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How do you value a REIT using NAV and FFO approaches?
REITs are valued using FFO (net income + depreciation - gains on sales) and NAV (market value of properties minus liabilities) because traditional P/E is distorted by non-cash depreciation. AFFO further adjusts for maintenance capital expenditures.
When do NPV and IRR give conflicting signals, and which should I trust?
NPV and IRR can conflict when ranking mutually exclusive projects due to differences in scale, timing, or reinvestment assumptions. When they disagree, always follow NPV because it directly measures the dollar amount of wealth created.
What are the key differences between forward and futures contracts?
Both forwards and futures lock in a future transaction price, but they differ in key structural ways: forwards are private OTC contracts with customized terms and counterparty risk, while futures are exchange-traded, standardized, and use daily mark-to-market settlement.
What is the efficient frontier and why does it matter in portfolio construction?
The efficient frontier represents the set of portfolios that offer the highest expected return for a given level of risk. It is the upper-left boundary of all possible portfolio combinations in risk-return space, and any portfolio below it is suboptimal.
What are the main estate planning and wealth transfer strategies tested on CFA Level III?
Estate planning for CFA Level III focuses on transferring wealth efficiently across generations while minimizing transfer taxes. Key strategies include lifetime gifting, generation-skipping transfers, trust structures, cross-border planning, and valuation discounts.
How do you apply DCF analysis to value a commercial real estate investment at CFA Level II?
CFA Level II real estate DCF involves projecting NOI year by year, calculating terminal value using a terminal cap rate, and discounting all cash flows at an appropriate rate. The terminal cap rate is typically higher than the going-in cap rate.
How do you evaluate an international capital budgeting project when you have to deal with foreign currency cash flows?
International capital budgeting has two equivalent approaches: convert foreign cash flows to home currency using forward rates then discount at home WACC, or discount foreign cash flows at the foreign WACC then convert at spot. Both should yield the same NPV.
How are private equity funds structured, and what is the typical relationship between GPs and LPs?
PE funds use a limited partnership structure where the GP manages investments and LPs provide capital. The J-curve effect shows negative early returns due to fees and unrealized investments, with returns accelerating as exits occur in later years.
How do you value preferred stock using the perpetuity model, and what drives preferred stock yields?
Preferred stock is valued as a perpetuity: V = D/r. It trades at a discount when the coupon rate is below the required return and at a premium when above. Callable preferred has limited upside, while adjustable-rate preferred trades near par.
What is the difference between absolute and relative purchasing power parity, and does PPP actually hold in practice?
Absolute PPP states the exchange rate equals the ratio of price levels, while relative PPP states exchange rate changes equal inflation differentials. Relative PPP holds roughly over the long run but fails short-term due to capital flows, sticky prices, and non-traded goods.
What are the key extensions of the CAPM and how do they address its limitations?
The standard CAPM has several limitations addressed by extensions. Black's Zero-Beta CAPM replaces the risk-free rate with the return on a zero-beta portfolio, the International CAPM adds currency risk factors, and the Conditional CAPM allows time-varying betas.
How do you use put-call parity to create synthetic positions and spot arbitrage opportunities?
Put-call parity (C + PV(K) = P + S) can be rearranged to create synthetic positions and identify arbitrage opportunities. When the relationship is violated, you can construct a risk-free profit by selling the overpriced side and buying the underpriced side.
What exactly counts as misrepresentation under the CFA Institute Standards of Professional Conduct?
Misrepresentation under Standard I(C) covers any untrue statement or omission of fact, including direct falsehoods, plagiarism, omission of material facts, and misleading presentations like cherry-picked performance data.
What are the key differences between monetary and fiscal policy, and how do they affect financial markets?
Monetary policy (central bank) uses interest rates and asset purchases, while fiscal policy (government) uses spending and taxation. They transmit differently to markets: monetary policy primarily affects yields and discount rates, while fiscal policy drives growth and deficit dynamics.
Can someone walk through the binomial option pricing model with a two-period example?
The binomial model prices options by building a stock price tree, calculating terminal payoffs, and using backward induction with risk-neutral probabilities. Here's a complete two-period example pricing a European call.
What is key rate duration and why is it better than effective duration for managing bond portfolios?
Key rate duration decomposes a bond's interest rate sensitivity across specific maturities on the yield curve, unlike effective duration which only measures sensitivity to parallel shifts. This distinction matters when yield curves shift non-parallel.
How do I interpret z-scores in hypothesis testing — and when should I use a z-test vs. a t-test?
A z-score measures how many standard deviations an observation falls from the population mean. Use a z-test when the population variance is known or when the sample size is large (n ≥ 30). Here's a decision framework and a worked example.
What's the difference between equilibrium and arbitrage-free term structure models?
Equilibrium models (Vasicek, CIR) derive the term structure from economic assumptions and may not match today's yield curve. Arbitrage-free models (Ho-Lee, BDT) are calibrated to exactly fit the current curve and are preferred for pricing securities with embedded options.
When should you use market-based vs. asset-based valuation, and what are the key differences?
The choice between market-based and asset-based valuation depends on the type of company and data availability. Market-based valuation uses multiples from comparables, while asset-based valuation sums individual assets minus liabilities at fair market value.
What's the relationship between spot rates and forward rates, and how do you derive one from the other?
Spot rates and forward rates are two sides of the same coin — they're just different ways of expressing the term structure of interest rates. The no-arbitrage relationship links them: investing for n years at the n-year spot rate must equal rolling over shorter investments at implied forward rates.
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