SIE Understanding Products and Their Risks Question 80: Answer and Explanation

Question: 80

What is an essential characteristic of hedge funds?

• A. All hedge funds are very similar.
• B. Hedge funds generally avoid borrowing to purchase assets.
• C. Hedge fund is another name for a mutual fund.
• D. Hedge funds generally have a goal of "absolute return."

Correct Answer: D

Explanation:

D: Choice D is correct because hedge funds generally have a goal of attaining a positive return, whether the broad market is having positive or negative returns. This is called an "absolute return." The word "hedge" generally refers to methods of purchasing assets whose returns do not correlate. That is, if one asset is decreasing in value, the other is expected to increase in value. Choice A is incorrect because hedge funds encompass many various types of funds, with different approaches to managing investments. Choice B is incorrect because several hedge funds borrow to purchase investments, so the return on capital can be greater when the values increase than if the fund only purchased assets equal to its liquid funds. Choice C is incorrect because hedge funds include a broad category of characteristics, many that are not common characteristics with mutual funds. Unlike many hedge funds, mutual funds are generally highly liquid.