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Cfa1 9 Alternative Investments Notes

Finance Notes > CFA Level 1 Notes

This is an extract of our Cfa1 9 Alternative Investments document, which we sell as part of our CFA Level 1 Notes collection written by the top tier of University Of London (examined By LSE) students.

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CFA Level 1

Alternative Investments

Investment Company
Open-End Fund (Open-End Investment Company)
Fund which can issue and redeem shares at any time
Shares can be bought directly from the fund
Shareholders receive an equity position in the underlying securities
Close-End Fund (Close-End Investment Company)
Fund with a fixed no. of shares outstanding
Shares issued to the public in an initial public offering
Shares normally not redeemable
Shares can be bought / sold on a secondary market
Valuing Investment Company Shares
Net Asset Value
NAV = Per Share Value - Liabilities
Liabilities
Management fee
Administrative expenses
Continuing distribution fee
Distribution fee
Additional Fees for Managed Funds
Front-End Load
Sales commissions charged at purchase
Back-End Load
Redemption fee changed at exit of the fund
Contingent Deferred Sales Charge
Redemption fee that decline the longer the shares are held to discourage quick trading turnover
Investment Strategies
Growth strategy (focus on high P/E stocks)
Value strategy (focus on low P/E stocks)
Index fund track (own securities in identical proportion to the index)
Global fund (include both foreign and home securities)
1 CFA Level 1

Alternative Investments

International fund (exclude securities from the home country)
Stable value fund (focus on fixed income instruments and guaranteed investment)
Exchange Traded Fund (ETF)
ETF
Fund traded on a stock market
Portfolio of securities
Can be open-end (most common) or close-end
Advantages of ETF
Diversification
Exchange traded
Transparent
Regulated
High liquidity
Availability of hedging (using futures and options)
Cost effective (no load fee)
Dividend
Potential Disadvantages of ETF
Narrow-based market index (diversification)
High bid-ask spread
Low trading volumes
Types of ETF
Broad domestic market index
Style (value or growth)
Sector or Industry
Foreign country or region (multiple countries)
Fixed income
Commodity
Actively managed funds
Risk in ETF
Market risk (systemic risk)
Asset class risk / Sector risk
Trading risk (liquidity risk)
Tracking error risk
Derivatives risk (credit risk) (if investing in derivatives)
2 CFA Level 1

Alternative Investments

Currency risk
Country risk
Applications of ETF
Implementing asset allocation
Diversifying sector / industry exposure
Gaining exposure to international market
Equitizing idle cash
Managing cash flows
Fulfilling overall investment strategy
Bridging transitions in fund management
Managing portfolio risk (hedging through selling short)
Applying long / short strategies
Real Estate
Form of tangible assets (e.g. buildings and buildable lands) divided into different divisions that can be owned by investors
Forms of Real Estate Investment
Free and clear equity (free simple) (indefinite full ownership rights)
Leveraged equity (full ownership rights but subject to mortgage obligations)
Mortgages (mortgage loans) (mortgage-backed securities)
Aggregation vehicles (collective investment in real estate)
Features of Real Estate Property
Immovability and indivisibility
Uniqueness in terms of location and view
Illiquidity due to immovability and indivisibility
Non-existence of auction market
High transaction costs and management fees
Unavailability of real estate information
Valuation Approaches
Sales Comparison Approach
Uses the market data of sale prices of a comparable property
Unique features of the property and changing market conditions should be taken into account
Cost Approach
Consider the value of a property as the cost of the land 3 CFA Level 1

Alternative Investments

Add the cost of replacing the property (construction costs)
Deduct the physical and functional depreciation
Land cost can be estimated using the sales comparison approach
Hedonic Price Model
Major characteristics that can affect the value are identified
Characteristics can be the age, size, location, vacancy rate and amenities
Properties are given a quantitative rating for each of the characteristics
Sales price for all recent transactions are regressed on their characteristics rating
Dependent variable (Y-axis) is the transaction price
Independent variables (X-axis) are the ratings for each of the characteristics
Estimated slope coefficients (CE) are calculated based on recent transactions
Estimate slope coefficients represent the valuation of each characteristic
Value = Age  Age CE + Size  Size CE + …
Income Approach (Perpetuity Discount Model)
Calculate the current value (CV) of the property based on the net operating income (NOI) of the property and capitalization rate (CR)
NOI is the annual income generated by the property after deducting all expenses
CR is the market value of a comparable property
CV = NOI / CR
Discounted After-tax Cash Flow Approach
Link the value of a property to an investor's marginal tax rate
NPV of an investment equals the PV of after-tax cash flows
PV is discounted at the investor's required rate of return minus the equity portion
Equity portion is the percentage of ownership using capital other than mortgage loan
Depreciation is deductible for NOI
Gross Potential Income (GPI)
It is the income based on a full occupancy
Vacancy Rate (VR)
The percentage of the property that is vacant
Effective Gross Income (EGI)
EGI = GPI x VR

Private Equity 4

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