CFA Level I Alternative Investments Practice Questions

Correct answer: A. Appraisals lag transaction prices and smooth reported values, which understates true volatility and correlation

Appraisal-based indexes rely on valuations that adjust slowly to market information, which smooths the return series. The result is understated standard deviation and correlation with other assets, so the index overstates the diversification benefit relative to the true economic risk.

• AA. Correct. Appraisal smoothing is the known bias in appraisal-based real estate indexes.
• BB. Lease cash flows are not riskless, and property values still change with market conditions.
• CC. Geographic mix does not explain the index's artificially low volatility.
• DD. Annualizing does not change true volatility; the low figure comes from smoothed valuations, not holding-period length.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: B. Survivorship bias

Survivorship bias occurs when historical index returns are calculated using only funds that are still operating and reporting today, systematically excluding funds that failed or stopped reporting (often due to poor performance), thereby overstating average historical returns. This is distinct from backfill bias (Choice C), where a new fund's historical track record is added retroactively to an index only after it decides to start reporting (self-selecting for funds with good early histories), and from look-ahead bias (Choice A), which involves using information not actually available at the time of a decision. Currency translation bias (Choice D) is not a standard hedge fund database bias.

• AA. Look-ahead bias involves using information not actually available at the time of an analysis, such as data revisions, not the exclusion of failed funds from a historical database.
• BB. Survivorship bias arises when funds that closed or stopped reporting drop out of the historical database, leaving only surviving, typically better-performing funds and overstating the index's historical returns.
• CC. Backfill (instant history) bias occurs when a fund's past returns are added to the index only once it decides to start reporting, typically after a good track record, which is a related but distinct bias from failed funds being dropped.
• DD. Currency translation bias concerns distortions from converting returns across currencies, unrelated to funds dropping out of a database after closing.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: D. Reported returns to be negative in the fund's early years, due to fees and unrealized investment costs, before turning positive as portfolio companies mature and are exited

The J-curve effect describes the typical pattern in private equity fund returns: early negative or low reported IRRs stemming from management fees, deal costs, and the J-curve's characteristic lag before investments are marked up or exited, followed by improving and eventually positive returns as portfolio companies mature and are realized.

• AA. Incorrect. A continuous decline throughout the fund's life contradicts the eventual recovery and positive returns the J-curve describes.
• BB. Incorrect. A steady linear rise does not match the characteristic dip-then-rise 'J' shape the effect is named for.
• CC. Incorrect. Carried interest is earned on profits upon successful exits, typically later in the fund's life, not as an upfront first-year payment.
• DD. Correct. This is the standard description of the J-curve: early dip from fees/costs, later rise as value is created and realized.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: A. To reduce net exposure to broad market movements while profiting from relative mispricing between selected securities

Long/short equity managers buy stocks they expect to outperform and short-sell stocks they expect to underperform. This can reduce net market exposure (the portfolio's overall beta) while still capturing returns from the manager's stock-selection skill (relative value). Net exposure can be varied, and some managers keep a modest net long or net short bias, but reducing reliance on market direction is the core purpose. The claim that returns are guaranteed is wrong because relative bets can lose money. The claim that all risk is eliminated is wrong because stock-specific and relative-value risk remain. The claim that the aim is a leveraged single directional bet is wrong because that describes a purely directional strategy.

• AA. Correct. The primary goal of long/short equity is to reduce or neutralize exposure to overall market direction while capturing returns from the manager's relative security selection, longs expected to outperform, shorts expected to underperform.
• BB. Incorrect. Long/short strategies don't guarantee positive returns in all conditions; they can still lose money if the manager's relative bets are wrong, even with reduced market exposure.
• CC. Incorrect. Long/short strategies don't eliminate all risk; they specifically retain, and aim to profit from, stock-specific and relative-value risk while reducing market risk.
• DD. Incorrect. This describes the opposite of the strategy's purpose; long/short investing reduces directional market bets rather than maximizing leveraged exposure to one direction.

• Source: CFA Institute refresher reading: Hedge Funds, accessed October 2026

Correct answer: D. Validators are chosen in proportion, often with randomization, to the assets they commit; a slashing penalty on staked assets discourages cheating

In proof-of-stake consensus, validators lock up (stake) crypto-assets and are selected, usually with a random element, in proportion to their stake. Dishonest validation can result in slashing, a forfeiture of part of the stake, which provides the economic deterrent.

• AA. This describes proof-of-work, where miners compete to solve puzzles.
• BB. Public proof-of-stake networks are permissionless and do not rely on a centrally appointed committee.
• CC. Hardware power determines success under proof-of-work, not proof-of-stake.
• DD. Correct. Selection depends on committed stake, and slashing penalizes misbehavior.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026

Correct answer: B. Long-lived assets, stable and often inflation-linked cash flows, and high barriers to entry

Infrastructure assets are typically very long-lived, capital-intensive, and often operate under regulatory frameworks or long-term contracts (e.g., toll or tariff structures) that produce relatively stable, sometimes inflation-linked cash flows; high capital requirements and regulatory approval also create high barriers to entry. Choices A, C, and D each contradict a core, well-established characteristic of infrastructure as an asset class.

• AA. Incorrect. This describes the opposite of infrastructure assets, which are long-lived and typically defensive rather than short-lived and highly cyclical.
• BB. Correct. Infrastructure assets like toll roads, utilities, and airports typically have very long useful lives, stable and often inflation-linked cash flows, and high barriers to entry from capital intensity and regulation.
• CC. Incorrect. Infrastructure investments are typically illiquid and privately held, priced by appraisal or models rather than continuously marked to market like public equities.
• DD. Incorrect. Infrastructure assets are frequently subject to significant government regulation, such as rate-setting or concession terms, which is a defining feature, not an absent one.

• Source: Exam outline: CFA Institute 2026 Level I Topic Outlines (learning outcomes), accessed October 2026