CFA Flashcards

The formula will most likely be used to calculate the value of an existing single-family home utilized for residential purposes:

Answer: sales comparison approach.

The sales comparison approach is the most appropriate method for valuing existing single-family homes. This approach estimates value by comparing the subject property to similar properties that have recently sold in the same market, making adjustments for differences. The income approach is for income-generating properties, and the cost approach is typically for new construction or unique properties.

Which of the following alternative investments is the best fit for a high-net-worth individual with a long time horizon and a need for immediate income?

Answer: Commercial real estate.

Commercial real estate is an excellent fit for a high-net-worth individual with a long time horizon and a need for immediate income. It typically generates stable rental income, providing immediate cash flow, and offers potential for capital appreciation over the long term. Venture capital involves high risk and long horizons with no immediate income, while multi-strategy hedge funds may offer some liquidity but are not primarily focused on immediate income.

Utilized buyout finance is assessing Siena Company relative to its peer companies. Siena is most likely a great candidate for an administration buy-in in the event that it has:

Answer: higher cash flow and less capable managers than its peers.

A company is most likely a great candidate for a management buy-in (MBI) if it has higher cash flow, as this cash flow is crucial for servicing the debt used in a leveraged buyout. Additionally, less capable existing managers present an opportunity for the new management team to improve operations and unlock value, making the target more attractive for an MBI.

A REIT's funds from operations (FFO) are most likely computed as follows:

Answer: Net income plus depreciation less gains from sales of real estate plus losses from sales of real estate.

Funds From Operations (FFO) is a key metric for REITs that adjusts net income to better reflect cash flow from operations. It is calculated by adding back depreciation and amortization to net income, and then adjusting for non-recurring gains or losses from the sale of real estate. This provides a clearer picture of a REIT's ongoing operational performance by removing non-cash expenses and non-operating income/losses.

Consider the following propositions: Phrase1: Commodities have generally had a higher Sharpe ratio than bonds but a lower Sharpe ratio than stocks. Phrase 2: Commodity price volatility is typically higher than reported consumer price inflation volatility. Which of these is the most likely case?

Answer: Only Statement 1 is incorrect.

Historically, commodities have generally exhibited lower Sharpe ratios compared to both stocks and bonds, making Statement 1 incorrect. However, commodity prices are known for their significant volatility, which is typically higher than the smoother, more stable reported consumer price inflation volatility, making Statement 2 correct. Therefore, only Statement 1 is incorrect.

The spot price of a commodity market is in contango if it is:

Answer: lower than futures prices

A commodity market is in contango when the futures price is higher than the current spot price. This market structure typically reflects the costs of holding the physical commodity over time, such as storage costs and insurance, exceeding any convenience yield. The opposite condition, where futures prices are lower than spot prices, is called backwardation.

Which of the following is the least likely source of profit from a commodity futures position with collateral?

Answer: Storage costs

Profit from a commodity futures position with collateral typically comes from the spot price return (or roll return) and the collateral yield (interest earned on the collateral). Storage costs, however, are an expense associated with holding physical commodities, not a source of profit from a futures position itself. In fact, storage costs contribute to contango, making futures prices higher than spot prices.

In 20x7, an investment in a hedge fund with a 2-and-20 fee structure rose in value each period, yielding an 8 percent net return net of management fees. Which of the following provisions would have the highest incentive fees for 20x7?

Answer: 6% soft hurdle rate and a high water mark provision.

Given an 8% net return after management fees, we compare incentive fees for each option. A soft hurdle rate means incentive fees are applied to the entire profit if the hurdle is met. Option A's 6% soft hurdle means 20% of the full 8% return is taken as incentive fee (1.6%). Options B and C have hard hurdle rates, meaning fees are only on profits *above* the hurdle (8%-7%=1% for B, 8%-5%=3% for C), resulting in lower incentive fees (0.2% and 0.6% respectively). Therefore, the soft hurdle rate in option A yields the highest incentive fees.

Which of the following alternative investments would be best for a high-net-worth individual with a long time horizon and a need for immediate income?

Answer: Commercial real estate.

Commercial real estate is the best alternative investment for a high-net-worth individual seeking a long time horizon and immediate income. It offers potential for capital appreciation over time and generates consistent rental income, fulfilling the need for immediate cash flow. Venture capital and multi-strategy hedge funds typically focus on capital growth rather than immediate income generation.

The esteem of an existing single—family domestic utilized for private purposes will most likely be calculated utilizing the:

Answer: sales comparison approach.

The sales comparison approach is the most appropriate and commonly used method for valuing existing single-family residential properties. This approach estimates value by comparing the subject property to similar properties that have recently sold in the same market, making adjustments for differences. The income approach is for income-generating properties, and the cost approach is typically for new construction or unique properties.

