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CFA > Alternative Investments > Flashcards

Alternative Investments Flashcards

1
Q

What are some of the motivations for investing in real estate?

A

1) Current income
2) Price appreciation
3) Inflation hedge
4) Diversification
5) Tax benefits

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2
Q

What are the three approaches used by appraisers to estimate value for private real estate?

A

1) Income
- Direct capitalization
- Discounted cash flow method
2) Cost
Based on adjusted replacement cost (unusual properties)
3) Sales comparison approach

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3
Q

What is the direct capitalization formula?

A

1st year NOI / Cap rate

Cap rate = (Discount rate - Growth rate)

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4
Q

How do we calculate the value of real estate based on cost approach?

A

(Replacement cost - Curable physical deterioration) - Incurable physical deterioration - Functional obsolescence - Locational obsolescence - Economic obsolescence

Incurable physical deterioration = (Replacement cost - Curable physical deterioration) * (Age of property/Expected life)

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5
Q

What is the total return formula for private real estate?

A

(NOI - Capital expentidures + Ending MV - Begin MV) / Beginning Market Value

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6
Q

What are the characteristics of appraisal-based indices?

A

Tend to lag transaction-based indices

Appear to have lower volatility and lower correlation with other asset classes

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7
Q

What are the types of transaction-based indices?

A

Repeat sales index

Hedonic index: must control for differences in the characteristics of the property

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8
Q

What is the loan-to-value formula (LTV)?

A

Mortgage amount / Appraised value of property

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9
Q

What is the debt service coverage ratio (DSCR)?

A

NOI / Debt service

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10
Q

What is the equity dividend rate?

A

Annual cash flow / Cash invested in property

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11
Q

What is the formula for FFO?

A

Net earnings + Depreciation + Deferred tax charges +/- Gains/Losses from sales of property

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12
Q

What is the formula for AFFO

(funds available for distribution)?

A

FFO - Non-cash rent - Maintenance-type capital - Leasing costs

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13
Q

What are the advantages of publicly traded equity real estate securities?

A

1) Superior liquidity
2) Greater potential for diversification
3) Superior quality and range of properties
4) Management service
5) Limited liability
6) Exemption from income taxation for REITs

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14
Q

What are the differences between REITs and REOCs?

A

REITs offer higher yields and income tax exemption, but have less operating flexibility.

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15
Q

How is value created in private equity?

A

1) Ability to re-engineer the private firm to generate superior returns
2) Ability to access credit markets on favorable terms
3) Better alignment of interests

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16
Q

What is the focus for venture capital? Buyout firms?

A

Venture capital: Revenue growth

Buyout firms: EBITDA growth

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17
Q

What are the different stages for venture capital?

A

1) Seed
2) Start-up
3) Expansion
4) Replacement

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18
Q

What are the types of buyout?

A

1) Acquisition capital
2) Leverage buyout (LBO)
3) Management buyout

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19
Q

What is the basic venture capital method?

A

1) Determine post-money valuation: POST = V/(1+r)^t
2) Determine pre-money valuation: PRE = POST - I
3) Determine ownership fraction: F = I/POST
4) Obtain # of shares: Y = x (F/(1-F))
5) Price of shares: p = I/Y

20
Q

What are the different valuation techniques available for private equity?

A

1) Discounted cash flows (operating history, expansion to maturity)
2) Earnings multiples (operating history)
3) Real option (seed; start-up)
4) Replacement cost (early stage)

21
Q

What are the three man input parameters in the LBO model (negociation model)?

A

1) Cash flow forecasts of target company
2) Expected returns from providers of financing
3) Amount of financing available for the transaction

22
Q

What are the different ratios provided by the GP in a private equity fund?

A

1) DPI: returned $ for every 1$ invested
2) RVPI: residual value to paid in
3) Total value to paid in (TVPI) = DPI + RVPI

23
Q

What the valuation of commodities is based on?

A

Discounted forecast of future possible prices based on such factors as the supply and demand of the physical item.

24
Q

What are the three types of trading participants in the commodity market?

A

1) Hedgers
2) Speculators
3) Arbitrageurs

25
Q

What is backwardation?

A

Spot price > Futures price (Positive calendar spread)

26
Q

What is contango?

A

Futures price > Spot price (Negative calendar spread)

27
Q

What is the insurance theory?

A

Commodity procdures who are long the physical good are motivated to sell the commodity for future delivery to hedge their production price risk exposure. Backwardation is normal.

28
Q

What is the hedging pressure hypothesis?

A

Producers along with consumers seek to protect themselves from commodity market price volatility by entering into price hedges to stabilize their projected profits and cash flows.

29
Q

What is the theory of storage?

A

Focuses on supply and demand dynamics of commodity inventories, including concept of convenience yield. High storage cost = contango

30
Q

What is the formula for future prices according to the theory of storage?

A

Futures price = Spot price + Direct storage costs - Convenience yield

31
Q

When is the convenience yield typically high?

A

When supply is scarce ; there is an inverse relationship with inventories

32
Q

What are the most relevant commodity swaps?

A

1) Excess return swap
2) Total return swap
3) Basis swap
4) Variance/volatility swap

33
Q

What is the roll return formula?

A

(Near-term futures closing price - Further-term futures closing price) / Near-term futures closing price * % of position being rolled

34
Q

What is the collateral return?

A

Interest rate for bonds or cash used to maintain investor’s futures position

35
Q

What are the characteristics of total returns for futures contracts when market is in backwardation?

A

Roll return is usually positive

Rolling requires buying more contracts to maintain same dollar position.

36
Q

What is the total return formula for fully collateralized futures contract?

A

Price return + Roll return + Collateral return

37
Q

For REITs, why is Net Asset Value Per Share (NAVPS) is preferable to Book Value Per Share?

A

NAVPS is preferable to BVPS in valuing REITs because of the use of the market value of assets. Although accounting values based on the fair value method also serve as a useful valuation metric, those based on historical cost are generally not relevant.

38
Q

What is the formula to calculate the NAVPS?

A

( (Next Year Net Operating Income/Cap rate) + Other assets - Liabilities) / # of shares

39
Q

What is the difference between the discount rates for NAVPS and DDM?

A

NAVPS: Discount rate (cap rate) based on private valuation of comparable properties
DDM: discount rate based on public equity investment

40
Q

What are some corporate governance clauses in private equity?

A

1) Key man clause:
2) Disclosure and confidentiality
3) Clawback provision
4) Distribution waterfall
5) Tag-along, drag-along
6) No-fault clause
7) Removal for cause
8) Investment restrictions
9) Co-investment

41
Q

What is the key man clause?

A

Some key executives play an important role in the management of the fund. If a key man leaves, the GP may be prohibited from making any new investments until a new key executive is appointed.

42
Q

What is a clawback provision?

A

A clawback provision requires the GP to return capital to LPs in excess of the agreed profit split between the GP and LPs.

43
Q

What is a distribution waterfall?

A

Mechanism providing an order of distributions to LPs first before the GP receives carried interest.

1) Deal-by-deal
2) Total return

44
Q

What are tag-along, drag-along rights?

A

Contractual provisions in share purchase agreements that ensure any potential future acquirer of the company may not acquire control without extending an acquisition offer to all shareholders, including the management of the company

45
Q

What is a no-fault clause?

A

A GP may be removed without cause, provided that a super majority (generally above 75 percent) of LPs approve that removal.

46
Q

When a company is sold by a private equity fund, which part of its capital structure most likely reduce in size?

A

Debt: debt reduction is a common source of value creation in LBO

CFA (10 decks)

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