Skip to content

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

Which statement best describes the payoff profile of a typical fixed income relative value strategy that uses high leverage to harvest small spread convergences?

These strategies typically generate frequent small gains but face occasional large losses, so returns are negatively skewed like selling liquidity or volatility insurance. Leverage magnifies tiny spread convergences, but in market stress spreads diverge sharply, producing outsized drawdowns.

  1. AFrequent small gains with exposure to occasional large losses, resembling a short position in volatility or liquidityCorrect
  2. BLarge frequent gains with small rare losses, similar to a long straddle
  3. CReturns that are perfectly uncorrelated with market stress by construction
  4. DReturns driven solely by the direction of equity markets

Explanation

Leveraged spread-convergence trades earn steady small profits but suffer large losses when spreads blow out in a crisis, as in 1998, giving negatively skewed returns similar to selling insurance. A long straddle has the opposite shape, and correlation to stress is not zero.

Did you get it right without looking?

One question tells you little. A timed set on Hedge Fund Investment Strategies shows your real accuracy, how long you take and where you lose marks.

Practise Hedge Fund Investment StrategiesFree diagnostic mock

More Hedge Fund Investment Strategies questions