CFA Practice Question

There are 139 practice questions for this study session.

CFA Practice Question

Suppose an investor enters a hedge fund with a $1,000,000 at the beginning of year 1, and in that year the fund is down 20%, that is, the value of the investment drops to $800,000 gross of fees. The investor still pays the management fee (that is why it is called a fixed fee), but the investor pays no incentive fee. Now suppose that after year 2 the investment value is up to $1,200,000, representing over a 50% gain in year 2 for the fund. The investor should pay an incentive fee on ______.
A. $200,000
B. $400,000
C. $1,200,000
Explanation: That is, he or she only pays a fee on the amount in excess of the entering NAV. The entering NAV in this case is called the high water mark. In subsequent years if there is a drop in NAV, the new high water mark will be the entering NAV of the previous year, or the previous high water mark, whichever is greater.

User Contributed Comments 2

User Comment
sals1230 The question should've mentioned that the HF has a high water mark policy in order for B to be correct, no?
krispy4 I believe it is always implied that the high watermark is the highest value reached. In this case, the benchmark is $1m, that is the watermark.

Going forward, the new watermark will be $1.2m
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