Free CFA Level II Alternative Investments Practice Questions

B is correct. The going-in cap rate (also called the initial cap rate or entry cap rate) is used to capitalize the first year's NOI to estimate the current property value. It reflects the market's current required rate of return on the property based on comparable transactions.

Value = Year 1 NOI / Going-in Cap Rate.

A is incorrect because the rate used to capitalize NOI in the final year for terminal value is called the terminal cap rate (or exit cap rate or residual cap rate). The terminal cap rate is typically higher than the going-in cap rate because properties age and may require more capital expenditure.

C is incorrect because the weighted average cost of capital (WACC) is a corporate finance concept used to discount total firm cash flows. While the discount rate in a real estate DCF serves a similar function, the going-in cap rate specifically refers to the direct capitalization ratio, not the WACC.

B is correct. Backfill bias (also called instant history bias or incubation bias) occurs when a hedge fund begins reporting to a database and its historical performance (before the reporting start date) is added retroactively. Funds typically only begin reporting after they have established a good track record, so the backfilled returns tend to be higher than average. This creates an upward bias in the database's historical returns.

A is incorrect because retroactive revision of reported returns is not what backfill bias refers to. Most databases record returns as reported and do not allow revisions. While reporting fraud could theoretically occur, it is not the same concept as backfill bias.

C is incorrect because stale pricing is a different issue (related to illiquid positions not being marked to market frequently). While stale pricing can affect hedge fund return characteristics (smoothing returns, understating volatility), it is not backfill bias.

AFFO = FFO - Recurring Capital Expenditures - Non-cash Rent Adjustments (straight-line rent)
$$\text{FFO} = 75{,}000{,}000$$ (calculated previously)
$$\text{AFFO} = 75{,}000{,}000 - 12{,}000{,}000 - 3{,}000{,}000 = 60{,}000{,}000$$

AFFO per share: $\frac{60{,}000{,}000}{20{,}000{,}000} = 3.00$

A is correct. AFFO provides a more refined measure of recurring cash flow by deducting maintenance capex and adjusting for non-cash items like straight-line rent.

B is incorrect because 3.15 might result from not deducting the straight-line rent adjustment. Straight-line rent overstates current cash rental income by spreading rent escalations evenly over the lease term.

C is incorrect because 2.75 would result from deducting additional items beyond the standard AFFO calculation or from using a higher maintenance capex figure.