Volume 5 Question Review
How do you determine the cash flow on a receive equity, pay fixed swap?
= NA x (equity return - fixed rate) **Benefit if equity return is positive and fixed rate is negative
What type of factor model is the fama-french model?
A fundamental factor model
Reverse stress testing
A risk management approach where the user identifies key risk exposures in the portfolio and subjects those exposures to extreme market movements - is only used in hypothetical scenario testing
Assumptions of the arbitrage pricing theory (APT)
APT makes less strong assumptions than CAPM 1) a factor model describes asset returns 2) there are many assets so investors can form well-diversified portfolios that eliminate asset-specific risk 3) no arbitrage opportunities exist among well diversified portfolios
Which options will never be exercised early?
American call options on non-dividend paying stock
Obsolescence charges are least likely to explicitly factor into the estimate of property value using the: A. cost approach. B. income approach. C. sales comparison approach.
B is correct - Obsolescence charges reduce the value of a property using the cost approach and are factored into the sales comparison approach by adjustments, including condition and location, to the price per square meter
T/F: gamma is always positive?
False! It is positive for long options and negative for short options
Stress test can be applied to which two types of scenarios?
Historical scenarios and hypothetical scenarios
For stocks what is the value for delta and gamma?
Long stock delta = 1 short stock delta = -1 stock gamma = 0
When valuing a dividend paying stock using the binomial model which changes must you make?
Must use [S bar = S - PV of dividend payments] when calculating Su, Suu, Sd, Sdd When checking the value must add the dividend in at the time period: ex Cu = max(Su + D - X, 0)
Debt Service Coverage Ratio (DSCR)
NOI/Debt Service
Risk budgeting
Sets an overall risk limit for a portfolio and allocates the risk to different asset classes
What are the two types of risk an active investment manager can assume in seeking to increase his information ratio?
The active manager may assume active factor risk and active specific risk (security selection risk) in seeking a higher information ratio.
When using a macroeconomic factor model what is the expected return?
The intercept Recall: Return = expected return + sum of factor risk x factor surprise + error/unexplained return
Long options will usually have a negative theta?
True
T/F: Statistical factor models do not rely on defining the factors up front.
True
T/F: Vega of a call equals vega of a put?
True
T/F: When using a macroeconomic factor, the expected return is the intercept
True! all the factor surprises should equal zero thus leading to the intercept being the expected return
T/F: Just like P/E and P//CF multiples are used to value equities, P/FFO, P/AFFO and EV/EBITDA multiples can be used to compare a given reits shares value with other reit shares?
True!! This is known as relative value approach to valuation
Surplus at risk
an application of VaR; it estimates how much the assets might underperform the liabilities with a given confidence level, usually over a year.
Residual value of private equity firm
is the net value of the returns that have not been paid out - measures unrealized return of LP's
Liquidity gap
the amount by which the sources and uses of liquidity do not match
What is the interpretation of N(d2)?
the risk neutral probability of an option expiring in the money
Using the no arbitrage approach how do you determine the value of a call option / put option?
-hS + Co = PV(-hS + C) where S and C can either be Su Cu or Sd Cd put option just swap P for C
What is the value of stock theta?
0 because stocks have no expiration
What are the three broad categorizations of multifactor models according to the type of factor used?
1 - macroeconomic factor models 2 - fundamental factor models 3 - statistical factor models - make minimal assumptions, however are difficult to interpret
Active share
A measure of how similar a portfolio is to its benchmark. A manager who precisely replicates the benchmark will have an Active Share of zero; a manager with no holdings in common with the benchmark will have an Active Share of one.
Gross Income Multiplier (GIM)
A method of appraising income-producing property based on a multiple of the annual gross income; also called a gross rent multiplier. Gross Income Multiplier = Sales Price / Gross Income
expectations approach
A procedure for obtaining the value of an option derived from discounting at the risk-free rate its expected future payoff based on risk neutral probabilities. ** Can not be used to value an American option!!
How to convert annual standard deviation into daily standard deviation?
Annual / sqrt(trading days) ** just remember that daily should be less than annual thus you should divide!
