Review Test Submission: Case study 1 Assessment
Test Case study 1 Assessment
Question 1
Which of the following is not considered business risk (risk primarily associated with the property)?
The business risk for a specific investment involves analysis of four distinct areas:
1. the market environment,
2. legal environment,
3. financing environment, and
4. tax environment.
Business risk is the risk associated with the ability of an investment to generate operating income. It can
be split into static risk and dynamic risk.
1.1
Static risk (unsystematic risk) is related to physical events which are beyond the control of the
investor and which normally results in a loss. They are insurable and predictable in the long run. Examples
include:
• fire,
• earthquake and
• flood damage and
• losses due to theft or malicious mischief.
1.2
Dynamic risk (or systematic risk) can produce either a profit or a loss. Dynamic risk is external
and is not under the direct control of the investor.
Question 2
An example of pyramiding is
pyramiding - i.e. the investor borrows the maximum that can be repaid, makes selective improvements to
increase property value, then sells at a profit and reinvests in larger properties to start the process over
again
• Buy to let
• Flips
• Social Housing
• Multi-let
Question 3
Equities share values could become worthless should:
Equity share values could become worthless should the asset become insolvent.
Question 4
The popularity cycle is also referred to as:
The popularity cycle (also referred to as the bandwagon or herd cycle) typically occurs during boom-orbust periods of real estate activity
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Question 5
By establishing an investors risk/ return preference and wealth. Which step of the real estate
investment process does this apply to:
Diversification of property investment opportunities in the tremendous range of investment alternatives
that real estate offers.
Question 6
Which of the following factors form part of legislative risk?
Political risk, also known as legislative risk, refers to the risk arising from governmental action like:
• changes in legislation (e.g. rent control),
• expropriation,
• nationalisation,
• changes in property taxes or
• income tax, etc
• municipal costs
Question 7
The gross rent multiplier model cannot deal with problems such as changing revenue streams over time
and varying operating expense ratios between properties
•
•
•
The gross rent multiplier approach assumes that any project with a favourable ratio of purchase
price relative to gross rents should be accepted:
Gross rent multiplier purchase price / gross rental income
Although extremely simple to use, this model cannot deal with problems such as changing
revenue streams over time and varying operating expense ratios between properties.
Question 8
Receipts or accruals of a capital nature are excluded when calculating Gross Income
(a) -All receipts and accruals of a capital nature
(b) -All receipts and accruals from any source outside the Republic.
Question 9
The Leisure sector is considered highly speculative as it is exposed to the vagaries of the economy.
Leisure in the form of hotels, however, is considered highly speculative as it is exposed to the vagaries of
the economy
Question 10
A Grading. allowance only applies if erection or improvements of a building commenced before 4
June 1988
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A Grading allowance only applies if erection or improvements commenced before 4 June 1988.
Question 11
One of the methods of valuation when it comes to property tax and land tax systems is
•
•
•
comparative sales method;
cost method;
income method
Traditional problems associated with property tax and land tax systems include the tax base (only
unimproved land or both land and improvements) and the method(s) of valuation (comparative sales
method; cost method; income method).
Question 12
Revenue has conceded that the signing of the sale agreement does not constitute the issuing of an invoice
and hence output tax on the commission will only be due and payable when the commission is received.
Fill the gap
Revenue has conceded that the signing of the sale agreement does not constitute the issuing of an invoice
and hence "output tax" on the commission will only be due and payable when the commission is received,
or an invoice is issued to the seller for the commission, whichever is earlier, this prevents negative effects
on cash flow.
Question 13
The efficient frontier can be described as a set of investment portfolios that are expected to provide the
highest returns at a given level of risk.
An efficient frontier is a set of investment portfolios that are expected to provide the highest returns at a
given level of risk.
