Reading 3.1

Question 1

Split estates are?

Answer 1

When different parties can own the surface and subsurface

Question 2

What is an MLP?

Answer 2

1) publicly traded limited liability partnership
2) has to have 90% of income from natural resources or RE
3) have general partners and limited partners

Question 3

How is effective economic ownership of NR is achieved?

Answer 3

1) leasing ownership rights from the owner of the NR
2) buying land that and that gives rights for some NR
3) Exchange traded securities

Question 4

What is pure play?

Answer 4

Pure play company is a public company that focuses only on one revenue stream.

Limits the exposure to only one risk

Question 5

What is a stochastic price?

Answer 5

Price that is not fixed, and is dependent on some variable

Question 6

What is the exchange option for NR?

Answer 6

You exchange one risky asset (input) for another risky asset (output) at a STOCHASTIC STRIKE PRICE

Question 7

On what is the value of an EXCHANGE OPTION dependent?

Answer 7

1) volatility of the delivered asset (output)
2) volatility of the received asset (input)
3) correlation between the 2 prices

Question 8

Volatility of an exchange option is comparable to?

Answer 8

Volatility of a 2 asset portfolio

Question 9

When is the exchange option value high? I.e when is it good to invest in NR development

Answer 9

When development cost and commodity prices are not positively correlated (i.e do not move in the same direction)

Question 10

What kind of option (american/european) is the option to develop NR?

Answer 10

Perpetual option (American option)

Question 11

Low hanging fruit principal?

Answer 11

Firstly develop the most attractive options = that have the potential to create the most value

Question 12

What factors determine when to exercise an option (i.e. develop the NR)?

Answer 12

1) volatility of the commodity price
2) volatility of the development cost
3) correlation between the two

Question 13

Option value formula

Answer 13

Intrinsic option value + Time value of option

Question 14

What is time value of option?

Answer 14

Excess above option’s intrinsic value

Question 15

What is the intrinsic value of an option?

Answer 15

Value of the option, if you exercise it immediately. But NEVER below zero, it cant be negative.

Question 16

Why some options should not be exercised immediately?

Answer 16

To benefit from:

1) convexity = price increases at an increasing rate, but cant go below 0
2) possible future price increase

Question 17

Risks for in the money and out of the money developments?

Answer 17

In the money: Driven by the commodity price.

Out of the money: longer the time horizon, the greater risk of changes in development cost, interest rates and other factors

Question 18

What is land banking

Answer 18

Investing in land expecting that it will increase in price or for development

Question 19

What determines the value of land?

Answer 19

Ability to generate value

Question 20

Type of land lots:

Answer 20

1) paper lots - vacant lots. Legal permission to develop are in place.

2) blue top lots - infrastructure (water, sewage, electricity) is being developed.

3) finished lots - infrastructure is ready, development fees (except building permits) have been paid

Question 21

On what factors does the value of land depend on? In terms of options

Answer 21

1) underlying asset - land
2) strike price - development cost
3) time to expiration - unlimited
4) pay off - spread between value of competed dev, and cost to dev.
5) volatility in the spread between the value of completed development and cost to develop
6) risk free rate
7) dividend yield - income of completed project
8) cost of holding undev land (taxes, maintenance)

Question 22

When is land more valuable?

Answer 22

When it can serve multiple purposes, as long as the values from these purposes are not perfectly correlated

Question 23

What is negative survivorship bias in undeveloped land returns? What are its consequences?

Answer 23

The databases of returns usually exclude high returns of successfully developed land.

=>

The returns are understated

Question 24

What is a Rotation period?

Answer 24

Time needed to grow the tree from planting to harvest

Question 25

What are vertically integrated companies?

Answer 25

Companies what are involved in all stages of the product developing process

Question 26

Pros of investing in timberwood:

Answer 26

1) flexibility - can postpone harvest of trees to wait for a better market
2) Stable demand - because a multipurpose commodity
3) inflation hedge
4) diversification (due to low correlation with stocks/bonds)

Question 27

Cons of investing in timberwood

Answer 27

1) prone to high risks of natural disasters because of long rotation period
2) long rotation period
3) timber values tied to cyclical industries

Question 28

How to gain exposure to timberwood:

Answer 28

1) ETFs
2) REITs
3) futures contracts
4) shares in timber companies

Question 29

Value of farmland property formula:

Answer 29

Annual operating income / Cap rate

Question 30

Operating income formula:

Answer 30

Income - Expenses (except financing)

Question 31

Net income formula

Answer 31

Operating income - Financing costs

Question 32

ROA formula:

Answer 32

Operating income / Total Assets

Question 33

ROE Formula

Answer 33

Net income / Total Equity

Question 34

Total equity formula for farmland

Answer 34

Purchase price - financing costs

Question 35

What is the capitalization rate (cap rate)?