Private equity committed capital $400 million Carried interest 20% First project investment capital $20 million Second project investment capital $45 million Third project investment capital $50 million Proceeds from first project $25 million Proceeds from second project $35 million Proceeds from third project $65 million Under a deal-by-deal method with a clawback provision and true-up every three years, the cumulative dollar amount the GP receives by the end of the three years is equal to: 1 million. 2 million. 3 million.
B is correct. On a cumulative basis for three years, the fund earns $10 million, of which $2 million goes to the GP. The $2 million earned by the GP corresponds to 20% of the difference between total three-year proceeds and three-year invested capital, or 0.2 × [(25 + 35 + 65) − (20 + 45 + 50)].
An ETF's reported tracking error is typically measured as the: A standard deviation of the difference in daily returns between an ETF and its benchmark. B difference in annual return between an ETF and its benchmark over the past 12 months. C annualized standard deviation of the difference in daily returns between an ETF and its benchmark.
C is correct. An ETF's tracking error is typically reported as the annualized standard deviation of the daily differential returns of the ETF and its benchmark. Tracking error measures the magnitude by which an ETF's returns deviate from its benchmark over time not over a day!!
Index A includes contracts of commodities typically in contango, whereas Index B includes contracts of commodities typically in backwardation. How will the two indexes perform relative to each other in a market that is trending upward? Index B is most likely to exhibit returns that are: A. lower than those of Index A. B. the same as those of Index A. C. higher than those of index A.
C is correct. Index B is likely to have higher performance than Index A in a market that is trending upward. Indexes that (perhaps inadvertently) contain contracts that more commonly trade in backwardation may improve forward-looking performance because this generates a positive roll return. Similarly, indexes that contain contracts that more commonly trade in contango may hurt performance for the same reason (i.e., negative roll return).
What is the call value and put value of an interest rate option?
Call Value = Max(Spot Rate - Exercise Rate, 0) x Notional Amount Put Value = Max(X - S, 0) x Notional Amount
How do you calculate call and put option delta?
Cd = N(d1)/e^dt Pd = -N(-d1)/e^(-dt) where d represents the dividend yield ** recall when d=0 the exponential term becomes 1!!
How do you find the call option price using the Black option valuation model on an interest rate option?
Co = Accrual Period x [FRA / e^rt x N(d1) - R/e^rt x N(d2)] FRA is the fixed rate and R is the exercise rate
Given D1 how do you find D2?
D2 = D1 - Sigma x Sqrt(T) where sigma is the standard deviation / volatility of the underlying
How do you calculate funds from operation (FFO)?
FFO = NI+ Depreciation + Deferred Tax +/- Gains/Losses ** Downside of FFO is does not take into account the value of other vacant properties
T/F: The price of the European-style option can be evaluated as the present value of the expected terminal option's payoffs using the risk-adjusted periodic rate.
False: According to the expectations approach of options valuation, option values are simply the present value of the expected terminal option payoffs (based on risk-neutral probabilities) discounted at the estimated risk-free interest rate, rather than the risk-adjusted periodic rate.
Do fixed income ETF's tend to have wider or narrower bid-ask spreads than equity etf's?
Fixed income ETF's tend to have wider bid-ask spreads than equity ETF's because the underlying fixed-income securities trade in dealer markets and are not continuously priced
What is the difference between IFRS and USGAAP in regards to investment property?
IFRS: Investment property is defined as property that is owned for the purpose of earning rentals or capital appreciation or both. Companies are allowed to value investment properties using either a cost model or a fair value model US GAAP: No formal definition of investment property. Most companies value investment properties using the historical cost accounting model
A short position in backwardation would have a positive or negative roll return?
Recall that in backwardation a long position has a positive roll return , thus a short position has a negative roll return
Excess Return Swap
Swap buyer receives payment equal to the excess of the actual commodity price over a reference price. Comparable to a series of long call options Swap buyer pays an upfront premium to seller. If underlying commodity price rises, counterparty pays buyer the difference, if underlying commodity price falls nothing happens and loss is limited to initial premium .a party may make a single payment at the initiation of the swap and then receive periodic payments of any percentage by which the commodity price exceeds some fixed or benchmark value, times the notional value of the swap
Basis Swap
This is where payment is exchanged based on the price difference between two related commodities that are not perfectly correlated. The difference between the price of these commodities is the 'basis' and pay offs are based on the widening or contraction of the basis.
