Alternative Investments Sample Questions - CFA L1 - Exams

1) Which of the following statements does not accurately explain the impact of demographics on the supply and demand for real estate?

A) Psychographic profiles simply means that properties that have certain characteristics which are desirable by the largest influx of people will experience a greater price appreciation.
B) If the fastest growing segment of the local population is made up of retired individuals, then the values of real estate properties such as detached homes may decline as this group downsizes or moves out to other communities in order to live their retirement years.
C) If the fastest growing segment of the local population is made up of 25-35 year olds, then real estate values will decline, since this age group is far from its peak earning years.
D) As employment opportunities grow in a community, the influx of new workers will almost always cause the values of real estate properties to appreciate.
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2) Which of the following statements with respect to investment companies is (are) true?

I. Shares of a closed-end fund may only be bought from the issuing company.
II. Load funds sell at a premium over the fund's NAV. However, they may only be redeemed at the fund's NAV.
III. Load funds are generally bought through brokers.
IV. If an investment company implements a 12b-1 charge into the mutual fund, then the management fee may be eliminated.

A) II and IV only
B) II and III only
C) III only
D) I and II only
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3) Which of the following statements with respect to the diversification effects of venture funds is (are) true?

I. Venture capital returns tend to be highly correlated with publicly-traded small capitalization stocks.
II. Venture capital returns tend to be negatively correlated with bonds.
III. The more diversified a venture capital fund is, the more correlated it will be with the public market.
IV. Most companies in a venture fund will have a very high degree of systematic risk.

A) I and III only
B) I and IV only
C) IV only
D) II and III only

4) A property that originally cost $750,000 and that is being depreciated over an eight-year period using straight line depreciation has the following information:

What is the amount of after-tax cash flow that will accrue to the owner of this property?

(a) $89,750

(b) $20,000

(d) $147,750

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5) Which of the following statements with respect to passive real estate investments is (are) true?
I. REITs are most beneficial to institutions that prefer to diversify their real estate exposure.
II. REIT managers may only use the capital raised through the issuance of the trust units in order to buy properties.
III. Instead of acquiring properties, mortgage REITs simply make out real estate loans.
IV. In the U.S., REITs do not have to pay taxes on their profits if they pay out at least 75% of their income to shareholders by way of dividends.

A) II, III and IV only
B) III only
C) I and IV only
D) I only
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6) Which of the following is neither an objective nor a constraint when it comes to investing in real estate?

A) The correlation of real estate returns to other asset classes such as stocks and bonds
B) The amount of liquidity that the investor requires
C) The amount of financing that the investor can get other than his or her own equity
D) The amount of risk that the real estate investor is willing to take
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7) Which of the following statements about leverage is incorrect?

A) Positive leverage occurs when the return on the real estate asset (before financing costs and taxes) exceeds the after-tax cost of the mortgage.
B) Positive leverage occurs when the return on the real estate asset (before financing costs and taxes) exceeds the pretax cost of the mortgage.
C) Positive leverage implies that the return on the investor's equity will always be greater than the return on the asset itself.
D) With negative leverage, it is possible to have a losing return on equity, even though the underlying asset may have a positive net operating income.
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8) Which of the following statements with respect to the performance of investment funds is (are) true?

I. Closed-end funds usually trade at a discount to their net asset value in order to take into account potential taxes that may result from the unrealized capital gains.
II. Empirical studies have shown that there is very little correlation between past performance and future performance for a fund.
III. Studies have found that only about a third of investment funds have performed better than the market on a risk adjusted basis.
IV. For open-end mutual funds, the supply and demand imbalances for the units may sometimes lead to a unit price that is different from the fund's NAV.

A) I, II and IV only
B) II only
C) I, II and III only
D) III and IV only
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9) Which of the following statements is not true when it comes to performing a valuation analysis for a property?