Question 14
In bottom up risk identification what are the core activities of Scenario building? (Page 281)
This usually involves developing two extreme scenarios:
• scenario 1 where everything occurs as expected and
• scenario 2 where everything goes wrong. This approach attempts to identify project risks by a
detail analysis of both likely and negative factors that might influence the budget.
Question 15
They are purchased by an equity investor who invests through a variety of legal entities.
Capital assets are purchased by an equity investor who invests through a variety of legal entities:
individual, partnership, close corporation, company, property unit trust, pension fund, and so forth. These
various legal entities are reviewed in Chapter
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Question 16
The definition of "goods" in the Value-Added Tax Act (No 89 of 1991) does not include
The definition of "goods" in the Value-Added Tax Act (No 89 of 1991) includes
• fixed property,
• sectional title units,
• share block units and
• timeshare units.
It therefore follows that the sale of any of these by a vendor is subject to VAT. The sale of any of the above
by a person not registered for VAT will not be subject to VAT.
Question 17
What does Risk identification involve?
This is because
Risk identification involves detailed examination of the investment strategy, through which potential
risks may be uncovered and appropriate responses formulated (Uher 1993:561).
Three approaches to risk identification can be distinguished: past experience, bottom-up approaches and
top-down risk identification approaches
Question 18
IRR is equal to the discount rate when the NPV is equal to Zero
Since the IRR is equal to the discount rate when the NPV is equal to zero
Question 19
Considering that the value of shares paid by investors do not necessarily relate to Net asset value;
we can derive that the equity share prices on the stock market could Plummet:
Equity share prices on the stock market could plummet to a fraction of their purchase price as the value
of shares paid by investors do not necessarily relate to net asset value, but rather to expectation of
earnings and share price appreciation of the investment.
Question 20
Above and below the long-term trend line, business cycle changes are are 20 percent.
Typically, business cycle changes are 20 percent above and below the long-term trend line, while real
estate cycles average as much as 40 percent above and below the trend line.
Question 21
Which of the following is not considered a component of investment management in property?
Estimation of the required rate of return should include three components:
(1) a real return (compensation for deferred consumption),
(2) an inflation premium, and
(3) a risk premium.
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Question 22
With direct property investment the institutional investor will receive a monthly income stream.
With direct property investment the institutional investor will receive a monthly income stream.
Question 23
In terms of Section 13, tax deductions granted are
Residential building allowance - Section 13 (ter)
- Residential building initial allowance - 10% of cost
- Residential building annual allowance - 2% of cost
Question 24
Which risk type is considered when there are changes in tax law, zoning and rent controls?
Legislative Risk is considered when Changes in tax law; zoning; rent controls; and other governmental
regulations
Question 25
Levies received by the share block company will not be subject to income tax in terms of section 10(1)(e).
Levies received by the share block company will not be subject to income tax in terms of section 10(1)(e).
any interest income arising as a result of the investment thereof is however subject to tax.
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Course (222REF7XE2) REAL ESTATE FINANCE AND INVESTMENT B
Test Case Study 1 Supplementary 2
Question 1
The volatility of an investment can be measured by the standard deviation:
As discussed in Chapter 10, the volatility of an investment can be measured by the standard deviation.
Question 2
Which statement about large institutional investors is the most accurate?
Large institutional investors use the opportunity, when buying property directly, to incorporate their
name into the name of the building. This is widely practiced and is undoubtedly a valuable advertising
medium.
The large institutional investors, with their large property portfolios, invariably set up a property and
portfolio management divisions because economies of scale warrant it.
The large institutional investors, because of their investment expertise, foresight and investment
budgets, are able to not only invest in prime properties requiring large investment sums.
Large institutional investors, however, are often hamstrung by various levels of decision making, which
may cause an option to lapse should a decision not be made timeously. It is in the interests of these
large institutional investors to streamline their decision-making processes to take advantage of short
notice opportunities.
Large institutional investors use the opportunity, when buying property directly, to incorporate their
name into the name of the building. This is widely practiced and is undoubtedly a valuable advertising
medium.
