NISM Series XIX-A · Unit 3 of 13 · about 5% of the paper
Concepts in the AIF industry: NISM Series XIX-A notes and practice questions
The vocabulary of private funds: commitment, drawdown, J-curve, GP and LP, and fees.
What to know in Unit 3
- Commitment and drawdown.
- J-curve.
- Carry, hurdle and catch-up.
Key terms, examples and exam traps
Commitment
A commitment is the total amount an investor agrees to invest in the fund, to be called in instalments over time.
Example. An investor commits ₹5 crore but pays as and when the fund asks.
Exam trap. This statement is false: A commitment is paid in full on day one.
Drawdown
A drawdown or capital call is the manager's notice to investors to pay a portion of their commitment for an investment or expenses.
Example. An investor receives a notice asking for 20% of the commitment.
Exam trap. This statement is false: A drawdown is a distribution of profits.
General partner and limited partner
The GP (manager) runs the fund; LPs (investors) provide the capital and have limited liability and no role in daily decisions.
Example. The manager makes investment decisions while investors supply capital.
Exam trap. This statement is false: LPs manage the fund's day-to-day investments.
J-curve
The J-curve describes how returns in a private fund are negative in early years due to fees and unrealised investments, then rise as investments mature and exit.
Example. A fund shows losses in years 1 to 3 and gains later.
Exam trap. This statement is false: Private funds show high returns from the first year.
Management fee
The management fee is a yearly percentage of commitments or invested capital charged to cover the manager's operating costs, regardless of performance.
Example. A manager charges 2% of commitments every year.
Exam trap. This statement is false: The management fee is paid only on profits.
Carried interest
Carried interest is the manager's share of fund profits, commonly 20%, earned after investors receive their capital and preferred return.
Example. The manager gets 20% of profits above the hurdle.
Exam trap. This statement is false: Carried interest is paid before investors get their capital back.
Hurdle rate
The hurdle rate or preferred return is the minimum return investors must receive before the manager earns carry.
Example. Investors get 10% a year before the manager shares profits.
Exam trap. This statement is false: The hurdle rate is the management fee.
Catch-up
A catch-up lets the manager receive a larger share of distributions after the hurdle until it has received its full carry percentage of total profits.
Example. After the hurdle, the manager gets most of the next distributions until it has 20% of profit.
Exam trap. This statement is false: A catch-up reduces the manager's carry.
Clawback
A clawback requires the manager to return excess carry if, over the fund's life, it received more than its entitled share.
Example. The manager repays carry after later losses wipe out earlier profits.
Exam trap. This statement is false: A clawback lets managers keep any carry paid.
Distribution waterfall
The waterfall sets the order in which distributions are paid: return of capital, preferred return, catch-up and then the carry split.
Example. Proceeds first return investors' capital and then pay the hurdle.
Exam trap. This statement is false: The waterfall pays the manager's carry first.
IRR and MOIC
IRR measures annualised return accounting for timing of flows; MOIC is total value divided by invested capital, ignoring time.
Example. A fund returns 2 times the capital over five years.
Exam trap. This statement is false: MOIC accounts for the timing of cash flows.
DPI, RVPI and TVPI
DPI is distributions divided by paid-in capital, RVPI is residual value divided by paid-in capital, and TVPI is their sum.
Example. A fund has returned half of the capital paid in and holds more.
Exam trap. This statement is false: DPI includes unrealised value.
Vintage year
The vintage year is the year in which a fund first invested; funds are compared with others of the same vintage.
Example. A fund launched in 2018 is compared with other 2018 funds.
Exam trap. This statement is false: Vintage year is the year of exit.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “General partner and limited partner”?
- The GP (manager) runs the fund; LPs (investors) provide the capital and have limited liability and no role in daily decisions.
- Managers must give investors periodic reports, including audited financials and NAV, within timelines set by SEBI.
- Distributors must avoid or disclose conflicts, such as higher commission on a product, and put client interest first.
- Private equity invests in unlisted companies, usually taking significant ownership, with the aim of growing value and exiting later.
Q2. Which term is described here? Carried interest is the manager's share of fund profits, commonly 20%, earned after investors receive their capital and preferred return.
- Disclosure to investors
- Investor transfer rights
- Deal sourcing
- Carried interest
Q3. Which statement best describes “J-curve”?
- The J-curve describes how returns in a private fund are negative in early years due to fees and unrealised investments, then rise as investments mature and exit.
- A distributor must assess a client's financial position, experience, risk appetite and horizon before recommending an AIF.
- Alternatives are typically illiquid, with money locked for years and limited exit options before the end of the fund's life.
- A drawdown or capital call is the manager's notice to investors to pay a portion of their commitment for an investment or expenses.
Q4. Which term is described here? IRR measures annualised return accounting for timing of flows; MOIC is total value divided by invested capital, ignoring time.
- Concentration of investor base
- IRR and MOIC
- Category III AIF
- Concentration risk
Q5. Which term is described here? The vintage year is the year in which a fund first invested; funds are compared with others of the same vintage.
- Alignment of interest
- Vintage year
- Fair value
- Category III taxation
Q6. Which statement about “Hurdle rate” is correct?
- Due diligence is carried out only after the investment.
- The hurdle rate or preferred return is the minimum return investors must receive before the manager earns carry.
- The hurdle rate is the management fee.
- The statement shows the manager's personal investments.
Frequently asked questions
How much of NISM Series XIX-A comes from Unit 3?
Unit 3 (Concepts in the AIF industry) usually carries about 5% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series XIX-A Unit 3?
Commitment and drawdown. J-curve. Carry, hurdle and catch-up.
Are these NISM Series XIX-A practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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