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CFA Level I · CFA Level I Exam · Alternative Investment Performance and Returns

A hedge fund has a 20% incentive fee with a hard hurdle rate of 5% and no management fee. The fund earns a gross return of 13% on $200 million. Compared with a soft hurdle of 5% on the same terms, the incentive fee under the hard hurdle is most likely:

The hard hurdle fee is $2.0 million lower than under a soft hurdle. Hard hurdle fee is 20% of the profit above the hurdle, which is 3.2. A soft hurdle charges 20% of the whole profit, which is 5.2.

  1. A$1.6 million lowerCorrect
  2. Bthe same
  3. C$2.0 million higher

Explanation

Gross profit = 13% x 200 = 26. Hard hurdle: fee only on the excess over 5% (10), so fee = 20% x (26 - 10) = 3.2. Soft hurdle: once the hurdle is exceeded, fee applies on the entire profit = 20% x 26 = 5.2. The hard hurdle fee is 2.0 lower, not 1.6 lower; hence checking: 5.2 - 3.2 = 2.0. The soft hurdle fee is therefore higher by 2.0, so the hard hurdle fee is lower by 2.0.

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