ALTERNATIVE INVESTMENTS ANALYSIS AUGUST 2023 PAST PAPER

TUESDAY: 22 August 2023. Morning Paper. Time Allowed: 3 hours.

Answer ALL questions. Marks allocated to each question are shown at the end of the question. Show ALL your workings. Do NOT write anything on this paper.

QUESTION ONE

1. Examine TWO ways in which moral hazard could manifest itself in alternative investments. (4 marks)

2. Evaluate THREE features of fund structures as used in alternative investments. (6 marks)

3. Bob Real estate investors are planning to sell a warehouse and have collected the following information as depicted in Table 1 below:

Additional information:

1. Each adjustment to be based on unadjusted sales price of the comparable.
2. Depreciation: The property depreciates at a rate of 5% per annum.
3. Condition adjustment: Good – 5%, average – none, poor – 5%.
4. Location adjustments: Prime -none, secondary -10%.
5. Over the past 24 months, the sales prices have been appreciating at a rate of 0.5% per month.

Required:

Estimate the value of the warehouse using the sales comparison approach. (10 marks)

(Total: 20 marks)

 

QUESTION TWO

1. Argue TWO cases why alternative investments are complement to traditional investments. (4 marks)

2. In relation to crowd funding, highlight TWO risks of the crowdfunding to:

The investors. (2 marks)

The borrowers. (2 marks)

3. Usawa hedge fund has a management and incentive fee of 1.5% and 30% respectively. The fund has no hurdle rate and has a net asset value (NAV) of Sh.200 million at the start of the year. At the end of the year, the net asset value (NAV) after the fees was Sh.270 million.

Additional information:

1. The management fees are computed at the end of the year.
2. There are no redemption or subscription fees.

Required:
Calculate:

The incentive fees. (2 marks)

The management fees. (2 marks)

The ending net asset value (NAV) before fees. (2 marks)

4. Kalahari Ltd. has a current market value of Sh.65 million and has an outstanding debt of Sh.22.5 million.
A leveraged buyout firm (LBO) recognises certain inefficiencies in Kalahari Ltd. and offers to purchase the outstanding equity and payoff the outstanding debt for Sh.100 million. After the elimination of the operating inefficiencies at Kalahari Ltd., the earnings before interest, tax, depreciation and amortisation (EBITDA) increases from Sh.9.5 million to Sh.14 million per year. All the free cash flows will be used to pay off the debt of Sh.77.5 million to a zero balance in eight years’ time. After eight years, the firms EBITDA is expected to grow at a constant rate of 4% per annum.

The firm’s discount rate is 14% per annum.

Required:

Calculate:

The value of Kalahari Ltd. (2 marks)

The compounded annual return for the LBO. (4 marks)

(Total: 20 marks)

 

QUESTION THREE

1. Jayson Mwenda is an investor of mortgage backed securities and asset backed securities. He is concerned that the decline in interest rates will impact the cash flows of the following securities:
1. Home equity Asset Backed Securities (ABS).
2. Planned Amortisation Class (PAC) collateralised mortgage obligation (CMO).

Required:
Describe the impact on the cash flows for each of the above securities. (4 marks)

2. Discuss THREE differences between infrastructure and private equity investments as an alternative asset. (6 marks)

3. The general partner for the private equity fund charges a management fee of 2% and carried interest of 20% using the first total return method. The total committed capital for the fund was Sh.200 million. The following figures shown below are in “shillings millions” and NAV is Net Asset Value.

Required:
Compute:

The management fees for the year 2022. (1 mark)

The year carried interest is first paid and justify your answer. (1 mark)

The net asset value (NAV) before distribution for the year 2022. (2 marks)

The carried interest for the year 2022. (2 marks)

The net asset value (NAV) after distributions for the year 2022. (2 marks)

The distributed to paid in (DPI) for the year 2022. (2 marks)

(Total: 20 marks)

 

QUESTION FOUR

1. Describe THREE reasons why commodities should help diversify a portfolio of traditional assets as a form of alternative investments. (6 marks)

2. The spot price per bushel of a commodity is Sh.1,050. The total cost of carry per month is as follows:

Additional information:
1. The transport costs to and from storage are Sh.5 each.
2. The commodity is stored for 4 months.

Required:
Calculate the break-even futures price for the commodity. (4 marks)

3. Tranche M is a sequential pay structure with a par value of Sh.73 million and a coupon rate of Sh.7.5%. The tranche has been split to create a floater of Sh.13 million.

Required:

Calculate the cap rate for the inverse floater if the coupon rate for the floater is 1 Month secured
overnight financing rate (SOFR) plus 2%. (3 marks)

Calculate the cap rate on the floater assuming the coupon rate for the floater is 1 month SOFR + 2 % and
a floor is imposed on the inverse floater as zero. (2 marks)

4. Consider a Monte Carlo simulation analysis of a collateralised mortgage obligation (CMO) tranche with 6 different weighted rates. The market value of the tranche is Sh.80.44 million.

Required:

Calculate the theoretical values for each of the three spreads. (4 marks)

Determine the option adjusted spread (OAS) of the tranche. (1 mark)

(Total: 20 marks)

 

QUESTION FIVE

1. Examine THREE parties that are involved in asset securitisation. (6 marks)

2. Highlight THREE types of private investments in public equity (PIPE). (3 marks)

3. An investor is considering the purchase of an existing office building approximately five years old. The building when constructed was estimated to have an economic life of 50 years and the building to value ratio was 80%.

Based on current cost estimates, the structure would cost Sh.500 million to reproduce today. The building is expected to continue to wear out evenly over the 50-year period of its economic life.

Estimates of other economic costs associated with the improvement are as follows:
Repairable physical depreciation Sh.30 million to repair
Functional obsolescence (repairable) Sh.20 million to repair
Functional obsolescence (non-repairable) Sh.2.5 million per year rent loss

Additional information:
1. The land value in the area is Sh.100 million.
2. The discount rate for any deferred outlays or cost is 12% per year.

Required:
Calculate the estimated value for the property. (5 marks)

4.  Wetu Ltd. has decided to pool two bonds in order to create a collaterised debt obligation (CDO) structure with two tranches. Each bond has a notional value of Sh.150 million, a probability of default of 8% and a recovery of 0% in the event of default. The resulting CDO structure has two tranches-senior and junior, each with a notional value of Sh.150 million. The default correlation for the bond is 0.

Required:
Determine the expected amount to be received by:

Senior tranche. (3 marks)

Junior tranche. (3 marks)

(Total: 20 marks)

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