Chapter 10 CAIA Flashcards - Natural Resources & Land

Question 1

Split Estate

Answer 1

A split estate is when surface rights and mineral rights are separately owned.

Question 2

Pure Play Investment

Answer 2

A pure play on an investment is an investment vehicle that offers direct exposure to the risks and ​returns of a specific type of investment without the inclusion of other exposures.

Question 3

Exchange Option

Answer 3

An exchange option is an option to exchange one risky asset for another rather than to buy or sell one asset at a fixed exercise or strike price.

Question 4

Perpetual Option

Answer 4

A perpetual option is an option with no expiration date. All perpetual options are American options, since a European perpetual option could never be exercised.

Question 5

Low Hanging Fruit Principle

Answer 5

The low-hanging-fruit principle states that the first action that should be taken is the one that reaps the highest benefits over costs. Thus, the order in which natural resource properties are developed should tend to be driven by the low-hanging-fruit principle.

Question 6

Time Value of an Option

Answer 6

The time value of an option is the excess of an option’s price above its intrinsic value. The sum of an option’s intrinsic value and its time value is equal to the option’s total value (or price), as depicted in Equation 10.1:

Question 7

Land Banking

Answer 7

Land banking is the practice of buying vacant lots for the purpose of development or disposition at a future date. This practice is common in the home-building industry and allows home builders to secure land tracts for eventual use in the fulfillment of housing development pipelines.

Question 8

Paper Lots

Answer 8

Paper lots refers to sites that are vacant and approved for development by the local zoning authority but for which construction on streets, utilities, and other infrastructure has not yet commenced.

Question 9

Blue Top Lots

Answer 9

Blue top lots are at an interim stage of lot completion. In this case, the owner has completed the rough grading of the property and the lots, including the undercutting of the street section, interim drainage, and erosion control facilities, and has paid all applicable fees required. At this stage, a home builder can obtain a building permit upon payment of the ordinary building permit fee.

Question 10

Finished Lots

Answer 10

Finished lots are fully completed and ready for home construction and occupancy. All entitlements, including infrastructure to the lot, finished grading, streets, common area improvements, and landscaping, have been completed. All development fees, exclusive of the building permit and inspection, have been paid.

Question 11

Binomial Option Pricing

Answer 11

Binomial option pricing is a technique for pricing options that assumes that the price of the underlying asset can experience only a specified upward movement or downward movement during each period.

Question 12

Risk Neutral Probability

Answer 12

A risk-neutral probability is a probability that values assets correctly if, everything else being equal, all market participants were risk neutral. A risk-neutral probability may be viewed as being equal to a statistical probability that has been adjusted for risk so that it can be used to price risky assets in a risk-neutral framework.

Question 13

TIMO

Answer 13

Timberland investment management organizations (TIMOs) provide management services to timberland owned by institutional investors, such as pension plans, endowments, foundations, and insurance companies.

Question 14

Agency Risk

Answer 14

Agency risk is the economic dispersion resulting from the consequences of having another party (the agent) making decisions contrary to the preferences of the owner (the principal).

Question 15

Cap Rate

Answer 15

In real estate, the cap rate (capitalization rate) or yield is a common term for the return on assets (7.33% in this example). The concept is often used to value ​real estate so that the value of a property might be viewed as equal to the property’s expected annual net operating income divided by an estimate of an appropriate cap rate:

Question 16

Smoothing

Answer 16

Smoothing is reduction in the reported dispersion in a price or return series. Smoothed returns can mask risk.

Question 17

Managed Returns

Answer 17

Managed returns are returns based on values that are reported with an element of managerial discretion. There are four primary ways that values and returns can be managed: favorable marks, selective appraisals, model manipulation, and market manipulation.

Question 18

Favourable Mark

Answer 18

A favorable mark is a biased indication of the value of a position that is intentionally provided by a subjective source.

Question 19

Selective Appraisals

Answer 19

Selective appraisals refers to the opportunity for investment managers to choose how many, and which, illiquid assets should have their values appraised during a given quarter or some other reporting period.

Question 20

Model Manipulation

Answer 20

Model manipulation is the process of altering model assumptions and inputs to generate desired values and returns. Model manipulation can occur in complex ​unlisted derivative transactions and other unlisted assets that are valued using models. The reported values can be manipulated by altering the parameter values that are inserted into the model. For example, use of higher estimates of asset volatilities can generate higher option prices.

Question 21

Contagion

Answer 21

Contagion is the general term used in finance to indicate any tendency of major market movements—especially declines in prices or increases in volatility—to be transmitted from one financial market to other financial markets.