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CFA Level 2 > Alternative Investments > Flashcards

Alternative Investments Flashcards

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1
Q

Real estate investment

A
  • REITs - Indirect ownership
  • MBSs - Indirect lending
  • Mortgage - Direct lending
  • Private equity investment in real estate - Direct ownership
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2
Q

Investment vehicles

A
  • Commingled real estate funds (CREF)
  • Real estate operation company (REOC)
  • Real estate investment trust (REIT)
  • Mortgage-backed security (MBS)
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3
Q
  • National Council of Real Estate Investment Fiduciaries
  • National Association of Real Estate Invesment Trusts
A
  • NCREIF
  • NAREIT
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4
Q

Loan-to-value (LTV)

A

Borrowed funds / Total purchase price

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5
Q

Debt service coverage ratio (DSCR)

A
  • Maximum debt service (DSCR) = NOI / Debt service (loan payment)
  • Loan amount for an interest only mortgage = Debt service (loan payment) / Mortgage rate
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6
Q
  • Net lease
  • Gross lease
  • Full repairing and insuring basis (FRI)
A
  • Tenant is responsible for the operating expenses
  • Owner is responsible for the operating expenses
  • The tenant is responsible for most costs
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7
Q

Natural breakpoint

A

Example: minimum rent of 30$ plus 10% of sales over 300$ per square foot. Since 30$ = 10% of 300$ → 300$ is the natural breakpoint

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8
Q

Types of growth and the sector of real estate they affect

  • Job
  • Population
  • Savings rate
A
  • Office
  • Multi-family
  • Retail
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9
Q

Mortgage lending value

A
  • Done in Germany
  • Prudent valuation
  • Takes into account economical fluctuations
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10
Q

3 valuation approaches

A
  • Income
  • Sales comparison
  • Cost
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11
Q

2 Income approaches to valuation

A
  • Direct capitalization - Capitalizes current NOI using a growth implicit capitilization rate
  • Discounted cash flow - Applies an explicit growth rate to construct an NOI stream from which PV is derived
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12
Q

Calculating NOI

A

Rental income at full occupancy + Other income = Potential gross income (PGI)

PGI - vacancy and collection loss = Effective gross income (EGI)

EGI - operating expenses (OE) = NOI

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13
Q

Direct capitalization rate

A

Capitalization rate = Discount rate - growth rate

Value = NOI / Capitalization rate

/

NOI is usually based on the first year of ownership

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14
Q

Direct capitalization rate assuming that the sale price for a comparable property is a good indication of the value of the subject property

A

Capitalization rate = NOI / Sale price of comparable  

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15
Q

Direct capitalization versus DCF

A
  • Direct capitalization applies a capitalization rate or an income multiplier to the forecasted first-year NOI
  • In contrast, when doing a DCF, the future cash flows are projected each year until sale of the property
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16
Q

Going-in cap rate

A

First year NOI / Property value

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17
Q

All risks yield (ARY)

A
  • Market value = Rent / ARY
  • ARY = the cap rate derived by dividing rent by the recent sales prices of comparables
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18
Q

Rents increases and expected return

A
  • If rents are expected to increase after every rent review - expected return will be higher than cap rate
  • If rents are expected to increase at a constant growth rate - expected return will equal the cap rate plus the growth rate
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19
Q

Implicit vs explicit

A

g is explicit in discount rate whereas g is implicit in the cap rate

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20
Q

Relation between interest rate and real estate value

A

Higher interest rate will raise the expected return and thus lower the value of the property

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21
Q

Cost approach deductions

A
  • Functional obsolescence
  • Locational obsolescence
  • Economical obsolescence
  • Depreciation
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22
Q

Appraisal-based index

A

[NOI - CAPEX + (Ending MV - Beginning MV)] / Beginning MV

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23
Q

2 transaction-based indices types

A
  • Repeat sales
  • Hedonic (requires only one sale of a property and the price is adjusted for its specific characteristics)
24
Q

Equity yield rate

A

= Cash flow / Equity

  • Cash flow = NOI - Debt Service
  • Equity = Purchase price - Loan amount (debt)
25
Q

UPREITs

A

Short for “umbrella partnership real estate investment trust,” an UPREIT is an alternative to a section 1031 like-kind exchange as a way to defer or completely avoid capital gains tax liability when an individual or company wants to sell appreciated real estate. Instead of selling the property, the owner contributes it to an UPREIT in exchange for securities called “operating partnership units” or “limited partnership units.” The partnership units are worth the same amount as the contributed property. Unlike selling the property, this transaction doesn’t create a taxable event

26
Q

DOWNREITs

A

A joint venture between a real estate owner and a real estate investment trust (REIT) that assists the real estate owner in deferring capital gains tax on the sale of appreciated real estate. Real estate owners who contribute property to DownREITs receive operating units in a partnership. Unlike UPREITs - which do not own real estate and act basically as an umbrella for a number of business entities that own real estate - a DownREIT does own real estate, some outright and some through limited partnerships with those who have contributed property to it

27
Q

Non-cash rent deductions

A

Are the result of the accounting practice of straight lining the rental revenue from long-term leases. (The amount of this deduction is the difference between the average contractual rent over the leases’ terms and the cash rent actually paid

28
Q

IFRS allowed valuation types

A
  • Cost model
  • Fair value model
  • The chosen model must be applied to all similar investments
29
Q

US GAAP allowed valuation types

A
  • No specific definition for investment properties
  • Most companies use the historical cost model
30
Q

Net asset value per share (NAVPS)

A

[MV value of assets - MV of liabilities] / Numbers of shares outstanding

Goodwill, deferred financing expenses and deferred tax assets or liabilities are usually excluded

31
Q

Net asset value per share (NAVPS) from NOI

A

Can be calculated by capitalizing NOI at the cap rate and then dividing by the number of outstanding shares

