SIE Understanding Products and Their Risks Question 22: Answer and Explanation

Question: 22

Which of the following is a typical characteristic of a mutual fund but not a hedge fund?

• A. Short selling
• B. Leverage
• C. Registered investment adviser
• D. Arbitrage

Correct Answer: C

Explanation:

C: A mutual fund is required to be registered with the SEC as a registered investment adviser (RIA) in which hedge funds are not required to register as an RIA. Therefore, hedge funds are not allowed to advertise freely but must target their distribution to accredited investors who are considered to be knowledgeable about investments. Short selling, Choice A, is borrowing an investment one does not own and selling it. This is done in anticipation of the investment declining in value so that it may be bought for less than the price for which it was sold. The investment purchased is returned to the entity that loaned the investment. Hedge funds may frequently sell short, whereas mutual funds generally do not. Leverage, Choice B, is borrowing to increase the return on investment. In this way, gains or losses are expanded, relative to the capital position of the fund. Hedge funds regularly use leverage. Mutual funds generally do not. Arbitrage, Choice D, is simultaneously buying and selling the same investment to profit from the inefficiencies in the market. Hedge funds may use arbitrage to some extent. Mutual funds generally do not.