THURSDAY: 2 September 2021.      Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings.


1.         Explain four characteristics of alternative investments that differentiate them from traditional investments.(4 marks)

2.        Evaluate four types of taxation that could be levied on alternative investments products.     (4 marks)

3.        Differentiate between the following types of stripped mortgage backed securities (MBS):

Principal only (PO) strips.      (2 marks)

Interest only (JO) strips.     (2 marks)

4.         An analyst has gathered the following data to value a real estate investment trust (REIT):

REIT valuation projections and assumptions

Appropriate discount rate                                                       8.5%

Expected dividend per share (DPS), 1 year from today Sh.1.00

Expected dividend per share (DPS), 2 years from today Sh.1.06

Long term growth rate in dividends, starting in year 3  5.0%


The intrinsic value of the REIT on a per share basis using the two step dividend discount model.    (4 marks)

5.           Bermuda Life Insurance Company (BLIC) is an active lender on commercial real estate property and has provided you with the following information relating to property A:

  1. The loan term is 5 years.
  2. Interest rate of 5.75% interest only.
  3. Maximum loan to value (LTV) of 75% and minimum debt service coverage ratio of 1.5 times.
  4. The net operating income is as provided below:

Year                                                   1                        2                              3

Net operating income (Sh.)  2,775,840         2,859,119             2,994,889

  1. The appraised value of the property is Sh.48 million.


The maximum loan amount on the property.        (4 marks)

(Total: 20 marks)



1.          Explain two uses of Monte Carlo Simulation Model in valuation of mortgage backed securities (MBS).    (4 marks)

2.          Alfred Ngugi is evaluating an agency collateralised mortgage obligation (CMO) structure using the Monte Carlo Simulation Model based on a 10% volatility assumption:

Tranche               Z-spread               Option adjusted spread (OAS)

A                             200                                            170

B                              185                                           150

C                             250                                            140



Determine the option cost (in basis point) for each tranche.     (2 marks)

Determine which tranche appears to be most attractive.    (2 marks)

3.          Examine four advantages of investing in a real estate operating company (REOC).   (4 marks)

4.          Fahari Real Estate Investment and Business Advisors does valuation on behalf of clients buying and selling real

estate. The firm has been provided with the following data regarding Boma apartment complex as well as recent sales in the area:


Boma apartment complex                                     Sh.”000″

Gross potential rental income                                      300,000

Estimated vacancy and collection losses                        6%

Insurance                                                                              17,500

Taxes                                                                                     7,500

Utilities                                                                                 17,500

Repair and maintenance                                                  30,000

Depreciation                                                                         35,000

Interest on proposed financing                                        27,500


Additional information on buildings recently sold:

                                                       Office buildings       Apartments

                                                            Sh.”000″                 Sh.”000″

Net operating income                             750,000                      150,000

Sales price                                              5,000,000                   1,250,000

All incomes are on annual basis.


Determine the value of Boma apartment complex.    (5 marks)

Describe three challenges of using comparable companies to value private targets.     (3 marks)

(Total: 20 marks)



1.           Discuss three reasons for creating collateralised debt obligations (CDOs).     (6 marks)

2.          In relation to commodities investment:

Differentiate between “basis” and “calendar spread”.    (2 marks)

Outline three roles of commodity indexes.    (3 marks)

The November price of an agricultural commodity is Sh.2.50 per kilogram, the effective interest rate is 1% and the storage cost per kilogram are Sh.0.05 per month. The commodity is stored from November to February.


Compute the February arbitrage free price.     (3 marks)

3.          Fund A with an initial investment of Sh.20 million liquidates with Sh.24 million cash after one year. The hurdle rate is 15% and the incentive fee is 20%.


Determine the distribution to fund manager assuming:

The fund uses a hard hurdle.      (3 marks)

The fund has a soft hurdle and a 50% catch up rate.    (3 marks)

(Total: 20 marks)



1.           Summarise five unique risks of investing in hedge funds.    (5 marks)

2.          Christopher Wamalwa, an investor in real estate in Kwetu County is considering taking a residential mortgage facility offered by Nyumba Housing Finance to construct a rental apartment.

Additional information:

  1. The mortgage company advanced him Sh.6 million repayable within 30 years.
  2. The interest rate is 12% per annum payable on a monthly basis.
  3. Payment consist of both interest and principal.


Construct a constant payment mortgage (CPM) schedule for the first six months.    (7 marks)

Describe one advantage and one disadvantage of using constant mortgage amortisation (CMA) approach in analysing mortgage payments.      (2 marks)

3.          Alex Mutiso owns a mall using mortgage financing, spread over ten years period.

Additional information:

  1. The beginning mortgage balance in month 33 is Sh.297,825.
  2. Prepayment in month 33 is Sh.1,841,347.
  3. Outstanding loan amount is Sh.358,326,766.


Single monthly mortality rate (SMM).     (2 marks)

Conditional prepayment rate (CPR).   (2 marks)

Interpret your answers in  (i) and (c)  above.    (2 marks)

(Total: 20 marks)



1.            Explain the following terms in the context of private equity:

Carried interest.   (1 mark)

Claw-back provision.    (1 mark)

Vintage year.       (1 mark)

J — curve effect.   (1 mark)

2.            Suggest two reasons why leveraged buyout funds (LBO) are less risky compared to venture capital funds.(4 marks)

3.            Hekima fund has a 2 and 20 fee arrangement with no hurdle rate and a net asset value (NAV) of Sh.500 million. The NAV increased to Sh.625 million at the end of year before fees. Management fees are distributed annually based on the start of the year NAV.


Annual management fee.    (1 mark)

Incentive fee.    (1 mark)

Total annual fee.     (1 mark)

Ending NAV after fees.    (1 mark)

Percentage return net of fees.     (1 mark)

4.         You have recently landed a job as the Chief Investment Officer (CIO) at Delta Limited. One of your client is considering investing in real estate and you are now evaluating three potential real estate investment options as follows:

Direct investment in a hotel building:

Expected net operating income (years 1 — 7)                          Sh.7 million

Expected net operating income (year 8)                                   Sh.8.5 million

Required return on equity investment                                       12%

Net operating income growth rate after 8 years                        3.5%

II              Real estate investment trust (REIT)

Recent net operating income                                                    Sh.140 million

Non cash rents                                                                         Sh.10 million

Full year adjustments for acquisition                                       Sh.10 million

Other assets                                                                             Sh.40 million

Total liabilities                                                                          Sh.250 million

Current market price per share (MPS)                                     Sh.130

Outstanding ordinary shares                                                    12 million

Going in capitalisation rate                                                       8%

Net operating income growth rate                                            2.4%

III            Real estate operating company (REOC)

Expected adjusted funds from operation (AFFO) in            year 8          Sh.14.5 million

Holding period                                                                                         7 years

Present value of all dividends for 7 years                                                Sh.42 million

Outstanding ordinary shares                                                                    2 million

Capitalisation rate                                                                                     8%

Growth rate from year 8                                                                          2.4%


Additional information:

  1. The hotel building under consideration has existing tenant with long-term lease that will expire in seven years.
  2. The real estate operating company (REOC) terminal value at the end of the seven years is to be based on a price to adjusted funds from operations (AFFO) multiple of 12 times (12x).


The estimated value of the hotel building using the discounted cash flow approach. (3 marks)

Determine whether the real estate investment trust (REIT) is fairly priced using the net asset value (NAV) approach.   (3 marks)

The estimated value per share of the real estate operating company (REOC).   (1 mark)

(Total: 20 marks)

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