32
Q

Price multiples

A
  • Price-to-funds from operation (P/FFO)
  • Price-to-adjusted funds from operation (P/AFFO)
  • EV/EBITDA
33
Q

FFO

A

= accounting net earnings excluding depreciation charges, deferred tax charges and gains or losses from sales of property and debt restructuring

34
Q

AFFO

A

= FFO excluding non-cash rent and maintenance-type CAPEX and leasing costs

35
Q

Private equity major players

A
  • Blackstone
  • Carlyle
  • KKR
  • Texax Pacific Group
  • Permira
36
Q

Marketability

A

The right to sell the asset

37
Q
  • CLO
  • CDO
  • CPECs
A
  • Collaterized loan obligations
  • Collaterized debt obligations
  • Convertible preferred equity certificates
38
Q

MEP

A

Management equity program

39
Q
  1. Ratchet
  2. Vintage year
  3. Key man clause
  4. Clawback provision
  5. Distribution Waterfall
A
  1. Determines the allocation of equity between shareholders and the management team. Rewards management for meeting performance targets
  2. The year the fund was launched
  3. Terms regardins the departure of a key executive
  4. Money or benefits that are distributed and then taken back as a result of special circumstances
  5. Deal-by-deal or total return
40
Q
  1. Tag-along- drag along rights
  2. No-fault divorve
  3. Removal for cause
  4. Investment restrictions
  5. Co-investment
A
  1. If a majority shareholder sells his or her stake, then the minority shareholder has the right to join the transaction and sell his or her minority stake in the company
  2. A GP may be removed with the approval of a super majority of LPs
  3. Removal of a GP under certain conditions
  4. Diversification requirements
  5. LPs have first right of co-investing with the GP
41
Q

PME

A

Public market equivalent

42
Q

Venture capital method

A
  • POST = I/F
  • PRE = POST - I
  • F = I/POST (F is the required ownership fraction for the investor)
  • y = x [F/(1 - F)] (y is the number of shares required to achieve ownership fraction)
  • price = I/y
  • x = number of shares owned by the other parties
  • W (wealth) = V/ (1 + R)t
  • I = $Investment
  • p1 = I/y
43
Q

POST with probabilities

A
44
Q

Ownership fractions

A
  • Ownership fraction of investors = F
  • Ownership fraction of entrepreneurs = 1 - F
45
Q

Carried interest

A

A share of any profits that the general partners of private equity and hedge funds receive as compensation, despite not contributing any initial funds

46
Q

BRIC

A
  • Brazil
  • Russia
  • India
  • China
47
Q

Distribution waterfall

A
  • Deal-by-deal
  • Total return
    • # 1 - Only after the LPs are totally repaid
    • # 2 - As a proportion of total profit if a certain return threshold is obtained
48
Q

Multiples used in private equity valuation

A
  • PIC (paid in capital): the ratio of paid in capital to date divided by committed capital
  • DPI (distributed to paid in): cumulative distributions paid out to LPs as a proportion of the cumulative invested capital. This ratio is often called “cash-on-cash return.” It provides an indication of the private equity fund’s realized return on investment. DPI is presented net of management fees and carried interest
  • RVPI (residual value to paid in): value of LPs’ shareholding held with the private equity fund as a proportion of the cumulative invested capital. The numerator is measured as the remaining portfolio companies as valued by the GP. This ratio is a measure of the private equity fund’s unrealized return on investment. RVPI is presented net of management fees and carried interest
  • TVPI (total value to paid in): the portfolio companies’ distributed and undistributed value as a proportion of the cumulative invested capital. TVPI is the sum of DPI and RVPI. TVPI is presented net of management fees and carried interest
49
Q

Correlation between commodities prices and the stock price of companies operating in the related commodity

A

The returns from a portfolio of companies are only slightly correlated with commodity returns. These publicly traded natural resource companies reflect other price-relevant factors, such as the strategic position of the company, management quality, capital structure, expectations and ratings of revenue and profit growth, risk sensitivity, information transparency, and information credibility

50
Q

The insurance perspective

A

Hedgers (producers) hold commodities in stock, and therefore must have a short position in commodity futures. To attract speculators, hedgers must offer an insurance premium. Therefore, the futures price for a commodity is less than the expected spot price in the future normal backwardation

51
Q

The hedging pressure hypothesis

A

Consumers who demand commodities may want to hedge their risk. This causes the futures price to be higher than the expected spot price in the future. Under these circumstances, investors seeking to earn an insurance premium will choose to short the commodity futures. The hedging pressure hypothesis argues that investors will receive a risk premium that is a positive excess return for going short in a normal contango commodity futures market

52
Q

The theory of storage

A

Emphasizes the role of inventories, and conceptually links inventories with commodity futures prices. The difference between futures prices and spot prices can be explained by storage costs and the so-called convenience yield of holding specific commodities in inventory. This theory predicts an inverse relationship between the level of inventories and the convenience yield—the lower the inventories, the higher the convenience yield

53
Q
  • PAC
  • TAC
  • PSA
A
  • Planned Amortization Class
  • Target Amortization Class
  • Public Securities Association - measures the prepayment speed by specifying the conditional prepayment rate (CPR)
54
Q

CMO structure

A
  • Structured so that the prepayment risk (as measured by the average life variability) is lower for the PAC I tranche than the support tranche
  • The PAC I tranche as both less extension and less contraction risk
55
Q

Synthetic CDO

A

Created by combining a portfolio of default-free securities with a combination of credit default swaps undertaken as protection sellers

56
Q

Balloon risk

A
  • The risk that a borrower may not be able to come up with the funds for the balloon payment at maturity
  • Is a concern if rates are expected to increase (extension risk)

CFA Level 2 (13 decks)

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