Question 1 of 21
Assertion (A): Leverage can increase private equity returns.
Reason (R): Debt magnifies equity gains when company value rises.
id: 11
model: GPT 5.2
topic: Leverage impact
Explanation
Start from the capital structure identity: enterprise value is allocated first to debt holders up to what they are owed, and the remainder belongs to equity. Assertion (A) is true because when a company is purchased with significant debt, equity is a smaller slice of the capital stack; if enterprise value increases and debt does not increase proportionally, the residual value accruing to equity rises more sharply in percentage terms. Reason (R) is true and explains the mechanism: debt creates a fixed claim, so increases in firm value largely flow to the residual claim (equity), magnifying gains on a smaller equity base. The caveat (implicit in the concept) is symmetric: leverage also magnifies losses when value falls, but that does not negate the truth of A or the explanation in R.
Question 2 of 21
Assertion (A): Private equity funds invest in multiple companies.
Reason (R): Diversification reduces idiosyncratic risk.
id: 21
model: GPT 5.2
topic: Portfolio diversification
Explanation
From first principles, idiosyncratic (company-specific) risk is the uncertainty unique to one firm—execution risk, product failure, litigation, customer loss—and it can be reduced by holding multiple independent exposures. Assertion (A) is true because many private equity funds construct portfolios across several companies (and sometimes across sectors or vintages) rather than concentrating in a single deal, though concentration can vary by strategy. Reason (R) is true because diversification can reduce the impact of any one company’s adverse outcome on the overall fund’s return. R explains A because building a multi-company portfolio is a direct implementation of the diversification principle: spreading capital across deals improves the fund’s risk profile without necessarily eliminating systematic (market-wide) risks. The incorrect options would require denying either that funds commonly portfolio-build or that diversification reduces idiosyncratic risk, both of which contradict basic portfolio logic.
Question 3 of 21
Assertion (A): Private equity investors often pay a control premium.
Reason (R): Control enables strategic and operational changes.
id: 20
model: GPT 5.2
topic: Control premium
Explanation
First principles: an asset is worth more if the owner can change decisions to improve cash flows or reduce risk; control is the right to make those decisions. Assertion (A) is true because acquiring control can require paying more than a minority stake would cost, reflecting the additional rights and influence obtained. Reason (R) is true because control can allow replacement of management, capital structure redesign, M&A execution, and operational initiatives—actions that may be difficult with only a passive minority stake. R explains A because the control premium is the price of these value-creation rights; investors pay extra because control expands the feasible set of actions that can raise value. The other options fail by treating control as irrelevant to value, contradicting the logic of ownership rights.
Question 4 of 21
Statements about how private equity firms create value:
(1) Improving operational efficiency of portfolio companies.
(2) Using financial leverage to amplify equity returns.
(3) Relying primarily on short-term trading gains.
(4) Strategic repositioning and governance changes.
Which of the statements given above are correct?
id: 2
model: GPT 5.2
topic: Value creation in private equity
Explanation
From first principles, equity value increases when expected future cash flows rise and/or the risk-adjusted discount rate or exit multiple improves. (1) is correct because operational efficiency can raise free cash flow via higher revenues, better margins, or lower working-capital needs. (2) is correct because leverage changes the capital structure: if the enterprise value grows and debt is serviced, gains accrue to the smaller equity base, magnifying equity returns (while also increasing risk). (3) is incorrect because “short-term trading gains” requires liquidity and frequent price discovery; private equity’s illiquidity and control-oriented approach typically targets multi-year value creation, not rapid turnover. (4) is correct because governance, incentives, and strategic repositioning can change business fundamentals and exit attractiveness, affecting both cash flows and valuation at sale.
Question 5 of 21
Assertion (A): Private equity is immune to market risk.
Reason (R): Private equity investments are not publicly traded.
id: 16
model: GPT 5.2
topic: Market risk
Explanation
First principles: “market risk” is exposure to economy-wide factors (growth, rates, credit conditions, valuation multiples), not merely exposure to daily price quotation. Assertion (A) is false because private companies still sell into markets, face cost cycles, and are valued using market-driven discount rates and exit multiples; these drivers move with broader conditions. Reason (R) is true because private equity stakes are not publicly traded, which reduces continuous mark-to-market pricing and observed volatility. However, R does not make A true: absence of public trading changes price observation frequency, not underlying economic sensitivity. Therefore the correct choice is that A is false while R is true.
Question 6 of 21
Assertion (A): Private equity investments are illiquid.
