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Answer: Expected returns of illiquid assets can be overstated due to measurement biases.
**B is correct.** Expected returns of illiquid assets can be overstated due to measurement biases such as infrequent trading, survivorship, and reporting biases. **A is incorrect.** Corporate bonds that trade less frequently or have larger bid-ask spreads actually have **higher** returns, not lower returns, to compensate investors for the additional liquidity risk. **C is incorrect.** US Treasuries do exhibit illiquidity risk premiums between on-the-run and off-the-run bonds, with off-the-run bonds typically offering higher yields to compensate for their lower liquidity. **D is incorrect.** Hedge funds which **do place restrictions** on investor withdrawals have shown higher returns, not those without restrictions. The restrictions help fund managers manage liquidity and pursue less liquid investment strategies that may generate higher returns.
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The chief investment officer (CIO) of a large university endowment fund is considering whether to add illiquid assets to the university's investment portfolio. Before making a decision, the CIO asks an investment analyst to review illiquidity risk premiums across and within asset categories and to prepare a report with findings. Which of the following statements is correct for the analyst to include in the report?
A
Corporate bonds that trade less frequently or have larger bid-ask spreads have lower returns than more liquid corporate bonds.
B
Expected returns of illiquid assets can be overstated due to measurement biases.
C
US Treasury instruments are the only assets that do not exhibit illiquidity risk premium.
D
Hedge funds that do not place restrictions on withdrawals exhibit higher returns.
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