TUESDAY: 5 December 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. Enumerate FOUR reasons why commodity returns may have low correlation with stock prices and bond prices. (4 marks)
2. The current cash price of one barrel of Murban crude oil is Sh.9,000, while the four month future price is Sh.8,700 per barrel. The four month expected futures spot price is Sh.9,200 per barrel. The annual storage cost is 6% and the annual cost of funding is 5%.
Required:
Calculate the following:
Implied convenience yield. (3 marks)
Total cost of carry. (3 marks)
Implied risk premium. (2 marks)
3. Usawa Fund is a hedge fund with a value of Sh.100 million at the beginning of the year. Usawa Fund charges 2%
management fee based on assets under management at the beginning of the year and a 20% incentive fee with a 5% hurdle rate and uses a high water mark provision. Incentive fees are calculated on gains net of management fees. The end values before the fees are as follows:
Year 1 Sh.130 million
Year 2 Sh.135 million
Required:
Calculate:
The total fees for year 1. (2 marks)
The net return for year 1. (2 marks)
The total fees for year 2. (2 marks)
The net return for year 2. (2 marks)
(Total: 20 marks)
QUESTION TWO
1. Summarise FOUR general categories of leveraged buyouts (LBO) that can create value. (4 marks)
2. In relation to the environment of alternative investments:
Explain the term “adverse selection”. (2 marks)
Describe TWO ways in which adverse selection can occur in alternative investments. (4 marks)
3. The structure for an asset-backed security transaction is as follows:
Senior tranche Sh.220 million
Subordinate tranche 1 Sh.50 million
Subordinate tranche 2 Sh.30 million
Additional information:
1. The value of the collateral for the structure is Sh.320 million.
2. Subordinate tranche 2 is the first loss tranche.
Required:
Calculate:
The amount of overcollaterisation. (2 marks)
The amount of the loss for each tranche if losses due to defaults over the life of the structure total
Sh.35 million. (2 marks)
The amount of the loss for each tranche if losses due to defaults over the life of the structure total
Sh.85 million. (3 marks)
The amount of the loss for each tranche if losses due to default over the life of the structure total
Sh.110 million. (3 marks)
(Total: 20 marks)
QUESTION THREE
1. Describe FOUR lessons learnt from historical evolution of alternative investments. (8 marks)
2. Peter Kemoli has gathered the following values for distributions, contributions and net asset value for two private equity funds named PE Fund 1 and PE Fund 2 that belong to the vintage year 2016 stage focus buyout:
Additional information:
1. Positive number correspond to years in which investors received net distributions.
2. Negative numbers correspond to years in which investors made net contributions and the figures for the year 2022 correspond to the net asset values (NAVs) of each of the two funds at the end of that year.
Required:
Calculate the following for the two funds:
Interim internal rate of return. (6 marks)
The distribution to paid-in ratio (DPI). (2 marks)
The distribution to paid-in ratio (DPI). (2 marks)
The residual value to paid-in ratio (RVPI). (2 marks)
(Total: 20 marks)
QUESTION FOUR
1. Describe THREE key elements of structured products. (6 marks)
2. Kibet Waweru, the fund manager of Capital Fund Managers, is looking at the historical passthrough security.
Kibet discovers the following:
• Mortgage balance in month 42 Sh.520,000,000
• Scheduled principal payment in month 42 Sh.2,000,000
• Prepayment in month 42 Sh.4,900,000
Required:
The single monthly mortality (SMM). (2 marks)
Interpret the single monthly mortality (SMM) computed in (b) (i) above. (1 mark)
Compute the conditional prepayment rate (CPR) for month 42. (2 marks)
Interpret the conditional prepayment rate (CPR) computed in (b) (iii) above. (1 mark)
3. ABC Pension Fund is considering equity investment in real estate and two options are for consideration.
Option 1: Investment in a public equity real estate investment trust (REIT).
Option 2: Equity investment in a public real estate operating company (REOC).
The relevant data is presented below:
Additional information:
The REOC terminal value at the end of seven years is to be based on a price-to-AFFO multiple of 12 times.
Required:
Determine whether the REIT is properly valued using the Net Asset Value approach. (4 marks)
Calculate the estimated value per share for the REOC using the discounted cash flow approach. (4 marks)
(Total: 20 marks)
QUESTION FIVE
1. Enumerate THREE advantages and THREE disadvantages of peer to peer lending. (6 marks)
2. The coupon curve of prices for agency passthrough as of the end of a reporting period are presented below:
An investor currently holds a 4% agency passthrough security.
Required:
Calculate the current coupon duration for a 100 basis point rate shock. (2 marks)
3. A property has been appraised for Sh.5 million and is expected to have net operating income (NOI) of Sh.400,000 in the first year. The lender is willing to make an interest only (IO) loan at an interest rate of 8% as long as the loan to value ratio does not exceed 80% and debt service coverage ratio (DSCR) is at least 1.25. The balance of the loan will be due after seven years.
Required:
Compute the following:
The amount of loan that can be raised. (3 marks)
The equity dividend rate or cash on cash return assuming the property is purchased at its appraised value. (3 marks)
4. An office building was leased six years ago at Sh.2,000,000 a year. The next review occurs in two years. The estimated rental value in two years based on current market conditions is Sh.3,000,000. The contract term rent is discounted at 7% and the incremental rent is discounted at 8%.
Required:
Calculate the value of the office building today using the layer method. (6 marks)
(Total: 20 marks)
