CAIA UPDATED STUDY GUIDE ALL QUESTIONS
AND ANSWERS SURE A+
✔✔Other than moneyness of the best available use, what are three factors regarding
the uses that would cause a multiple-use option to have a low value? - ✔✔1) High
similarity among the profitability of each alternative
2) Low volatility of the profitability of each alternative
3) High correlation between the profitability of each alternative.
✔✔What is the effects of smoothed or stale asset values on the estimates of long-term
average returns? - ✔✔For large samples there would typically be only a small difference
between mean based on stale returns and the mean based on true returns, so the use
of stale valuation tends to have little effect on the estimations of long-run returns.
✔✔What is the effect of smoothed or stale asset values on the estimation of historic
return volatility? - ✔✔Smoothed asset values understate risk, therefore historical return
volatility will be lower than unsmoothed risk.
✔✔What is contagion in financial market? - ✔✔Contagion is the general term used in
finance to indicate any tendency of major market movements, especially declines, to be
transmitted from one financial market to other financial markets.
,✔✔Explain the implications of Hotelling's Theory of long-term commodity prices. -
✔✔Hotelling's theory states that prices of exhaustible commodities, such as various
forms of energy and metals, should increase by the prevailing nominal interest rate -
perhaps with a risk premium. Therefore, ignoring storage costs, expected spot prices of
a commodity should be equal to the future value of the current spot price compounded
at the nominal riskless rate plus a risk premium.
✔✔What are the three costs of carry that determine the price of a forward contract on a
physical asset? - ✔✔Storage costs, convenience yield (when viewed as a negative
cost), and interest (financing) charges.
✔✔What is the name of the condition in which the expected spot price of a commodity
in one year exceeds the one-year forward price of the commodity? - ✔✔Normal
backwardation
✔✔What is the primary reason that causes a commodity futures market to be in
contango or backwardation? - ✔✔(1) Backwardation, contango, and, in fact, the entire
slope and shape of the term structure are determined by differences in cost of carry,
and (2) in an efficient market, all forward contracts offer equal risk-adjusted expected
returns, regardless of the slope and shape of the term structure of forward prices.
✔✔What is the name of the following quantitiy: the spot price of a commodity minus a
forward price of the commodity? - ✔✔The basis of the commodity contract
✔✔What is the primary reason that the forward price of an asset could be substantially
smaller than the price generated by the cost-of-carry model? - ✔✔The cost of carry
model indicates a maximum forward price. When arbitrageurs cannot borrow a
commodity without incurring expenses (other than the time value of money), it is
possible that forward prices will be less than those implied by the cost of carry model.
✔✔In the context of analyzing the returns of futures contracts, what is excess return? -
✔✔The excess return of a futures contract is the return generated exclusively from
changes in futures prices. The term "excess return" is used elsewhere in investment
with a different meaning: the total return minus the riskless rate.
✔✔What is the definition of roll return that is earned through holding futures contracts? -
✔✔Roll return or roll yield from holding futures contracts is defined as the portion of the
return of a futures position attributable only from the change in the contract's basis
through time.
✔✔List three important propositions regarding the accrual of roll return through holding
futures contracts through time. - ✔✔1) Proposition 1: Roll return is not generated at the
time that one position is closed and a new position is opened.
,2) Proposition 2: Realized roll return is not necessarily positive when markets are
backwardated.
3) Proposition 3: A position that generated a positive roll return does not indicate that
the position's total returns were superior (i.e., that there was alpha).
✔✔List four explanations that commodities should help diversify a portfolio of traditional
assets. - ✔✔1) Unlike financial securities, commodities have prices that are not directly
determined by the discounted value of future cash flows
2) More so than traditional asset prices, nominal commodity prices should be positively
correlated with inflation largely because commodity prices form part of the definition and
computation of inflation
3) Commodity price changes may be negatively correlated with the returns to stocks
and bonds is that they may react very differently at different parts of the business cycle.
4) Low or negative correlation between commodity prices and financial assets is based
on commodities being a major cost of corporate production and thus consistent with
lowered corporate profits.
✔✔Name three factors that theory suggests should drive the extent to which natural
resource price changes drive the performance of firms that process those natural
resources. - ✔✔1) The price elasticity of the demand for the good
2) The price elasticity of the supply for the good
3) The extent to which an operating firm is exposed to or has hedged its expenses and
revenues (i.e. its profits).
✔✔To what extent have gold prices driven the equity values of gold mining firms based
on data from the during the financial crisis in late 2008? - ✔✔In the short run, it
appeared that the operationally-intensive firms related to gold production were driven
more by the volatility of the equity markets than by the volatility of the gold prices.
✔✔Why are most listed MLPs in the U.S. involved in producing, processing and
distributing energy products? - ✔✔MLPs receive tax treatment predicated on adhering
to regulations, including that at least 90% of the entities' revenues come from specified
businesses, such as energy (in the U.S.)
