3: Real Assets

Question 0

What are the disadvantages of RE investing?

Answer 0

• Heterogeneity
• Illiquidity
• Lumpiness, this points to the fact that RE is an “indivisible” asset

Question 1

What are the benefits of RE investing?

Answer 1

• Diversification
• Income Tax Advantages
• Absolute returns
• Cash flow streams
• Hedge against unanticipated inflation

Question 2

Potential benefits of RE derivatives

Answer 2

• Price Discovery
• Better risk management
• capacity to short sell real estate

Question 3

Classifications of RE

Answer 3

Equity vs. Debt
International vs. Domestic
Residential vs. Commercial
Private vs. Public

Question 4

As-if Basis for calculating changes in value of NCREIF NPI index

Answer 4

The change in the underlying property is calculated as-if the property was purchased at its appraised value at the beginning of the quarter and sold at the end of quarter appraised values.
If the property is actually bought or sold, then the transaction price is used

Question 5

2 ways RE investors can choose between FI or equity investments

Answer 5

1) choose between a bond like investment that pays principle and interest or an equity like investment that generates return by value appreciation
2) choose between early (equity-like) or later (debt-like) stages of development

Question 6

3 advantages and limitations of timberland investing

Answer 6

3 advantages:

1) attractive risk adjusted returns, especially vs. stocks and bonds
2) inflation hedging due to positive correlation with inflation
3) diversification due to low correlation with other asset classes

3 disadvantages:

1) illiquidity
2) long investment period, esp given long rotation periods
3) difficulty of timberland valuation

Question 7

3 steps to unsmooth smoothed returns that have autocorrelation

Answer 7

1) specify the form of autocorrelation (first-order or higher)
2) estimate parameters of the autocorrelation process
3) use the estimated autocorrelation coefficient to decipher the true return series

Question 8

3 elements of rollover risk in RE

Answer 8

1) Change in financing
2) Change in the nature of the RE investment
3) Change in ownership

Question 9

Advantages of private RE equity

Answer 9

• ability to select properties
• direct control
• tax timing

Question 10

Advantages of public RE investment

Answer 10

• easier investor access
• greater liquidity
• low transaction costs
• improved corp gov
• transparency

Question 11

Fisher effect

Answer 11

Nominal interest rate = real interest rate + premium for anticipated inflation

Question 12

Why is quality price information scarce in RE?

Answer 12

• uniqueness of properties
• long holding periods
• confidentiality of transaction information

Question 13

2 criticisms of Repeat sales index

Answer 13

• heavily represents properties with the most transactions

- changed value of properties that sold may be due to property specific events (ie renovations)

Question 14

Hedonic price index

Answer 14

Use observed prices of traded properties to infer prices of non traded properties

Question 15

Risks of international RE value

Answer 15

• volatility of asset in local currency

- volatility of exchange rate

Question 16

Motivations of adding farmland

Answer 16

• inflation hedge
• diversification
• increasing value due to food or energy shortage

Question 17

Risks of farmland investing

Answer 17

• greater integration of agricultural and energy markets

- expropriation

Question 18

Risks to patent investments

Answer 18

• illiquidity
• tech/operational risk
• obsolescence
• macro/ sector risk
• regulatory risk
• legal risk
• expiration risk

Question 19

IP related strategies

Answer 19

1: acquisition and licensing
2: enforcement and litigation
3: sale license back
4: patent lending strategies (securitization and / or mezz lending
5: patent sales
6: patent pooling

Question 20

Economic characteristics of infrastructure

Answer 20

1: high barriers to entry
2: economies of scale
3: inelastic demand for services
4: low operating costs
5: long duration

Question 21

Financial characteristics of infrastructure

Answer 21

Attractive returns 
Long term, stable and predictable CFs
Low correlation 
Inflation hedge 
Good for long term pension liabilities 
Low sensitivity to market changes
Low default rates 
Socially responsible investing

Question 22

Risks of infrastructure projects / companies

Answer 22

Construction, operational, business, leverage, refinancing, legal, regulatory, environmental, political, social

Question 23

Infrastructure risks at fund level

Answer 23

Concentration
Illiquidity
Pricing
Governance

Question 24

Infrastructure risks for investors

Answer 24

Lack of experience 
Investment program 
Integration in ALM
Timing of investment 
Advisers/counter parties 
Legal 
Reputation

Question 25

Ways of selling timber

Answer 25

1: negotiated sales
2: bidding or auction system
3: wood supply agreement

Question 26

Sawtimber

Answer 26

Large logs processed into lumber

Question 27

Pulpwood

Answer 27

Processed into chips of flakes

Good got paper manufacturers, diapers etc

Question 28

Other ways to generate income from Timberland investments

Answer 28

1: recreational licenses/leases
2: mineral rights
3: right of way and access rights
4: wetlands and stream mitigation banking
5: species and conservation banking
6: carbon credits

Question 29

Steps for effective commodities risk management (EMSMPM)

Answer 29

1. Estimate NAV
2. Measure event risks
3. Stress test w/ VAR
4. Measure liquidity risks
5. Performance attribution
6. Mitigate operational risks

Question 30

3 ways to stress test a commodities portfolio

Answer 30

1. Scenario analysis by mimicking extreme historic events
2. Shock FMEs and observe changes to the NAV
3. Shift forward curves and observe changes to the NAV

Question 31

Historical relationship between spot commodity prices and futures commodity prices

Answer 31

1. highly positively correlated
2. futures holders earn greater returns than spot commodities holders
3. both prices exceed inflation

Question 33

4 theoretical frameworks for commodity futures excess returns

Answer 33

1. CAPM : the premise is that expected return depends on amount of systematic risk, highly questionable
2. Insurance perspective: predicated on normal backwardation, most hedgers have a long position in commodities and most speculators are short. The positive risk premium paid by hedgers is considered an insurance risk premium paid to investors with long positions in commodity futures
3. Hedging Pressure Hypothesis: Extends the insurance perspective and assumes that hedgers/speculators may be net long or short futures, depending on their positions in the underlying commodities. So risk premiums exist in future prices whether the commodity is in contango or backwardated. Risk premiums can be positive/negative depending on the net position of hedgers/speculators
4. Storage theory: uses reasons for holding inventory to explain the source of commodity futures excess returns. Theory contends that futures prices are dependant on storage costs, convenience yield and risk free rates. Recollect that Futures Price = Spot Price x e^ (r-y+c), where Y is the convenience yield and C is the storage cost. Main thing: convenience yield is high when inventories are low.

Question 34

Durable assets

Answer 34

used in the production of a good/service but are not consumed in it

Question 35

Non durable assets

Answer 35

consumed in the production of a good/service