Canadian Securities Course (CSC) Level 2 Practice Exam

What can be expected from funds of hedge funds in terms of risk control?

1. No diversification and excessive diversification.

2. Access to hedge funds and diversify with smaller amounts.

3. Additional costs and risk of negative returns.

4. Managers unable to control risks effectively.

The correct answer is: Access to hedge funds and diversify with smaller amounts.

The choice highlighting access to hedge funds and the opportunity to diversify with smaller amounts accurately reflects the characteristics of funds of hedge funds. These investment vehicles pool capital from multiple investors to gain access to a range of underlying hedge funds, which typically require a more substantial minimum investment than individual investors may be willing or able to commit. By investing in a fund of hedge funds, smaller investors can achieve diversification across various hedge fund strategies and asset classes without the need to meet high minimum investment thresholds associated with direct investments in individual hedge funds. This approach allows for a more balanced risk exposure while still accessing the sophisticated strategies employed by hedge fund managers. In this context, the potential benefits include enhanced risk control through diversification, as the fund can spread risk across different strategies and hedge funds. It also comes with the added value of professional management, which can further assist in risk mitigation. The other options reflect misunderstandings of the mechanics and objectives of funds of hedge funds.