Hedge Fund Course - Wiley Finance Series

9.10 The auditor is wrong. Hedge fund positions are not valued at the lower of cost or market. For financial reporting/performance calculations, positions are valued at market. For tax reporting (see Chapter 10), positions are valued at historical cost.

9.11 The firm does have assets. First, the fund certainly has cash balances. Second, all of the short positions are collateralized in the stock loan or reverse repo market. These transactions are required because the fund must borrow the securities it has sold short. The cash collateral backing these securities loans are carried as short-term assets. The short-only hedge fund could take substantial short positions in futures or other derivatives. In this case, the leverage calculated from the total assets may understate the effective leverage of the fund substantially. If the leverage calculated using the total assets divided by partner's capital provides a misleading measure of leverage, investors can calculate leverage using the cash market equivalent of the derivatives positions.

9.12 The fund must recognize the dividend in April because the stock has gone ex-dividend in April. On the ex-dividend date, the value of the shares falls by roughly the amount of the dividend. The package of the soon-to-be-received dividend plus the ex-dividend stock approximately equals the price of the stock before the ex-dividend date. To fairly present the NAV at month-end, the accounting records must include the future dividend payment:
On April 29
Dividend receivable
$50,000
Dividend income
$50,000
In early May, the payment is received but it is of minor economic consequence because the owners of the fund in April are given credit for the income:
On May 5
Cash
$50,000
Dividend receivable
$50,000

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