Reason (R): There is no organized secondary market for private equity stakes.
id: 9
model: GPT 5.2
topic: Illiquidity
Explanation
From first principles, liquidity means the ability to sell an asset quickly, in size, at low transaction cost, and at a price close to fair value. Assertion (A) is true because private equity stakes are not standardized exchange-traded securities and typically cannot be sold on demand. Reason (R) is true because the absence of a centralized, deep, continuous market with transparent pricing forces sales to be negotiated, slower, and often at a discount, which is exactly what illiquidity describes. R explains A because market structure (or lack of it) is a primary driver of liquidity. Alternative choices fail because they either misstate liquidity as a property of the asset regardless of trading venue, or they deny the causal link between organized markets and liquidity.
Question 7 of 21
Statements about leveraged buyouts (LBOs):
(1) LBOs use borrowed funds to acquire equity.
(2) Stable cash flows support higher leverage.
(3) LBOs eliminate all operational risk.
(4) Equity returns are sensitive to leverage levels.
Which of the statements given above are correct?
id: 4
model: GPT 5.2
topic: Leveraged buyouts
Explanation
Start with definitions: an LBO is an acquisition where debt finances a large portion of the purchase price, with equity providing the remainder. (1) is correct because the transaction explicitly relies on borrowed funds to acquire a controlling equity stake. (2) is correct because debt service is contractual; stable and predictable operating cash flows reduce default risk and allow higher debt capacity. (3) is incorrect because leverage does not remove business or operational risk; it can amplify it by reducing financial flexibility and increasing the consequences of earnings shortfalls. (4) is correct because leverage changes the equity “residual claim”: small changes in enterprise value can produce large changes in equity value when debt is high, making equity returns highly sensitive to leverage and repayment path.
Question 8 of 21
Statements about private equity investments:
(1) Private equity involves ownership interests in companies that are not publicly traded.
(2) Private equity investors typically seek active involvement in management.
(3) Private equity investments are generally liquid due to active secondary markets.
(4) Private equity returns are primarily realized through exit events.
Which of the statements given above are correct?
id: 1
model: GPT 5.2
topic: Private equity characteristics
Explanation
Start from first principles: “private equity” means an equity (ownership) claim in an enterprise whose shares are not listed for continuous public trading. (1) is therefore correct because the defining feature is non-publicly traded ownership interests. Next, value creation in private equity is not usually passive; owners often influence governance, strategy, capital structure, and operating decisions, so (2) is typically correct. Liquidity requires a deep, standardized, continuous market; while secondary sales exist, they are not generally “active” in the sense of public equities and can be slow, negotiated, and discounted—so (3) is incorrect. Finally, because distributions are commonly back-ended (sale to a strategic buyer, sponsor-to-sponsor sale, IPO, recapitalization), realized returns are primarily tied to exit events, making (4) correct.
Question 9 of 21
Statements about exit strategies in private equity:
(1) Initial public offerings are a common exit route.
(2) Trade sales involve selling the company to another firm.
(3) Exits typically occur immediately after acquisition.
(4) Exit timing significantly affects realized returns.
Which of the statements given above are correct?
id: 3
model: GPT 5.2
topic: Private equity exits
Explanation
First principles: private equity returns are “realized” when ownership is monetized—i.e., when the investor can convert the stake into cash (or marketable shares) and distribute proceeds. (1) is correct because an IPO can convert a private company into a publicly traded one, enabling sale of shares over time. (2) is correct because a trade sale is a sale to a strategic buyer (another firm) that often pays for synergies and control. (3) is incorrect because immediate exit would defeat the purpose of operational and strategic improvements; holding periods are typically long enough to execute a value-creation plan and reach an attractive exit market. (4) is correct because exit timing affects both the sale price (multiples, market conditions) and the annualized return (IRR), so the “when” can be as important as the “how.”
Question 10 of 21
Statements about holding periods in private equity:
(1) Holding periods are typically long.
(2) Longer holding periods allow deeper operational changes.
(3) Short holding periods reduce illiquidity risk.
(4) Holding period length influences exit strategy.
Which of the statements given above are correct?
id: 5
model: GPT 5.2
topic: Private equity holding periods
Explanation
From first principles, illiquid ownership claims require time to create value and time to convert that value into cash via an exit. (1) is correct because private equity commonly involves multi-year holding periods to implement operational, strategic, and financial changes and to wait for favorable exit markets. (2) is correct because deeper changes—systems upgrades, pricing strategy, add-on acquisitions, talent and incentive redesign—often take years to implement and show up in cash flows. (3) is incorrect because “illiquidity risk” is not eliminated simply by intending to hold for a shorter time; if a market for the stake is still thin, a short intended horizon can actually increase the chance of needing to sell at an unfavorable time or discount. (4) is correct because the feasible exit route (IPO readiness, strategic buyer interest, sponsor sale) and the best timing depend on how long the investor plans (and is able) to hold.
