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CAIA Level One Reversed > 3. Real Assets > Flashcards

3. Real Assets Flashcards

1
Q

Reversed

Physical economic resource, direct creator of consumption opportunity.

A

Real Asset

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2
Q

Reversed

Real asset that is not currently being used. Value of undeveloped land lies in the future consumption.

A

Undeveloped Land

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3
Q

Reversed

Investors purchase undeveloped land for the purpose of developing the land in the future. Key, is they plan on selling it to home-builders in the future.

A

Land Banking

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4
Q

Reversed

Lots are vacant, but zoned for development.

A

Paper Lots

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5
Q

Reversed

Process of development has begun, rough grading and temporary drainage. Some development and building permit fees have not been paid.

A

Blue Top Lots

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6
Q

Reversed

Lots are ready for construction and all developmental fees paid. Only remaining, payment of building permit fees and property inspection.

A

Finished Lots

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7
Q

Reversed

  1. Type: more uses for a property, higher value. Thus, single use property risky. 2. Location: lots in path of development or near cities, high value. Thus, rural lots risky.
A

Key Risks of Undeveloped Residential Land

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8
Q

Reversed

Strike: construction and other costs incurred for development. Time to Exp: generally unlimited Underlying Asset: combination of land and improvements Option Payoff: diff. between value of completed project and all costs of development& construction

A

Land as a Call Option

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9
Q

Reversed

current value of improved property= (UpVal x UpProb) + [DownVal x (1-UpProb)]

A

Binomial Option Pricing Model to Evaluate Land

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10
Q

Reversed

  • long term investments in wood via existing forestland - returns exhibit low correlation to with stock and bond returns
A

Timberland

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11
Q

Reversed

  • low correlation with stocks and bonds - may act as hedge against inflation - invest in real asset, land - renewable resource although long growth cycle - flexibility of harvesting - timber used for variety of products
A

Advantages of Timberland Investing

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12
Q

Reversed

-trees destroyed by fire - value tied to cyclical industries - supply not fixed - tech and recycling may reduce need - investment horizon long

A

Disadvantages of Timberland Investing

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13
Q

Reversed

  • real asset that generates crop income - more closely related to commodity prices than rent
A

Farmland

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14
Q

Reversed

  • renewable annual cash flow - steady cash stream - short growth cycle - multi-purpose option - expected increase in world population - not dependent on local economies, listed on international futures - scalable: strong competition to lease farmland
A

Farmland Benefits

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15
Q

Reversed

  • agency risks - political risks - less harvest flexibility - natural forces can destroy - farm specific inefficiencies - revenues driven by market factors
A

Farmland Disadvantages

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16
Q

Reversed

Based on - correlation - volatility - current closeness to profitability

A

Option to Produce Alternative Crop

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17
Q

Reversed

  • best way is to own - two indices: DAX Global Agribusiness Index & Thomson Reuters in the Ground Global Equity Index - ETF: MOO
A

Farmland Exposure

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18
Q

Reversed

broadly defined as the underlying foundation of basic services, facilities, and institutions upon which society depends

A

Infrastructure

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19
Q

Reversed

infrastructure investments that must be constructed

A

Greenfield Projects

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20
Q

Reversed

infrastructure projects that may already exist and could be transferred from public to private sector

A

Brownfield Projects

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21
Q

Reversed

Positive: - significant need - economic growth tied - proceeds from sale can be used for other things Risks: - regulatory risk - continued government influence - right to revoke a lease

A

Government Influence on Infrastructure Projects

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22
Q

Reversed

  • Listed Stocks and Listed Funds - Closed End Funds: structured like private equity - Unlisted (evergreen) Open End Funds
A

Types of Infrastructure Investments

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23
Q

Reversed

intangible asset that can be owned

A

Intellectual Property

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24
Q

Reversed

  • discounted cash flow model V = (p x CF1)/(r-g)
A

Intellectual Property Modeling

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25
Q

Reversed

  • results in lower price and return volatility, which makes assets look less risky than they might be
A

Smoothing

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26
Q

Reversed

  • returns were generally positive and volatility low - strong Sharpe ratio - returns based on appraisal - tendency to smooth - based on quarterly
A

Historical Performance of Timber and Farmland (January 2000- December 2010)

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27
Q

Reversed

  • requires the borrower to pay a constant periodic amount, usually monthly, that will completely pay off the loan amount with the last payment - over time larger amount becomes principal repayment, less interest
A

Fixed Rate Constant Payment, Fully Amortized Mortgage

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28
Q

Reversed

MP = MB x [i/ (1 -i)^-n)] where: MP= constant monthly payment MB= mortgage balance at beginning of loan i = monthly interest rate n = number of months in the loan term

