9781118428160

The official study text for the Level I Chartered Alternative Investment Analyst (CAIA) exam The Chartered Alternative Investment Analyst (CAIA) designation is the financial industry's first and only globally recognized program that prepares professionals to deal with the ever-growing field of alternative investments. The second edition of CAIA Level I: An Introduction to Core Topics in Alternative Investments contains comprehensive insights on the alternative investment issues a potential Level I candidate would need to know about as they prepare for the exam. The information found here will help you build a solid foundation in alternative investment markets-with coverage of everything from the characteristics of various strategies within each alternative asset class to portfolio management concepts central to alternative investments. Uses investment analytics to examine each alternative asset class Examines quantitative techniques used by investment professionals Addresses the unique attributes associated with the alternative investment space Offers an online study guide outlining learning objectives and keywords This book is a must-have resource for anyone contemplating taking the CAIA Level I exam. So if you're ready to take your first step toward the CAIA charter, take the time to understand the insights offered here.

The CAIA Association is an independent, not-for-profit, global organization committed to education and professionalism in the field of alternative investments. It offers two exams (Level I and Level II) to financial professionals in this growing field. Upon successful completion, individuals are designated Chartered Alternative Investment Analyst (CAIA) Charter Holders. The CAIA Association has members from over seventy-five countries on six continents.

Mark J. P. Anson, PhD, CAIA, is a Managing Partner at Oak Hill Investment Management, LP. Dr. Anson previously served as President and Executive Director of Investment Services at Nuveen Investments, Chief Executive Officer at Hermes Pension Management Limited, and Chief Investment Officer at California Public Employees' Retirement System. He has published over 100 research articles in professional journals, has won two Best Paper Awards, is the author of six financial textbooks, and sits on the editorial boards of several financial journals.

Donald R. Chambers, PhD, CAIA, is the Associate Director of the Level 1 Curriculum at the CAIA Association and is the Walter E. Hanson/KPMG Professor of Finance at Lafayette College in Easton, Pennsylvania. Dr. Chambers previously served as the Director of Alternative Investments at Karpus Investment Management.

Keith H. Black, PhD, CAIA, is the Associate Director of the Level II Curriculum at the CAIA Association. He was previously an Associate at Ennis Knupp and, before that, an Assistant Professor at Illinois Institute of Technology.

Hossein Kazemi, PhD, CAIA, is a Cofounder of and the Program Director for the CAIA Association. Dr. Kazemi is a Professor of Finance at the University of Massachusetts Amherst, an Associate Director of the Center for International Securities and Derivatives Markets, and an Associate Editor of the Journal of Alternative Investments.