How do you value a fixed rate swap at time t after initiation o?
Vt=Notional Amount(FSo-FSt)(d1+d2+...+dn) FSo=fixed rate at contact initiation di=present value factor for the period
If a call option is overpriced relative to your estimate, how do you take advantage of this?
You should sell (write) the overpriced call option and then go long (buy) the replicating portfolio for a call option. The replicating portfolio for a call option is to buy h shares of the stock and borrow the present value of (hS- − c-). Recall if you are short call - you have to use a long call replicating portfolio Can use: Long asset + short derivative = long rfb in order to figure out what positions to take!!
interest rate cap
a portfolio of interest rate call options termed caplets each with the same exercise rate and with sequential maturities
adjusted funds from operation (AFFO)?
is a refinement to FFO and is designed to be a more accurate measure of current economic income because it considers the capital expenditures necessary to sustain the property's economic income Is the funds available for distribution AFFO = FFO - straight line adjustment - recurring maintenance type capital expenditures and leasing commissions
How does a true up work?
let's say a GP of a $100 million (fully capitalized) fund earns carried interest of 5%, so he's entitled to $5 million. The money is kept in an account and the next year the fund loses 3%, or $3 million. The GP would then have to take $3 million out of his $5 million to pay back the LPs for their losses. Disclaimer: I think this is the way this works from examples that I've worked through.
how can you replicate a long callable fixed rate bond?
long straight fixed-rate bond and short a receiver swaption
Rho
represents the rate of change between an options value and a 1% change in the interest rate - rho of a call is positive and rho of a put is negative
Which of the following three measures is the best measure of a REIT's current economic return to shareholders? A. NOI B. FFO C. AFFO
AFFO is correct!
T/F: A positive calendar spread is associated with futures markets that are in backwardation
True
T/F: An advantage of statistical factor models is that they make minimal assumptions. However, the interpretation of statistical factors is generally more difficult than the interpretation of macroeconomic and fundamental factor models.
True
T/F: ETF sponsors that engage in securities lending can generate additional portfolio income to help offset fund expenses, thereby lowering tracking error
True
T/F: Gross exposure measures the combination of long and short exposures and can be an important metric in the management of hedge fund exposure.
True
What are the steps involved in the cost approach to valuation?
1 - Estimate the market value of the land 2 - estimate the buildings replacement costs: Assume the building was built today using current construction costs and standards and adjust for physical deterioration / depreciations Types of depreciations include: 1) physical deterioration - relates to the age of the property. - curable deterioration means that fixing the problem will add value that is at least as great as the cost of the cure. While incurable means that fixing the problem will cost more than the value that will be added 2) functional obsolescence - loss in value due to a design that is not appropriate for the intended use of the property 3) location obsolescence - occurs if the location is no longer optimal for the property 4) economic obsolescence - occurs when new construction is not feasible under current economic conditions
What are the three assumptions of the Arbitrage Pricing Theory?
1 - a factor model describes asset returns 2 - there are many assets, so investors can form well-diversified portfolios that eliminate asset-specific risk (unsystematic risk) 3 - no arbitrage opportunities exist among well-diversified portfolios
The Alpha Fund has assets under management of €315 million and has an expected annualized return of 10.4% with a volatility of 17.52%. It uses the parametric method of VaR at the 5% level assuming 250 trading days per year. Calculate daily VaR
1) convert expected annual return to daily return = 10.4%/250 = .000416 2) convert annual standard deviation to daily standard deviation = .1752 / sqrt(250) = .1108 3) calculate as : .000416 - 1.65(.1108) = - 0.017867 4) find daily VaR as : 315mm x 0.017867 = 5.628mm
Which of the following commodities is least likely affected by weather, GDP growth and the level of emerging market wealth? A. gold. B. cotton. C. copper.
A is correct the price of gold, which historically has acted as a store of value, similar to currencies, and its price is less likely to be influenced by weather, GDP growth, or the level of emerging market wealth. Global supply and demand effects, such as inflation expectations and fund flows, are more important to the pricing of gold. B is incorrect. The price of cash crops such as cotton can be affected significantly by weather as a freeze can severely damage crops. C is incorrect. Copper is positively correlated to industrial production and GDP growth directly affects industrial product demand.
