Chapter 3

Agrregation of IRRs refers to the relationship between the IRRs of individual investments and the IRR of the combined cash flows of the investments.

A borrowing type cash flow pattern begins with one or more cash inflows and is followed only by cash outflows.

Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.

A catch-up provision permits the fund manager to receive a large share of profits once the hurdle rate of return has been achieved and passed.

A catch-up provision contains a catch-up rate, which is the percentage of the profits used to catch up the incentive fee once the hurdle is met.

A claw back clause, claw back provision, or claw back option is designed to return incentive fee to LPs when early profits are followed by subsequent losses.

The compensation scheme is the set of provisions and procedures governing management fees, general partner investment in the fund, carried-interest allocations, vesting, and distribution.

A complex cash flow pattern is an investment involving eighter borrowing or multiple sign changes.

Continuous compounding assumes that earnings can be instantaneously reinvested to generate additional earnings.

Deal-by-deal carried interest is when incentive fees are awarded separately based on the performance of each individual investment.

Discrete compounding includes any compounding interval other than continuous compounding such as daily, monthly, or annual.

Dollar-weighted returns are averaged returns that are adjusted for and therefore reflect when cash has been contributed or withdrawn during the averaging period.

Fully collateralized means that a position (such as a forward contract) is assumed to be paired with a quantity of capital equal in value to the notional principal of the contract.

Carried interest can be fund-as-a-whole carried interest, which is carried interest based on aggregated profits and losses across all the investments, or can be structured as deal-by-deal carried interest.

A hard hurdle rate limits incentive fees to profits in excess of the hurdle rate.

A hurdle rate specifies a return level that LPs must receive before GPs begin to receive incentive fees.

Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond managemant fees.

The interim IRR is a computation of IRR based on realized cash flows from an investment and its current estimated residual value.

The internal rate of return (IRR) can be defined as the discount rate that equates the present value of the costs (cash outflows) of an investment with the present value of the benefits (cash inflows) from the investment.

A lifetime IRR contains all of the cash flows, realized or anticipated, occurring over the investment's entire life, from period 0 to period T.

A log return is a continuously compounded return that can be formed by taking the natural logarithm of a wealth ratio: Rm=oo = ln(1+R) where ln( ) is the natural logarithm function, Rm=oo is the log return, or continuously compounded return, and m is the number of compounding intervals per year.

Management fees are regular fees that are paid from the fund to the fund managers based on the size of the fund rather than the profitability of the fund.

The modified IRR approach discounts all cash outflows into a present value using a financing rate, compounds all cash inflows into a future value using an assumed reinvestment rate, and calculates the modified IRR as the discount rate that sets the absolute values of the future value and the present value equal to each other.

A multiple sign change cash flow pattern is an investment where the cash flows switch over time from inflows to outflows, or from outflows to inflows, more than once.

Notional principle or notional value of a contract is the value of the asset underlying, or used as a reference to, the contract or derivative position.

A partially collateralized position has collateral lower in value than the notional value.

Carried interest is synonymous with an incentive fee or a performance-based fee and is the portion of the profit paid to the GPs as compensation for their services, above and beyond management fees.

A point-to-point IRR is a calculation of performance over part of an investment's life.

The term preferred return is often used synonymously with hurdle rate - a level that LPs must receive before GPs begin to receive incentive fees.

The reinvestment rate assumption refers to the assumption of the rate at which any cash flows not invested in a particular investment or received during the investment's life can be reinvested during the investment's lifetime.

The return computation interval for a particular analysis is the smalles time interval for which returns are calculated, such as daily. monthly, or even annually.

The return on notional principal divides economic gain or loss by notional principal of the contract.

Scale differences are when investments have unequal sizes and/or timing of their cash flows.

Simple interest is an interest rate computation approach that does not incorporate compounding.

A since-inception IRR is commonly used as a measure of fund performance rather than the performance of an individual investment.

A soft hurdle rate allows fund managers to earn an incentive fee on all profits, given that the hurdle rate has been achieved.

Time-weightes returns are averaged returns that assume that no cash was contributed or withdrawn during the averaging period, meaning after the initial investment.

Vesting is the process of granting full ownership of conferred rights, such as incentive fees.

The waterfall is a provision of the limited partnership agreement that specifies how distributions from a fund will be split and how the payouts will be prioritized.