Level I Alternatives practice questions

Many alternatives exhibit non-normal returns, including negative skewness and excess kurtosis, reflecting tail risks, leverage, and nonlinear payoffs.

• Option A is wrong because many alternatives are illiquid, appraisal-based, and/or employ nonlinear strategies, undermining normality and daily marking.
• Option C is wrong because exposures vary by strategy and over time; stable betas near 1.00 are not a general feature of alternatives.

Compute end NAV before any fees:

Management fee (2% of beginning NAV):

NAV after management fee:

New profits above HWM (after management fee):

Incentive fee (20% of new profits above HWM):

Ending investor NAV after all fees:

Investor net return:

• Option B uses profits over beginning NAV instead of over the HWM. After the management fee, profit over beginning NAV is $129.8 - 110 = 19.8$; incentive $= 0.20 \times 19.8 = 3.96$; ending NAV $= 129.8 - 3.96 = 125.84$; return $= \frac{125.84 - 110}{110} \times 100 = 14.40\%$.
• Option C calculates the incentive before the management fee. Profit above HWM before the management fee is $132 - 120 = 12$; incentive $= 0.20 \times 12 = 2.4$; then deduct management fee 2.2; ending NAV $= 132 - 2.4 - 2.2 = 127.4$; return $= \frac{127.4 - 110}{110} \times 100 = 15.82\%$.

Availability-based PPPs pay project companies for making the asset available, transferring demand risk (e.g., traffic volumes) to the public sector. This generally produces more stable cash flows and supports lower required returns than demand-based concessions.

• Option A is wrong because demand-based assets bear volume/demand risk; volume guarantees are uncommon and typically partial if present.
• Option B is wrong because availability-based PPP cash flows are typically well-suited to long-term fixed-rate debt; commodity price exposure is not a defining feature.

Compute post-money valuation from the ownership percentage, then back out the investment to get pre-money.

• Option B reports the post-money valuation instead of pre-money.

• Option C divides by the complement ownership, which is incorrect for pre-money.

DSCR = $\frac{\text{NOI}}{\text{Debt Service}}$.

• Option A inverts the ratio: $\frac{190{,}000}{240{,}000} = 0.7917 \approx 0.79$.
• Option C subtracts first, then divides by debt service: $\frac{240{,}000 - 190{,}000}{190{,}000} = \frac{50{,}000}{190{,}000} = 0.2632 \approx 0.26$.

With negative skew and excess kurtosis, downside tail risk is not fully captured by standard deviation, so the Sharpe ratio can be misleading.

• Option A is wrong because standard deviation assumes symmetric dispersion and misses tail shape and skewness.
• Option C is wrong because correlation can still be estimated; non-normality does not preclude assessing diversification, though smoothing and tails warrant caution.

Compute end-of-year values with a hard hurdle (no catch-up), applying the incentive only to profits above the hurdle and after the management fee.

Gross end-of-year pre-fee NAV:

Management fee (1.5% of beginning NAV):

NAV after management fee:

Profit after management fee relative to beginning NAV:

Hurdle amount (6% of beginning NAV):

Excess over hurdle (after mgmt fee):

Incentive fee (20% of excess over hurdle):

Ending NAV after incentive fee:

Net return:

• Option A: Treats the hurdle as soft (applies 20% to all profits after mgmt fee): incentive $0.20 \times 850{,}000 = 170{,}000$; ending $10{,}850{,}000 - 170{,}000 = 10{,}680{,}000$ ⇒ 6.8%.
• Option C: Applies the excess-over-hurdle test before the management fee (uses gross profit): excess $= 1{,}000{,}000 - 600{,}000 = 400{,}000$; incentive $0.20 \times 400{,}000 = 80{,}000$; ending $11{,}000{,}000 - 150{,}000 - 80{,}000 = 10{,}770{,}000$ ⇒ 7.7%.

Compute netback per barrel:

Compute net revenue interest (NRI):

Annual gross barrels:

Annual net barrels at NRI:

Annual netback cash flow:

• Option A ($43,800,000) ignores the royalty (uses WI only): $1{,}825{,}000 \times 0.60 \times 40 = 43{,}800{,}000$
• Option B ($29,200,000) miscomputes NRI as WI minus royalty: $(0.60 - 0.20) = 0.40;\ 1{,}825{,}000 \times 0.40 \times 40 = 29{,}200{,}000$

Compute initial equity, exit enterprise value, exit equity value, and MOIC.

• Option B ignores debt at exit and treats enterprise value as equity: $\frac{400}{120} = 3.33$.
• Option C subtracts the initial debt instead of the exit debt: $400 - 180 = 220; \ \frac{220}{120} = 1.83$.

Compute loan amount, annual debt service (interest-only), equity invested, BTCF, then equity dividend rate.

Correct answer: 15.0%.

• Option A uses NOI instead of BTCF in the numerator: $\frac{400{,}000}{1{,}500{,}000} = 0.2667 = 26.7\%$
• Option B uses total purchase price instead of equity in the denominator: $\frac{225{,}000}{5{,}000{,}000} = 0.045 = 4.5\%$