Stabilized NOI
If first-year NOI is not representative of the NOI of similar properties because of a temporary issue (e.g., renovation), the subject property's NOI should be stabilized. - Calculate NOI as if temporary issue doesn't exist - Capitalize NOI (NOI/Cap rate) - Deduct PV of temporary issue costs
Total Return Swap
This is where the protection buyer receives payment equal to the percentage change in the level of a reference index or commodity multiplied by a notional principal. If prices go up buyer receives money, but if prices go down buyer must pay money
T/F: The factors in fundamental factor models are based on attributes of stocks or companies, and Beta is standardized?
True
T/F: The investor's outlook with respect to the future course of the stock price is not a relevant consideration for the no-arbitrage approach or the expectations approach
True
T/F: When using the two-period binomial model to value interest rate options, the value of the underlying instrument at Node 0 is the spot rate.
True
T/F: The maximum amount of debt that an investor can obtain on commercial real estate is usually limited by either the ratio of the loan to the appraised value of the property (loan-to-value, or LTV, ratio) or the debt service coverage ratio (DSCR), depending on which measure results in the lowest loan amount
True Recall: Loan to value = Loan / Value DSCR = NOI / debt service once find debt service divide by mortgage rate to find interest only loan amount
T/F: Evidence suggests that private equity real estate investments have a lower correlation with stocks and bonds than publicly traded REITs.
True - When real estate is publicly traded, it tends to behave more like the rest of the stock market than the real estate market.
T/F: the rolling windows backtesting method is implemented twice when backtesting a multifactor strategy?
True - once at the factor level and once at the portfolio level
T/F: If you are long a futures or forward contract and the price of the underlying has risen, the value of a futures contract is most likely lower than that of the equivalent forward contract.
True - this is based on the fact that futures are marked to market everyday
T/F: Factor (smart beta) strategy ETFs are most likely to be used to modify portfolio risk, and seek outperformance relative to a benchmark?
True!
T/F: the higher the interest rate the higher the call value and the lower the put value?
True!
T/F: Given P/FFO ratio you can calculate the share price by finding FFO per share?
True! First find FFO = NI - depreciation +/- deferred tax charges +/- gains and losses from sale of property and debt restructuring then divide by shares outstanding plug in to find the price!!
Is it ever profitable to exercise American options prior to maturity?
Two possible cases. The first case is the early exercise of an American call option on a dividend-paying stock. The second case is the early exercise of an American put option
How do you find property value under direct capitalization method versus discounted cash flow method?
Under direct capitalization method = Year 1 NOI / Going in cap rate Under discounted cash flow method discount yearly NOI and the terminal value
How do you value a property under the direct capitalization method?
Under the direct capitalization method, the value of the property = NOI/(r − g). If NOI is not expected to grow at a constant rate we can NOT use the direct capitalization method, and must use the discounted cash flow method (finding a terminal value) or the layer method
How do you value a currency swap?
Va=FBa-Sa/b x FBb (FB is the fixed rate bond and S is the exchange rate) FBk=NAk(rfix,k(d1+d2+...+dn)+dn) (Value of bond is PV of cash flows)
T/F: compared with an all cash purchase, will a mortgage most likely increase return on equity?
Yes, as long as the mortgage rate was less than the interest rate
How do you calculate net asset value per share for a REIT?
[Market value of assets - market value of liabilities] / shares outstanding where value of assets = value of operating assets + value of other assets value of other assets include accounts receivable and cash and cash equivalents and value of operating assets = NOI / cap rate
interest rate floor
a portfolio of interest rate put options termed floorlets each with the same exercise rate and with sequential maturities
What factors are included in the carhart four factor model?
size factor, value factor, market factor and momentum factor momentum factor = winners - losers E(RP)=RF+(BimktRMRF)+(BisizeSMB)+(BivalueHML)+(BimomWML)
What are the major factors that affect supply and demand of precious metals?
supply - determine by availability of extractable reserves demand - influenced by fund flows, industrial production and inflation in paper currency