A

Monthly Mortgage Payment Calculation

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29
Q

Reversed

Book One, Page 290

A

Calculating Monthly Interest, Principal and the Outstanding Balance

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30
Q

Reversed

  • borrowers may make additional payment - cause balance to decline more rapidly - benefit borrowers in a falling interest rate environment
A

Unscheduled Principal Payments

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31
Q

Reversed

calls for interest only payments during the first part of the loan , and fully amortized payments during the second part of the loan

A

Interest Only Mortgages

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32
Q

Reversed

generally originate at one interest rate, after which, the interest rate fluctuates up or down during the loan term based on the movement of a published index

A

Variable Rate Mortgages (ARMs)

33
Q

Reversed

limit the amount the interest rate may increase in any one adjustment period

A

Interest Rate Caps

34
Q

Reversed

allows borrowers to make lower monthly payments for the first few years of the loan (typically first 5 years) and larger payments for the remainder of the term

A

Graduated Payment Mortgage

35
Q

Reversed

specialized version of adjustable rate mortgages that are structured to provide borrowers payment flexibility

A

Option Adjustable-Rate Mortgage Loans (option ARMs)

36
Q

Reversed

when a mortgage requires periodic payment that will not fully amortize the amount of the loan by the end of the loan term, the final payment is an amount that is larger

A

Balloon Payment Loan

37
Q

Reversed

-sums the total housing expenses and divides the sum by the monthly income of the borrower - front end ratio: borrower may limit housing costs to gross income to 28% -back end ratio: borrower may limit housing costs and other debt such as auto and credit loans to 36% of gross income

A

Debt to Income Ratio

38
Q

Reversed

  • the amount of the loan relative to the market or appraised value of the property - loan considered well collateralized is LTV 80% or less LTV = balance of the loan/ market value of the property
A

Loan to Value

39
Q

Reversed

  • borrowers: companies - income generation - balloon payment: generally not fully amortized - usage: long term invest prop, short term dev prop - covenant: usually several - cross collateral provisions: allow banks to pool to reduce risk
A

Commercial Mortgage Characteristics

40
Q

Reversed

more important in commercial than residential

A

Default Risk

41
Q

Reversed

calculated as the property’s net operating income (NOI) divided by the amount of annual interest payable - typical required 1.2 or greater interest coverage ratio = NOI/ annual interest payment

A

Interest Coverage Ratio

42
Q

Reversed

DSCR = NOI/ total loan payment

A

Debt Service Coverage Ratio (DSCR)

43
Q

Reversed

fixed charges ratio = NOI/ all fixed payments

A

Fixed Charges Ratio

44
Q

Reversed

is an investment structure that promises payments that are secured by a pool of mortgages

A

Mortgage Backed Securities (MBS)

45
Q

Reversed

are different from MBS in that investors self select into tranches that have different terms of principal and interest payments

A

Collaterized Mortgage Obligations

46
Q

Reversed

residential loan option that allows part of full payment early

A

Prepayment Option

47
Q

Reversed

annual reduction in the mortgage principal if the same percentage is repaid each month for an entire year

A

Conditional Payment Rate

48
Q

Reversed

Public Securities Association studied prepayments Assumes: - CPR of 30 year loan is .2% per month - increased by .2 % by month until month 30 - at that pt, remains constant at 6% for the rest of the mortgage life

A

PSA Prepayment Benchmark

49
Q

Reversed

  • backed by commercial real estate - key risk: default risk - LTV btw 65-80% - LTV > 75%, higher risk Exhibit following characteristics: - tranches - credit rating differ across tranches - tranche char- senior tranch, fixed income, junior based on underlying commercial loan risk - narrow tranches
A

Commercial Mortgage Backed Securities

50
Q

Reversed

  • structured product - different tranches to investors -
A

Collateralized Mortgage Obligations

51
Q

Reversed

  • simplest form of a CMO - pays predetermined share of the interest to each tranche - principal payment receipts based on tranche seniority - many if not most of the underlying mortgages are insured - more effected by interest rate and prepayment risk than default risk
A

Sequential Pay CMOs

52
Q

Reversed

as mortgage rates fall, prepayment increases and the average life of the pass-through security decreases

A

Contraction Risk

53
Q

Reversed

as mortgage rates rise, prepayment rates slow and the average life of the pass through security increases

A

Extension Risk

54
Q

Reversed

  • Accrual tranches or Z bonds- receive no interest payment - Principal only and interest only CMOs - Floating rate tranches - Planned amortization class (PAC) tranches - formed to provide a group of investors a more predictable cash flow stream - Targeted Amortization Class (TAC) tranches: like PAC, but with more complexity
A

