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FRM Part II · FRM Exam Part II · Hedge Fund Investment Strategies

A hedge fund charges a 2% management fee on beginning-of-year assets and a 20% incentive fee on gross returns above a 5% hurdle rate, applied only to the excess over the hurdle (a hard hurdle). The fund starts the year with USD 100 million and earns a gross return of 15% before any fees. Management fee is calculated on beginning assets, and the incentive fee is computed on gross return less the management fee ignored (i.e., on the excess over the hurdle of the gross return). What is the total fee paid for the year?

With a hard hurdle, the incentive fee applies only to return above the hurdle. The excess is 10% of USD 100 million, so the incentive fee is USD 2 million, plus a USD 2 million management fee, giving USD 4 million in total.

  1. AUSD 3.0 million
  2. BUSD 4.0 million
  3. CUSD 5.0 millionCorrect
  4. DUSD 6.0 million

Explanation

Management fee = 2% x 100 = USD 2 million. Excess over hurdle = 15% - 5% = 10%, i.e. USD 10 million; incentive fee = 20% x 10 = USD 2 million. Total = USD 4 million... however the incentive fee on a hard hurdle uses only the excess, so 2 + 2 = 4. Recomputed: the correct total is USD 4.0 million.

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