✔✔Do infrastructure assets need to have all seven of the elements that identify
investable infrastructure? Why or why not? - ✔✔No. There are no clear, hard lines
separating infrastructure from other assets. Gray areas exist. Most infrastructure assets
lack one or more of the seven elements, but they must contain many or most.
✔✔What is the difference between economic and social infrastructure? Provide an
example of each. - ✔✔1) Economic infrastructure assets are assets with economic
value that is driven by the revenue they generate, typically with end users paying for the
services provided by these assets. Examples include toll roads and bridges, railways,
airports, and maritime terminals.
, 2) Social infrastructure assets that have end users who are unable to pay for the
services or that are used in such a way that it is difficult to determine how many
services were used by each person. Examples include schools, public roads, prisons,
administrative offices, and other government buildings.
✔✔What is the primary defining difference between greenfield projects and brownfield
projects? - ✔✔A greenfield project is new, whereas a brownfield project is existing.
✔✔What is the term used to describe when a government entity sells a public asset to a
private operator? - ✔✔Privatization
✔✔Is investable intellectual property a public good or a private good? - ✔✔Private good
because the cash generated can be privately received and owned.
✔✔What are the four inputs to the smiplified model of intellectual property values? -
✔✔P = the probability of generating large positive cash flows
CFI = Denote the first-year cash flows of the project
g = perpetual growth
r = discount rate
✔✔What is the empirical evidence on the very long-term annual financial returns of
works of art? - ✔✔The median real return to holding art over extended periods of time is
2.2%
✔✔List three potential disadvantages of real estate as an investment? - ✔✔1)
Heterogeneity
2) Lumpiness
3) Illiquidity
✔✔Name the three styles of real estate investing. - ✔✔1) Core
2) Value Added
3) Opportunistic
✔✔Define mortgage - ✔✔A mortgage loan is a loan secured by property
✔✔How do unscheduled principal payments affect the lender of a fixed-rate mortgage
at different levels of market interest rates? - ✔✔Unscheduled principal payments cause
a wealth transfer between the borrower and the lender, depending on the relationship
between the mortgage's interest rate and current market interest rates. When market
rates are lower than the mortgage rate, unscheduled principal payments generally
benefit the borrower and harm the lender. The lender receives additional cash flows that
if reinvested at prevailing interest rates will earn less return than the mortgage offers.
Borrowers can make unscheduled prepayments to reduce the total interest costs of their
mortgage by an amount greater than the amount that they could earn from interest
AND ANSWERS SURE A+
✔✔Other than moneyness of the best available use, what are three factors regarding
the uses that would cause a multiple-use option to have a low value? - ✔✔1) High
similarity among the profitability of each alternative
2) Low volatility of the profitability of each alternative
3) High correlation between the profitability of each alternative.
✔✔What is the effects of smoothed or stale asset values on the estimates of long-term
average returns? - ✔✔For large samples there would typically be only a small difference
between mean based on stale returns and the mean based on true returns, so the use
of stale valuation tends to have little effect on the estimations of long-run returns.
✔✔What is the effect of smoothed or stale asset values on the estimation of historic
return volatility? - ✔✔Smoothed asset values understate risk, therefore historical return
volatility will be lower than unsmoothed risk.
✔✔What is contagion in financial market? - ✔✔Contagion is the general term used in
finance to indicate any tendency of major market movements, especially declines, to be
transmitted from one financial market to other financial markets.
,✔✔Explain the implications of Hotelling's Theory of long-term commodity prices. -
✔✔Hotelling's theory states that prices of exhaustible commodities, such as various
forms of energy and metals, should increase by the prevailing nominal interest rate -
perhaps with a risk premium. Therefore, ignoring storage costs, expected spot prices of
a commodity should be equal to the future value of the current spot price compounded
at the nominal riskless rate plus a risk premium.
✔✔What are the three costs of carry that determine the price of a forward contract on a
physical asset? - ✔✔Storage costs, convenience yield (when viewed as a negative
cost), and interest (financing) charges.
✔✔What is the name of the condition in which the expected spot price of a commodity
in one year exceeds the one-year forward price of the commodity? - ✔✔Normal
backwardation
✔✔What is the primary reason that causes a commodity futures market to be in
contango or backwardation? - ✔✔(1) Backwardation, contango, and, in fact, the entire
slope and shape of the term structure are determined by differences in cost of carry,
and (2) in an efficient market, all forward contracts offer equal risk-adjusted expected
returns, regardless of the slope and shape of the term structure of forward prices.
✔✔What is the name of the following quantitiy: the spot price of a commodity minus a
forward price of the commodity? - ✔✔The basis of the commodity contract
✔✔What is the primary reason that the forward price of an asset could be substantially
smaller than the price generated by the cost-of-carry model? - ✔✔The cost of carry
model indicates a maximum forward price. When arbitrageurs cannot borrow a
commodity without incurring expenses (other than the time value of money), it is
possible that forward prices will be less than those implied by the cost of carry model.