Other CMO Structures and Tranches

55
Q

Reversed

  • 1994: crisis as prepayments fell as interest rates rose
A

CMO Financial Crisis

56
Q

Reversed

  • trade on exchanges - 75% income must be from RE investments - liquid
A

Real Estate Investment Trust (REITs)

57
Q

Reversed

  • No corporate taxes - Liquidity - May be margined - Asset allocation - Professional management - Income: REITs have to distribute 90% income - Corporate governance: no more 50% held by 5 or fewer
A

Benefits of Investing in REITs

58
Q

Reversed

  • solid 12.8% return - high standard deviation (22.4%), next commodities - negative skewness and leptokurtosis - min return -24.1%, max drawdown -69.1% - positive correlation with global equity and bond - zero correlation with commodities - neg corr with VIX, i.e. greater uncertainty in equity market is negatively related to mortgage returns
A

Risk and Return of Mortgage REITs

59
Q

Reversed

working backwards on a decision tree from the final nodes

A

Backward Induction Process

60
Q

Reversed

if valuing a real estate firm rather than a property

A

Profit Approach

61
Q

Reversed

valuation approach for real estate - subtracting interest and other cash flowed owed and discounting remaining cash flows

A

Equity Residual Approach

62
Q

Reversed

  • most common method used for appraising
A

Discounted Cash Flow Approach for Real Estate Investments (Income Approach)

63
Q

Reversed

income if all offices and space are occupied

A

Potential Gross Income

64
Q

Reversed

potential gross income less the vacancy loss

A

Effective Gross Income

65
Q

Reversed

  • if NPV greater than zero, project should go forward - if IRR is greater than the discount rate, project should move forward
A

DCF Decision Outcomes

66
Q

Reversed

  • Financial Risk - Business Risk - Operational Risk - Liquidity Risk - Inflation Risk: may be good inflation hedge - Legal Risk
A

Real Estate Investment Risk Factors

67
Q

Reversed

  • invest pooled capital in private real estate - 10 year with 2-3 years investment period\ Advantages: - access - access to fund management Disadvantages: - lose direct control - lack liquidity - performance difficult to measure
A

Private Equity Real Estate Funds

68
Q

Reversed

  • specific type of private equity RE fund - first type
A

Commingled Real Estate Funds (CREFs)

69
Q

Reversed

  • financing mechanisms that allow investors to raise capital and hire expert - limited partnerships or REITS or corporations - if limited, depreciation tax deductions may be passed directly
A

Syndications

70
Q

Reversed

Advantages: - gain access with limited amount of capital - funds generally buy and sell - more liquidity - regulated by SEC Disadvantages: - right to defer redemptions - stale prices - fees - tax inefficient compared to ETF

A

Open Ended RE Mutual Funds

71
Q

Reversed

  • tradable investment that track a particular index - Do Jones U.S. Real Estate Index
A

ETF

72
Q

Reversed

  • exchange traded mutual funds Advantages: - liquidity - purchased on margin - can take long or short position - increased transparency - regulated by SEC Disadvantages: - difficult to get exposure to what you want - tax inefficient
A

Closed End RE Mutual Funds

73
Q

Reversed

  • must have 75% or more underlying RE holding claims to RE - highly correlated with over market - more highly correlated with small cap than large cap
A

Equity REITs

74
Q

Reversed

reduction in value of an asset with the passage of time

A

Depreciation

75
Q

Reversed

  1. when depreciation is not allowed, the after tax IRR will be less than the pre-tax IRR reduced by the tax rate 2. the effective tax rate is equal to the stated tax rate when tax deductible depreciation equals economic depreciation 3. after tax IRR is slightly higher in the accelerated depreciation than in nonaccelerated 4. when outlays can be fully expensed for tax accounting purposes, the after tax return will generally be approximately equal to the before tax
A

Principals of Depreciation

76
Q

Reversed

allows a firm to write off the value of an asset more quickly than the true economic decline in the asset

A

Accelerated Depreciation

77
Q

Reversed

National Council of RE Investment Fiduciaries NPI calculated: - appraised -unleveraged basis - before tax - value weighted NPI used as proxy for commercial RE investment

A

Real Indices Based on Appraisal

78
Q

Reversed

uses the underlying characteristic of an asset to estimate prices of the assets in the index

A

Hedonic Price Index

79
Q

Reversed

  • strong 14.5% return - largest max gain 31% - max drawdown -68.3% - negative skewness and leptokurtosis - high positive correlation with global equity and high yield bond - neg corr with VIX - low positive correlation with commodities
A

Equity REIT Performance

CAIA Level One Reversed (8 decks)

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