Question 11 of 21
Statements about risks in private equity:
(1) Illiquidity risk is significant.
(2) Business risk depends on company operations.
(3) Market risk is completely eliminated.
(4) Leverage increases financial risk.
Which of the statements given above are correct?
id: 6
model: GPT 5.2
topic: Private equity risk
Explanation
First principles: risk is uncertainty in outcomes relative to what investors expect, including the ability to meet cash needs and to exit at a fair price. (1) is correct because private equity stakes cannot usually be sold quickly at transparent prices, exposing investors to time-to-exit and discount risk. (2) is correct because business risk arises from operations—competition, costs, technology shifts, customer concentration—and differs by company and sector. (3) is incorrect because lack of daily market pricing does not remove exposure to macro conditions; demand, financing conditions, and valuation multiples still move with the economy and capital markets, affecting exit value. (4) is correct because leverage adds fixed obligations (interest and principal), raising the probability and severity of distress when cash flows fall.
Question 12 of 21
Assertion (A): Private equity investors commit capital for long periods.
Reason (R): Capital cannot be withdrawn easily before exit.
id: 17
model: GPT 5.2
topic: Capital commitment
Explanation
From first principles, committing capital means agreeing to fund an investment whose payoff arrives later, and liquidity constraints determine how long the investor must wait. Assertion (A) is true because private equity funds and deals are structured with multi-year investment and harvesting periods. Reason (R) is true because investors generally cannot redeem like they can in open-end public funds; instead, they must wait for distributions from exits or pursue a negotiated secondary sale. R explains A because the inability to easily withdraw is the structural reason that commitment must be long-term: the investor’s capital is tied to the timing of realizations. The alternative options fail by treating private equity as if it offered daily liquidity similar to mutual funds or ETFs.
Question 13 of 21
Assertion (A): Private equity investors expect higher returns.
Reason (R): Investors are compensated for illiquidity and risk.
id: 18
model: GPT 5.2
topic: Risk–return trade-off
Explanation
First principles: in competitive capital markets, investors require higher expected returns to bear additional non-diversifiable risk and to give up liquidity. Assertion (A) is true because private equity is commonly pursued with the goal of earning returns above those available in more liquid public markets (though outcomes can vary). Reason (R) is true because illiquidity (difficulty selling) and the risks of concentrated, control-oriented, leveraged exposures require compensation in the form of an expected premium. R explains A because the expectation of higher returns is the economic “payment” investors demand for bearing these constraints and uncertainties. The incorrect options fail by denying the basic pricing logic that risk and illiquidity must be priced to attract capital.
Question 14 of 21
Assertion (A): Longer holding periods encourage long-term decision-making.
Reason (R): Investors are less pressured by short-term market prices.
id: 14
model: GPT 5.2
topic: Holding period incentives
Explanation
First principles: when performance is judged continuously by public prices, managers can be incentivized to optimize short-term optics rather than long-term cash flows. Assertion (A) is true because multi-year ownership and illiquidity make the investor’s payoff more dependent on durable value drivers than on quarterly price moves. Reason (R) is true because private equity investors do not face the same daily mark-to-market feedback loop as public shareholders; there is less immediate punishment or reward from short-term price fluctuations. R explains A because reduced short-term pricing pressure allows owners and managers to prioritize investments and restructuring that may depress near-term results but improve long-run cash flows. The other options fail by either denying the long-horizon nature of private equity or denying how market pricing frequency shapes incentives.
Question 15 of 21
Statements about private equity fee structures:
(1) Management fees are charged regardless of performance.
(2) Performance fees align manager incentives with investors.
(3) Fees are typically lower than public mutual funds.
(4) Carried interest depends on investment success.
Which of the statements given above are correct?
id: 7
model: GPT 5.2
topic: Private equity fees
Explanation
Start from fee mechanics: fund managers incur ongoing operating costs (staff, sourcing, monitoring), and investors pay for those through management fees. (1) is correct because management fees are generally charged as a contractual percentage base and do not require positive performance in a given period. (2) is correct because performance fees (carried interest) tie a meaningful portion of manager compensation to value creation, aligning incentives toward profitable exits and away from simply growing the fee base. (3) is incorrect because private equity commonly features higher and more complex fees than public mutual funds when considering both management fee and carry. (4) is correct because carried interest is typically earned only when investments generate profits (often after meeting specified distribution terms), so it depends on investment success rather than mere passage of time.
Question 16 of 21
Assertion (A): Carried interest aligns manager incentives with investors.
