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Lyons Managers LLC is a small investment management firm that invests exclusively in publicly traded securities. The president of the firm, James Bouchard, is considering diversifying into private equity investments, venture capital deals, and hedge funds because some of the firm’s best clients are inquiring about these types of investments. He has asked his senior analyst, William Hosep, to conduct research and learn more about them.As Hosep begins his research regarding private equity, Bouchard tells him one of his goals is to invest in private equity funds that purchase companies with excellent growth prospects and track records with strong operating histories. Further, Bouchard worries that debt markets may become tighter, so he wants to invest in private equity funds that can obtain high multiples when exiting investments in portfolio companies without relying on new debt offerings.Hosep next decides to research the structure of private equity funds. He compiles a list of their important features, three of which are summarized in the following statements:Statement 1: The limited partners’ share of profits of the private equity fund is referred to as carried interest.Statement 2: Private equity investments are typically made using partnership agreements that have a predetermined end date.Statement 3: A distribution waterfall is a technique used to order the distributions to which limited and general partners are entitled.Hosep examines the calculation method for carried interest of private equity funds. Exhibit 1 shows an example of the cash flows and distributions of a private equity fund over the last five years. The carried interest is 20% of profits, and the committed capital is $75 million. Hosep continues his research by examining venture capital investments. He finds an article describing three of their typical characteristics.Characteristic 1: Venture capital investments have a strong asset base.Characteristic 2: Venture capital investments have low cash flow predictability.Characteristic 3: The exit strategy of a venture capital investment is difficult to anticipate.Hosep develops an example of a venture capital deal so that he can explain to Bouchard how the share price of a deal is calculated. The deal information is found in Exhibit 2. Bouchard asks Hosep if he knows of a hedge fund strategy that involves the use of both equities and fixed income securities. Hosep mentions the convertible bond arbitrage strategy. |
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