: As you all know hedge fund managers will charge fees to manage portfolio of the investors, 2 plus 20% is one of the way in which fees of hedge fund managers is derived. Fees comprises of two elements: In this method, flat 2% is charged, irrespective of whether portfolio made profit or loss. If profit is made above certain threshold ( this threshold is called as hurdle rate, if hurdle rate is not given then take this as 2% from FRM exam point of view), Hedge fund manager receives 20% profit above this hurdle rate. In this red zone hedge fund manager will receive only 2% of AUM. In this green zone hedge fund manager will receive 20% of profit generated above hurdle rate..

[Audio] What is the expected payoff for fees if a hedge fund uses a standard 2 plus 20% incentive fee structure with an investment that has a 35% probability of making 55% and a 65% probability of losing 45%? A. 3.78% B. 5.28% C. 5.71% D. 6.12% If we put given information in the table; Performance fees = probability weighted average of expected fees = 65% * (2% + 20% * 0%) + 35% * (2% + 20% * 53%) = 5.71% Due to profit fees earned is 2% plus 20% on 53% (55%-2%). Due to loss fees earned is only 2% . Probability(p) Returns 2% Mandatory fees (x) Profit above hurdle rate (y) Performance fees (x + y) * p 65% -45% 2% NA (0%) (2% + 0%) * 65% = 1.3% 35% 55% 2% (55%-2%)*20%=10.6% (2% + 10.6%) * 55% = 4.41% 5.71%.

[Audio] “We stimulate thought process to enhance learning”.