Reason (R): Carried interest depends on investment performance.
id: 15
model: GPT 5.2
topic: Fee alignment
Explanation
Start with a definition: carried interest is a performance-based share of profits paid to the manager, distinct from fixed management fees. Assertion (A) is true because when a meaningful portion of compensation is tied to profits, managers have incentives to pursue actions that increase investors’ net gains rather than merely increasing assets managed. Reason (R) is true because carry is generally earned only if investments perform successfully (often after returning capital and meeting agreed return thresholds). R explains A because dependence on performance is precisely what creates alignment: if investors do better, the manager is paid more; if investors do poorly, the manager’s carry is reduced or eliminated. Alternative options fail by ignoring the difference between fixed fees (cost coverage) and variable fees (incentive alignment).
Question 17 of 21
Assertion (A): Private equity investors focus on improving operations.
Reason (R): Operational gains increase firm value at exit.
id: 13
model: GPT 5.2
topic: Operational improvements
Explanation
From first principles, firm value reflects expected future free cash flows discounted for risk; operations drive those cash flows. Assertion (A) is true because private equity often targets controllable levers—pricing, procurement, productivity, working capital, and growth initiatives—to improve cash generation. Reason (R) is true: higher sustainable cash flows (or improved margins/efficiency) typically support a higher exit valuation (either via higher earnings, higher free cash flow, or improved risk profile and multiples). R explains A because if the payoff is realized at exit, then improving the underlying earnings and cash flow base is a direct way to raise exit proceeds. Incorrect choices would imply private equity value comes mainly from market timing rather than fundamental improvement, which is not the core model described.
Question 18 of 21
Assertion (A): Private equity investors often take an active role in portfolio companies.
Reason (R): Active involvement allows investors to influence operations and strategy.
id: 8
model: GPT 5.2
topic: Active ownership
Explanation
First principles: an equity owner can create value by changing decisions that drive cash flows and risk, not just by holding an asset and hoping market prices rise. Assertion (A) is true because many private equity investments are structured to give investors control or significant influence (board seats, voting rights, covenants, management incentives). Reason (R) is also true: active involvement is the mechanism that lets owners alter operations (pricing, cost structure, salesforce effectiveness), strategy (product mix, acquisitions), and governance (KPIs, incentives). R correctly explains A because the purpose of being active is precisely to influence value drivers. Options B–D fail because they either deny the truth of A or R, or deny the causal connection between influence and active involvement.
Question 19 of 21
Assertion (A): Stable cash flows make companies attractive private equity targets.
Reason (R): Predictable cash flows support debt servicing.
id: 12
model: GPT 5.2
topic: Cash flow stability
Explanation
First principles: debt requires scheduled payments regardless of business conditions, so the key risk is failing to generate sufficient cash to meet those obligations. Assertion (A) is true because stable cash flows reduce the probability of financial distress and provide management with planning flexibility during transformation efforts. Reason (R) is true because predictable operating cash flows are the primary source used to pay interest and repay principal in leveraged structures. R explains A because if a private equity strategy uses leverage, then cash flow stability directly increases feasible leverage and reduces default risk, making the target more attractive. Other options fail by ignoring that “attractive target” often means “financeable at reasonable terms” as well as “improvable operationally.”
Question 20 of 21
Assertion (A): Exit valuation is critical to private equity performance.
Reason (R): Most cash flows occur at exit rather than during holding.
id: 19
model: GPT 5.2
topic: Exit valuation
Explanation
Start with the cash-flow structure: private equity often has limited interim liquidity, and the largest distribution typically comes when the investment is sold. Assertion (A) is true because the exit multiple and sale price frequently dominate total proceeds and therefore dominate realized return metrics such as MOIC and IRR. Reason (R) is true because, relative to public equities, a larger share of the investor’s cash inflow may be concentrated in the terminal event (exit), not steadily realized through frequent trading. R explains A because if most cash arrives at exit, then the valuation achieved at exit mechanically becomes the key determinant of performance. Incorrect choices would imply that interim accounting values alone determine performance, which is inconsistent with how returns are realized.
Question 21 of 21
Assertion (A): Private equity returns depend heavily on exit conditions.
Reason (R): Returns are typically realized only when investments are sold or listed.
id: 10
model: GPT 5.2
topic: Exit dependence
Explanation
First principles: a return is only “locked in” when cash (or liquid securities) is received; interim valuation marks do not pay investors. Assertion (A) is true because private equity outcomes are often concentrated in the exit valuation multiple, buyer demand, financing conditions, and public market sentiment (if IPO). Reason (R) is true because monetization typically occurs at a liquidity event—sale to a buyer, sponsor-to-sponsor transaction, or IPO—so the conditions at that moment directly set proceeds. R explains A because if realization happens at exit, then exit conditions necessarily dominate realized performance. The incorrect options fail by treating interim operating improvements as sufficient for realized return without acknowledging the conversion-to-cash step.