Preface xiii

Acknowledgments xvii

About the Authors xxi

PART ONE Introduction to Alternative Investments 1

CHAPTER 1 What Is an Alternative Investment? 3

1.1 Alternative Investments by Exclusion 3

1.2 Alternative Investments by Inclusion 4

1.3 Structures among Alternative Investments 8

1.4 Investments Are Distinguished by Return Characteristics 12

1.5 Investments Are Distinguished by Methods of Analysis 14

1.6 Goals of Alternative Investing 17

1.7 Overview of This Book 19

CHAPTER 2 The Environment of Alternative Investments 21

2.1 The Participants 21

2.2 Financial Markets 28

2.3 Regulations 30

2.4 Taxation 38

CHAPTER 3 Statistical Foundations 41

3.1 Frequency and Probability Distributions 41

3.2 Compounding Multiple Time Period Returns 44

3.3 Return Distributions and Autocorrelation 48

3.4 Moments of the Distribution: Mean, Variance, Skewness, and Kurtosis 50

3.5 Computing Sample Statistics 54

3.6 More on Standard Deviation and Variance 59

3.7 Testing for Normality 64

3.8 Other Measures of Risk 66

3.9 Estimating Value at Risk (VaR) 70

3.10 Time Series Return Volatility Models 75

3.11 Conclusion 77

CHAPTER 4 Risk, Return, and Benchmarking 79

4.1 Benchmarking 79

4.2 Asset Pricing Models 82

4.3 Three Methods of Models 82

4.4 Cross-Sectional versus Time-Series Models 85

4.5 Single-Factor and Ex Ante Asset Pricing 87

4.6 Empirical Analyses with the CAPM 90

4.7 Multifactor Models 96

4.8 Alternative Asset Benchmarking 103

4.9 Conclusion 107

CHAPTER 5 Correlation, Alternative Returns, and Performance Measurement 109

5.1 Correlation 109

5.2 Internal Rate of Return 118

5.3 Problems with IRR 122

5.4 Returns Based on Notional Principal 129

5.5 Distribution of Cash Waterfall 132

5.6 Performance Measures 139

CHAPTER 6 Alpha and Beta 147

6.1 Overview of Beta and Alpha 147

6.2 Ex Ante versus Ex Post Alpha 149

6.3 Inferring Ex Ante Alpha from Ex Post Alpha 155

6.4 Return Attribution 158

6.5 Ex Ante Alpha Estimation and Persistence 163

6.6 Return Drivers 164

6.7 Summary of Alpha and Beta Analysis 168

CHAPTER 7 Hypothesis Testing in Alternative Investments 169

7.1 Four Steps of Hypothesis Testing 170

7.2 A Test Assuming Normality 173

7.3 Tests with Inferential Statistics 176

7.4 Sampling and Testing Problems 181

7.5 Cumulative Returns and Performance 185

7.6 Statistical Issues in Analyzing Alpha and Beta 189

7.7 Summary of Alpha and Beta Estimation 196

7.8 Conclusion 198

PART TWO Real Assets 201

CHAPTER 8 Land, Infrastructure, and Intangible Real Assets 203

8.1 Land 203

8.2 Timber and Timberland 208

8.3 Farmland 210

8.4 Infrastructure 214

8.5 Intellectual Property 220

8.6 Valuation and Volatility 224

8.7 Historical Risks and Returns 228

CHAPTER 9 Real Estate Fixed-Income Investments 233

9.1 Residential Mortgages 233

9.2 Commercial Mortgages 241

9.3 Mortgage-Backed Securities Market 244

9.4 Collateralized Mortgage Obligations 249

9.5 Real Estate Investment Trusts 255

9.6 Risks and Returns of Mortgage REITs 256

CHAPTER 10 Real Estate Equity Investments 261

10.1 Real Estate Development 261

10.2 Valuation and Risks of Real Estate Equity 264

10.3 Alternative Real Estate Investment Vehicles 272

10.4 Real Estate and Depreciation 278

10.5 Real Estate Equity Risks and Returns 283

10.6 Risks and Returns of Equity REITs 288

PART THREE Hedge Funds 293

CHAPTER 11 Introduction to Hedge Funds 295

11.1 Distinguishing Hedge Funds 295

11.2 Hedge Fund Types 302

11.3 Hedge Fund Fees 304

11.4 Conclusion 315

CHAPTER 12 Hedge Fund Returns and Asset Allocation 317

12.1 Describing the Hedge Fund Universe 317

12.2 Mean, Variance, Skewness, and Kurtosis of Strategies 319

12.3 Categorizing Hedge Fund Strategies 321

12.4 Should Hedge Funds Be Part of an Investment Program? 328

12.5 Do Hedge Funds Undermine the Financial Markets? 333

12.6 Hedge Fund Indices 335

12.7 Conclusion 344

CHAPTER 13 Macro and Managed Futures Funds 345

13.1 Major Distinctions between Strategies 345

13.2 Global Macro 347

13.3 Returns of Macro Investing 351

13.4 Managed Futures 354

13.5 Systematic Trading 357

13.6 Systematic Trading Styles 359

13.7 Prior Empirical Research 369

13.8 Conclusion 376

13.9 Analysis of Historical Returns Conclusion 376

CHAPTER 14 Event-Driven Hedge Funds 381

14.1 The Sources of Most Event Strategy Returns 381

14.2 Activist Investing 384

14.3 Merger Arbitrage 397

14.4 Distressed Securities Funds 405

14.5 Event-Driven Multistrategy Funds 412

CHAPTER 15 Relative Value Hedge Funds 417

15.1 Convertible Bond Arbitrage 418

15.2 Volatility Arbitrage 433

15.3 Fixed-Income Arbitrage 447

15.4 Relative Value Multistrategy Funds 459