✔✔In the context of analyzing the returns of futures contracts, what is excess return? -
✔✔The excess return of a futures contract is the return generated exclusively from
changes in futures prices. The term "excess return" is used elsewhere in investment
with a different meaning: the total return minus the riskless rate.
✔✔What is the definition of roll return that is earned through holding futures contracts? -
✔✔Roll return or roll yield from holding futures contracts is defined as the portion of the
return of a futures position attributable only from the change in the contract's basis
through time.
✔✔List three important propositions regarding the accrual of roll return through holding
futures contracts through time. - ✔✔1) Proposition 1: Roll return is not generated at the
time that one position is closed and a new position is opened.
,2) Proposition 2: Realized roll return is not necessarily positive when markets are
backwardated.
3) Proposition 3: A position that generated a positive roll return does not indicate that
the position's total returns were superior (i.e., that there was alpha).
✔✔List four explanations that commodities should help diversify a portfolio of traditional
assets. - ✔✔1) Unlike financial securities, commodities have prices that are not directly
determined by the discounted value of future cash flows
2) More so than traditional asset prices, nominal commodity prices should be positively
correlated with inflation largely because commodity prices form part of the definition and
computation of inflation
3) Commodity price changes may be negatively correlated with the returns to stocks
and bonds is that they may react very differently at different parts of the business cycle.
4) Low or negative correlation between commodity prices and financial assets is based
on commodities being a major cost of corporate production and thus consistent with
lowered corporate profits.
✔✔Name three factors that theory suggests should drive the extent to which natural
resource price changes drive the performance of firms that process those natural
resources. - ✔✔1) The price elasticity of the demand for the good
2) The price elasticity of the supply for the good
3) The extent to which an operating firm is exposed to or has hedged its expenses and
revenues (i.e. its profits).
✔✔To what extent have gold prices driven the equity values of gold mining firms based
on data from the during the financial crisis in late 2008? - ✔✔In the short run, it
appeared that the operationally-intensive firms related to gold production were driven
more by the volatility of the equity markets than by the volatility of the gold prices.
✔✔Why are most listed MLPs in the U.S. involved in producing, processing and
distributing energy products? - ✔✔MLPs receive tax treatment predicated on adhering
to regulations, including that at least 90% of the entities' revenues come from specified
businesses, such as energy (in the U.S.)
✔✔Do infrastructure assets need to have all seven of the elements that identify
investable infrastructure? Why or why not? - ✔✔No. There are no clear, hard lines
separating infrastructure from other assets. Gray areas exist. Most infrastructure assets
lack one or more of the seven elements, but they must contain many or most.
✔✔What is the difference between economic and social infrastructure? Provide an
example of each. - ✔✔1) Economic infrastructure assets are assets with economic
value that is driven by the revenue they generate, typically with end users paying for the
services provided by these assets. Examples include toll roads and bridges, railways,
airports, and maritime terminals.
, 2) Social infrastructure assets that have end users who are unable to pay for the
services or that are used in such a way that it is difficult to determine how many
services were used by each person. Examples include schools, public roads, prisons,
administrative offices, and other government buildings.
✔✔What is the primary defining difference between greenfield projects and brownfield
projects? - ✔✔A greenfield project is new, whereas a brownfield project is existing.
✔✔What is the term used to describe when a government entity sells a public asset to a
private operator? - ✔✔Privatization
✔✔Is investable intellectual property a public good or a private good? - ✔✔Private good
because the cash generated can be privately received and owned.
✔✔What are the four inputs to the smiplified model of intellectual property values? -
✔✔P = the probability of generating large positive cash flows
CFI = Denote the first-year cash flows of the project
g = perpetual growth
r = discount rate
✔✔What is the empirical evidence on the very long-term annual financial returns of
works of art? - ✔✔The median real return to holding art over extended periods of time is
2.2%
✔✔List three potential disadvantages of real estate as an investment? - ✔✔1)
Heterogeneity
2) Lumpiness
3) Illiquidity
✔✔Name the three styles of real estate investing. - ✔✔1) Core
2) Value Added
3) Opportunistic
✔✔Define mortgage - ✔✔A mortgage loan is a loan secured by property
✔✔How do unscheduled principal payments affect the lender of a fixed-rate mortgage
at different levels of market interest rates? - ✔✔Unscheduled principal payments cause
a wealth transfer between the borrower and the lender, depending on the relationship
between the mortgage's interest rate and current market interest rates. When market
rates are lower than the mortgage rate, unscheduled principal payments generally
benefit the borrower and harm the lender. The lender receives additional cash flows that
if reinvested at prevailing interest rates will earn less return than the mortgage offers.
Borrowers can make unscheduled prepayments to reduce the total interest costs of their
mortgage by an amount greater than the amount that they could earn from interest