Answer 35

Expected rate of return on RE property

=

ROA

Question 36

2 types of farmland ownership

Answer 36

1) row cropland - crops that are replenished each year

2) Permanent cropland - long replenishment cycle

Question 37

2 types of farmland investment risk

Answer 37

1) agency risk - the lessee harms the land

2) political risk - decrease in subsidies

Question 38

Demand factors for agricultural products

Answer 38

1) global population growth
2) rising incomes
3) increased use of agricultural products in non-food based uses (biofuel)

Question 39

Future supply of agricultural products is dependent on:

Answer 39

1) changing agricultural yields
2) changing agricultural infrastructure
3) quality of cultivated land

Question 40

Reasons for growth in agricultural yields?

Answer 40

1) technology
2) improved agronomy (science of soil management, etc)
3) increase use of inputs (fertilizer)
4) increased use of machinery

Question 41

Pros of farmland investment

Answer 41

1) inflation hedge
2) diversification
3) constrained supply

Question 42

Cons of farmland investment

Answer 42

1) illiquidity
2) high transaction costs
3) Agency risk (the cost of that)

Question 43

4 main sectors of the agribusiness

Answer 43

1) agricultural products
2) seed & fertilizer
3) farm & machinery
4) packaged foods

Question 44

When is multiple use farmland most valuable?

Answer 44

1) When the value of different uses are not correlated

Even better if there is a agricultural and non-agricultural use

2) when profitability of the each crop is uncertain = very volatile

Question 45

How does smoothing impact risk? Why does it do so?

Answer 45

Smoothing decreases the perceived risk because STDEV is lower.

Question 46

What is anchoring?

Answer 46

Relying heavily on prior beliefs, not acknowledging new information

Question 47

Impact of smoothing on true returns?

Answer 47

Impact = True returns - Smoothed returns

Question 48

Stale data is?

Answer 48

No longer up to date data

Question 49

Causes of return smoothing / stale data

Answer 49

1) Time gap between deal and transaction
2) not appropriate indicators of valuation changes
3) managing data appraisal
4) data delays

Question 50

What problem does smoothing create?

Answer 50

1) reduces volatility
2) because reduces volatility reduces correlation estimates

Question 51

Main ways that returns can be “managed” (aka manipulated)

Answer 51

1) favorable mark - favorable price quote
2) selective appraisal - selected time and asset to be appraised
3) model manipulation - changing inputs/assumptions
4) Market manipulation - trading in such a way to move markets

Question 52

Difference between market and smoothed returns?

Answer 52

Smoothed returns decline on a delayed basis

Question 53

What is contagion?

Answer 53

Tendency of major market moves to be passed from one financial market to the other

Question 54

Timber return observations compared to General Market (volatility, sharpe ratio, skewness, excess kurtosis, max drawdown, partial autocorrelation, clustering around the mean)

Answer 54

GE - global equity

1) volatility: much less than GE
2) sharpe ratio: attractive, more than GE
3) skewness: modestly positive (vs negative for GE)
4) excess kurtosis: markedly positive (much more than GE)
5) maximum drawdown: very mild (much smaller than GE
6) Partial autocorrelation: markedly 4th order = there is a one year lag in recognizing value change
7) clustering around the mean: very tight

Question 55

Farmland return observations (volatility, sharpe ratio, skewness, excess kurtosis, max drawdown, partial autocorrelation, clustering around the mean)

Answer 55

GE - global equity

1) volatility: less than GE
2) sharpe ratio: very attractive, much more than GE
3) skewness: markedly positive (vs negative for GE)
4) excess kurtosis: markedly positive (much more than GE)
5) maximum drawdown: very small
6) Partial autocorrelation: markedly 4th order = there is a one year lag in recognizing value change
7) clustering around the mean: very tight

Question 56

A NR should be developed when which value is zero?

Answer 56

When TIME VALUE of the development option is ZERO

Question 57

Volatility used in the value of an exchange option is driven by which 3 factors?

Answer 57

1) volatility of delivered asset
2) volatility of a received asset
3) correlation between volatilities of delivered and received asset

Question 58

Pairwise correlation is

Answer 58

Two variable correlation