CHAPTER 16 Equity Hedge Funds 461

16.1 Sources of Return 462

16.2 Market Anomalies 466

16.3 The Fundamental Law of Active Management 472

16.4 Implementing Anomaly Strategies 475

16.5 The Three Equity Strategies 480

16.6 Conclusion 493

CHAPTER 17 Funds of Hedge Funds 495

17.1 Benefits and Costs of Diversification 495

17.2 Investing in Multistrategy Funds 502

17.3 Investing in Funds of Hedge Funds 505

17.4 Fund of Funds Historical Returns 508

17.5 Conclusion 520

PART FOUR Commodities 523

CHAPTER 18 Commodity Futures Pricing 525

18.1 Forward and Futures Contracts 525

18.2 Rolling Contracts 530

18.3 The Term Structure of Forward Prices 531

18.4 Backwardation and Contango 542

18.5 Returns on Futures Contracts 545

CHAPTER 19 Commodities: Applications and Evidence 551

19.1 Commodity Investing for Diversification 551

19.2 Commodity Investing for Return Enhancement 555

19.3 Investing in Commodities without Futures 557

19.4 Commodity Exposure through Futures Contracts 562

19.5 Three Fallacies of Roll Return 568

19.6 Commodity Futures Indices 570

19.7 Commodity Risks and Returns 572

19.8 Historical Risks and Returns 574

PART FIVE Private Equity 579

CHAPTER 20 Introduction to Private Equity 581

20.1 Private Equity Terminology and Background 581

20.2 Private Equity as Equity Securities 584

20.3 Private Equity as Debt Securities 587

20.4 Trends and Innovations in Private Equity 592

CHAPTER 21 Equity Types of Private Equity 599

21.1 Venture Capital versus LBOs 599

21.2 The Underlying Businesses of Venture Capital 600

21.3 Venture Capital Funds 601

21.4 Venture Capital Risks and Returns 609

21.5 Leveraged Buyouts (LBOs) 613

21.6 Leveraged Buyout Risks and Returns 623

CHAPTER 22 Debt Types of Private Equity 625

22.1 Mezzanine Debt 625

22.2 Distressed Debt 632

22.3 Risks of Distressed Debt Investing 637

PART SIX Structured Products 639

CHAPTER 23 Credit Risk and the Structuring of Cash Flows 641

23.1 An Overview of Credit Risk 641

23.2 Modeling Credit Risk 644

23.3 Structural Model Approach to Credit Risk 646

23.4 Reduced-Form Model Approach to Credit Risk 655

23.5 Structuring Using Collateralized Debt Obligations 663

23.6 Conclusion 666

CHAPTER 24 Credit Derivatives 667

24.1 Credit Derivative Markets 667

24.2 Credit Default Swaps 669

24.3 Other Credit Derivatives 678

24.4 Risks of Credit Derivatives 680

24.5 Conclusion 683

CHAPTER 25 Collateralized Debt Obligations 685

25.1 Introduction to Collateralized Debt Obligations 685

25.2 Balance Sheet CDOs versus Arbitrage CDOs 688

25.3 Cash-Funded CDOs versus Synthetic CDOs 692

25.4 Cash Flow CDOs versus Market Value CDOs 695

25.5 Credit Risk and Enhancements 696

25.6 New Developments in CDOs 699

25.7 Risks of CDOs 703

PART SEVEN Risk Management and Portfolio Management 709

CHAPTER 26 Lessons from Hedge Fund Failures 711

26.1 Problems Driven by Market Losses 711

26.2 Failures Driven by Fraud 721

26.3 Conclusion 727

CHAPTER 27 Risk Analysis 729

27.1 Investment Strategy Risks 729

27.2 Market Risk 730

27.3 Operational Risk 732

27.4 Investment Process Risk 734

27.5 Controlling Operational Risk 736

27.6 Aggregating the Risks of a Fund 740

27.7 Portfolios with Options 742

27.8 Conclusion 745

CHAPTER 28 Due Diligence of Fund Managers 747

28.1 Screening with Three Fundamental Questions 748

28.2 Structural Review 752

28.3 Strategic Review 756

28.4 Administrative Review 760

28.5 Performance Review 761

28.6 Portfolio Risk Review 767

28.7 Legal Review 770

28.8 Reference Checks 773

28.9 Measuring Operational Risk 774

CHAPTER 29 Regression, Multivariate, and Nonlinear Methods 777

29.1 Single-Factor Models and Regression 777

29.2 Multiple-Factor Models and Regression 781

29.3 Nonlinear Returns 783

29.4 Changing Correlation 785

29.5 Applications of Multifactor Models 787

29.6 Hedge Fund Performance Persistence 791

CHAPTER 30 Portfolio Optimization and Risk Parity 795

30.1 Mean-Variance Portfolio Optimization 795

30.2 Complications to Mean-Variance Optimization 803

30.3 Risk Budgeting 807

30.4 Risk Parity 810

CHAPTER 31 Portfolio Management, Alpha, and Beta 819

31.1 The Estimation of Alpha and Beta 819

31.2 The Separation of Alpha and Beta 821

31.3 Portable Alpha 822

31.4 Alpha, Beta, and Portfolio Allocation 827

31.5 Conclusion 831

APPENDIX Data Sources 833

Index 849

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CAIA Level I An Introduction to Core Topics in Alternative Investments, Print + eBook

CAIA Level I An Introduction to Core Topics in Alternative Investments, Print + eBook

1118428161

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