A) A comparable sales approach may be used to evaluate an investment property whose fortunes will largely depend on the unique circumstances of the investor.
B) While in theory all valuation methods should lead to the same market value for a property, in practice the results will vary greatly depending on which valuation model is used.
C) A fair market value analysis can be performed by using the comparable sales approach or the cost approach.
D) For properties that are unique in nature, using the discounted cash flow method would yield more meaningful results than the cost approach.
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10) Which of the following statements with respect to factors that influence the risk and return characteristics of a venture fund is (are) true?

I. The degree of diversification within a sector specific venture fund will dramatically impact the fund's risk.
II. Historically, venture capital funds have generated much higher rates of return after periods of low fund flows into the industry.
III. Generally, firms that have had venture capitalist backing performed no better after an IPO than firms that did not have similar backing.
IV. The geographical area in which a fund specializes could have a dramatic impact on the fund's risk and return.

A) I, II, III and IV
B) I and IV only
C) II and IV only
D) I and III only

ANSWERS

1) The Right Answer is c. Your answer was correct!
Explanation:
While it is true that the earning levels for the 25-35 age group is far below where it will be during the peak years, the availability of mortgage financing fills in any gap between how much this group earns and how much local housing costs.

2) The Right Answer is b. Your answer was correct!
Explanation:
Choice I is not entirely true. At first, the company issues closed-end units; however, the shares may be traded among shareholders afterwards without affecting the issuing company. Choice IV is incorrect because a management fee will always be charged, regardless of what the additional charges may be.

3) The Right Answer is a. Your answer was correct!
Explanation:
Choice II is incorrect because there is hardly any correlation between venture funds and bonds. Choice IV is incorrect because most companies backed by venture capital have a very low degree of association with the markets, thus having a very low systematic risk. On the other hand, the unique nature of each company results in a very high degree of unsystematic risk associated with their returns.

4) The Right Answer is c. Your answer was correct! Missing Information for Q4 is

Net income - 65000, Mortgage Principal payment - 32000, Increase in Accounts Payable - 12000, Increase in uncollectible Rent - 8000, Capital costs - 17000.

Explanation:

FCFequity = Net income + Dep - Mortgage Principal payment - Increase in uncollectible Rent + Increase in Accounts payable - Capital expenses

= 65000 + 93750 - 32000 - 8000 + 12000 - 17000 = 113750.

5) The Right Answer is b. Your answer was correct!
Explanation:
Choice I is incorrect because REITs were primarily constructed to suit the needs of small investors who wanted to have real estate exposure but did not have the financial resources to buy properties outright. Choice II is incorrect because REIT managers may also finance their acquisitions through the issuance of debt.

6) The Right Answer is a. Your answer was correct!
Explanation:
When investing in real estate, an investor must decide how much risk he or she is willing to take and how much liquidity he or she will need. This will determine the types of real estate investments that will be most suitable for the investor. Because real estate investing requires large amounts of capital, an investor's ability to raise capital will be a constraint as to what kinds of properties will be affordable. The correlation of real estate with other asset classes is important, but that does not constitute an objective or a constraint.

7) The Right Answer is a. Your answer was correct!
Explanation:
When looking at leverage, we have to compare the net operating income with interest charges; however, both of these are before-tax items.

8) The Right Answer is c. Your answer was correct!
Explanation:
Choice IV is incorrect because open-ended funds do not trade on exchanges. Instead, the fund companies issue as many units as needed in order to fulfill demand. Therefore, supply always equals demand, and the unit price of a mutual fund will always equal its NAV.

9) The Right Answer is a. Your answer was correct!
Explanation:
A comparable sales approach is most appropriate when there are many properties that are similar to the property in question. Therefore, when it comes to a unique property or a unique situation, using the discounted cash flow method would yield much more reliable figures.

10) The Right Answer is c. Your answer was correct!
Explanation:
Choice I is not really true. For diversification to be effective, it must involve an investment into various sectors. Therefore, no matter how many companies a sector fund may have, the fact that all the companies are in the same sector means that fund risk will really not be reduced that much. Choice III is incorrect because, in general, firms that have had venture capitalist backing perform much better after an IPO than firms that have not had similar backing.