A hedge fund with net asset value of $62 per share currently has a high water mark of $66. Suppose it is January 1, the standard deviation of the fund’s annual returns is 50%, and the risk-free rate is 4%. The fund has an incentive fee of 20%. A. What is the value of the annual incentive fee according to the Black-Scholes formula?
B. What would the annual incentive fee be worth if the fund had no high water mark and it earned its incentive fee on its total return?
C. What would the annual incentive fee be worth if the fund had no high water mark and it earned its incentive fee on its return in excess of the risk-free rate?
D. Re-calculate the incentive fee value for part (b) now assuming that an increase in fund leverage increases volatility to 53%.