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CFA Level I · CFA Level I Exam · Hedge Funds

A hedge fund manager expects a sustained market decline and holds mostly short positions in overvalued stocks, with a small long book to reduce risk. The most likely risk specific to this strategy is:

The key risk of a short bias strategy is that losses on short positions are theoretically unlimited, since a stock's price can rise without bound. Short squeezes and rising markets can magnify these losses. Such funds tend to correlate negatively, not positively, with equity indexes.

  1. Alosses that are theoretically unlimited if shorted stocks rise sharplyCorrect
  2. Binability to earn returns in any rising equity market
  3. Cautomatic correlation of +1 with long-only equity indexes

Explanation

A short position loses as the price rises, and there is no upper limit to a stock's price, so losses are theoretically unlimited. The fund can still earn returns in rising markets through stock selection. A short bias fund tends to have negative, not positive, correlation with equity indexes.

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