Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What is typically a characteristic of hedge funds?

1. Investment in publicly traded stocks only

2. Use of complex strategies and leverage

3. Regulated by the Securities and Exchange Commission

4. Only available to institutional investors

The correct answer is: Use of complex strategies and leverage

Hedge funds are known for employing complex investment strategies that often involve the use of leverage to enhance returns. This characteristic allows them to take advantage of various market conditions and investment opportunities that may not be accessible to traditional investment vehicles. The use of derivatives, short selling, and arbitrage strategies exemplifies the sophisticated approach that hedge funds can adopt. This versatility enables them to manage risk and pursue absolute returns rather than merely trying to outperform a benchmark index. The other options do not accurately capture the essence of hedge funds. While some hedge funds may invest in publicly traded stocks, they are not limited to this type of investment; they can also invest in real estate, commodities, private equity, and more. Hedge funds are not uniformly regulated by the Securities and Exchange Commission, which typically oversees mutual funds and other retail investment vehicles; hedge funds enjoy greater regulatory flexibility due to their limited investor base and the nature of their operations. Additionally, while many hedge funds may target accredited investors and institutional clients, they are also available to high-net-worth individuals under certain conditions, not exclusively limited to institutional investors. This flexibility in client base and investment approach differentiates hedge funds from other types of investment funds.