Answers to Questions and Problems

9.13
The equity of the fund is $50 million because the sum of the liabilities
and equity must equal the value of the assets. The NAV of a unit is the
equity divided by the number of units:
NAV = $50 Million/28,000 Units = $1,786 NAV per Unit
9.14
The financial statements of the hedge fund report the Treasury income
and in lieu interest expenses without adjustment for taxes. The fund
may subtract the interest expense on short positions from the income
received and report the net Treasury interest income. The hedge fund
is a flow-through tax entity so it doesn't pay taxes. Other types of
businesses, such as C corporations, would make an allowance for the
taxes payable on the Treasury income.
A hedge fund investor would exempt the Treasury interest from
taxable income on the state income tax form. Similarly, the substitute
interest payments would be treated as if the U.S. Treasury made the
payments. As a result, the hedge fund investors would not be able to
deduct the interest expense on state tax forms.
The hedge fund will likely receive some of the Treasury income
on long positions in the form of substitute interest payments. These in
lieu payments can be treated as U.S. Treasury income, even though
the actual payments were remitted by other parties.
9.15 The hedge fund might accrue the management fee daily. More likely,
the fund will book the management fee only once monthly and ad-
just the NAV during the month for a portion of the fee accrued. The
annual management fee on $100 million is 1 percent or $1 million.
The partnership agreement defines how this fee is split over 12
months, but often one-twelfth of the amount is assessed each month.
If the fund in question follows this simple rule, it will charge a man-
agement fee of $83,333 ($1 million/12) for May. Because May has
31 days, the fund may accrue a daily management fee of $2,688
($83,333/31). On May 5, five days of accrual would total $13,441
($2,688
x 5). If the general ledger system does not accrue the fee
daily, $13,441 should be subtracted from the fund's capital before
NAV is calculated.
9.16
If this hedge fund uses cash positions in stocks, bonds, or commodities,
it would have leverage of approximately 2:1. Because the futures po-
sitions do not appear on the balance sheet, the fund would show only
the cash held on deposit at the futures broker plus any excess cash.
Unless analysts adjust the futures positions, this fund would appear
to be unlevered and not invested in risky positions.
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