Kate Smith, CFA, is thinking about diversifying her typical investment portfolio with hedge funds. Werner calculates the diversification benefits of investing 5% of a portfolio's assets to hedge funds based on historical mean and standard deviation of hedge fund index results, as well as their association with traditional investment returns. Werner is most likely to:

Answer: overestimate the potential diversification benefits to the portfolio.

Using historical hedge fund index results to estimate diversification benefits often leads to overestimation due to several biases. These include survivorship bias (failed funds are removed, inflating returns), backfill bias (funds report past good performance upon joining an index), and liquidity bias (smoothed returns underestimate true volatility and correlation). These biases make hedge funds appear to have higher returns, lower volatility, and lower correlation with traditional assets than they actually do, thus overstating their diversification potential.

In a leveraged buyout (LBO), the mezzanine finance part is most likely to:

Answer: be convertible to equity or include warrants.

Mezzanine finance in a leveraged buyout (LBO) is a hybrid form of capital that combines debt and equity features. It is typically subordinated to senior debt but ranks above equity. A key characteristic is that mezzanine finance often includes an equity kicker, such as warrants or convertibility into equity, allowing lenders to participate in the company's upside potential if the LBO is successful.

The component of a long-only commodity futures position's yield that is not affected by whether the contract is in contango or backwardation is the:

Answer: collateral yield.

The collateral yield is the return earned on the cash collateral posted to secure a futures position, typically invested in low-risk assets like T-bills. This yield is independent of the relationship between spot and futures prices, which defines contango or backwardation. In contrast, the roll yield is directly affected by whether the contract is in contango (negative roll yield) or backwardation (positive roll yield).

Cathy Williams, CPA, is an asset manager who wants to put some of his money into alternative ventures. Williams buys a security that represents a proportional claim to a pool of loans' cash flows. Williams has most likely invested in which alternative investment category?

Answer: Real estate.

Investing in a security that represents a proportional claim to a pool of loans' cash flows is characteristic of securitized debt. This often includes mortgage-backed securities (MBS) or collateralized loan obligations (CLOs) backed by real estate or other loans. Such investments fall under the broader alternative investment category of real estate, which encompasses not just direct property ownership but also related financial instruments.

A private equity fund sells the following items to exit a portfolio company through a trade sale:

Answer: the portfolio company to one of the portfolio company‘s competitors.

A trade sale is an exit strategy where a private equity firm sells its portfolio company to a strategic buyer, typically another operating company. Selling the portfolio company to one of its competitors is a classic example of a trade sale, as the buyer often seeks to gain market share, achieve synergies, or acquire specific assets or technologies. Selling shares to the public is an IPO, and selling to another private equity firm is a secondary sale.

The phrase "mezzanine-stage financing" is used to characterize the financing in the context of venture capital:

Answer: to prepare for an initial public offering.

Mezzanine-stage financing is typically one of the later stages of venture capital funding, provided to companies that are already established and generating revenue. This capital is often used to fund expansion, prepare for an initial public offering (IPO), or position the company for an acquisition. It bridges the gap between earlier-stage venture capital and a public market exit.

When compared to its accounting-based net asset value (NAV), a hedge fund trading NAV:

Answer: will be lower because of adjustments for illiquid positions.

A hedge fund's trading NAV is often a more conservative estimate than its accounting-based NAV, especially due to adjustments for illiquid positions. Illiquid assets, which are difficult to sell quickly without a significant price concession, may be valued at a discount to reflect potential liquidation costs or market uncertainty. This aims to provide a more realistic, albeit lower, value that the fund could realize in a sale.

A portfolio manager is more likely to predict higher returns if a percentage of assets is allocated to alternative investments, because alternative investments:

Answer: often employ leverage.

Alternative investments, such as hedge funds and private equity, frequently employ leverage to enhance potential returns. While leverage also amplifies risk, the ability to generate higher returns through borrowed capital is a key reason why portfolio managers allocate assets to these categories. This characteristic differentiates them from many traditional investments and contributes to their appeal for return-seeking investors.

Which of the following assertions concerning a public company's annual reports, SEC filings, and press releases in the United States is the most accurate?

Answer: Interim SEC filings typically update the major financial statements and footnotes.

Interim SEC filings, such as Form 10-Q (quarterly reports), provide updated financial statements (balance sheet, income statement, cash flow statement) and relevant footnotes for the most recent quarter. These filings are crucial for investors to stay informed about a company's financial performance and position between annual reports. Annual reports to shareholders are often marketing documents, and only annual SEC filings (10-K) are fully audited.

A private equity firm that wishes to obtain money from a portfolio company without giving up ownership is most likely to:

Answer: recapitalization.

Recapitalization involves altering a company's capital structure, often by issuing new debt to fund a large dividend payment to shareholders, including the private equity firm. This allows the private equity firm to extract cash from the portfolio company without selling its ownership stake. Trade sales and secondary sales, conversely, are exit strategies that involve relinquishing ownership.