Question 3
Taking into account that property values are influenced by their income earnings potential which is
guaranteed by contractual lease agreements; property values will show unless very adverse economic
growth condition prevail.
Property shares are valued closer to their net asset value. Property values are influenced by their income
earning potential which, to a large extent, is guaranteed by contractual lease agreements. Unless very
adverse economic conditions prevail, property values will show a steady growth.
Question 4
Why is the hindsight bias a potential flaw in risk identification?
A potential flaw in relying on past history is the unintentional use of "hindsight bias" (Ashley 1989). This
means that after the event the critical risks are readily identified, but that relevant information about other
risks may be disregarded.
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The biggest danger, however, in the use of history for future risk identification is the occurrence of new
events not encountered previously. This is of special importance in conditions which are changing rapidly,
as in the present-day South Africa.
Question 5
Another view of risk is that the tighter the probability distribution of expected future returns
the smaller the total risk of an investment
Another view of risk is that the tighter the probability distribution of expected future
returns the smaller the total risk of an investment.
Question 6
The Leisure sector is considered highly speculative as it is exposed to the vagaries of the economy
Leisure in the form of hotels, however, is considered highly speculative as it is exposed to the vagaries of
the economy
Question 7
Which investment is preferred according to the Risk absorption ratio?
•
•
Like the profitability index, the RA ratio is an relative measure used to compare projects of
different sizes.
If all other risk and return measures are equal, the investment with the greatest risk-absorbing
capacity will be preferred
Question 8
Large institutional investors use the opportunity, when buying property directly to incorporate their name
into the name of the building.
Large institutional investors use the opportunity, when buying property directly, to incorporate their
name into the name of the building. This is widely practiced and is undoubtedly a valuable advertising
medium
Question 9
lease premiums (rental) are deductible over the period of the lease and apportioned if the lease
commences during part of the year
Deductions of lease premiums (rental) for occupation or use of land or buildings for the production of
income. The premium is deductible over the period of the lease and is apportioned if commencing during
part of the year. The lease period referred to is limited to a maximum of 25 years.
Question 10
Which statement is correct:
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Question 11
Market risk refers to the risk associated with the market as a whole, and has nothing to do with the
specific investment
Market risk involves such factors as
• interest rates,
• business confidence,
• political unrest or
• stability, that tend to influence all investments, but not necessarily in the same way.
Question 12
Which statement about Variance of an investment is false?
1. The risk of an investment (its variance) is given by the expected variability of cash flows from the
expected value.
2. If risk is defined as the variance of expected return, then the riskier the investment, the greater
will be the variance of the expected return.
3. Useful measures of the risk (the uncertainty) are the variance and the standard deviation.
4. The variance indicates how much a variable fluctuates around the average.
5. The variance is computed by adding up the squares of all the differences between the values of
the variable and the average of the values (i.e. adding the squares of the deviations from the
mean), and then dividing by the total number of values
6. Both the variance and the standard deviation are absolute measures of risk.
7. When two investments are compared, it is often more meaningful to use a measure which
indicates the relative risk of each investment. Such a measure is the coefficient of variance
8. The risk index (RI) which is the inverse of the coefficient of variance is calculated by dividing the
return by the standard deviation. It measures the amount of return per unit of risk, if risk is
measured by the standard deviation.
9. An investment with a high RI provides a greater return for a given unit of risk
10. The risk index is subject to the same shortcoming than that of the coefficient of variance: it fails
to distinguish correctly between risky alternatives under certain conditions.
11. If a decline in the return of one asset is offset by the return on another asset, the variance of the
combination will be less than the variation of either asset held singly.
12. Portfolio decisions will maximize an investor's expected return at a given level of risk. The risk is
composed of two elements; business-related risk (known as unsystematic risk) and market risk
(called systematic risk). An asset's variance actually measures both risks.
Question 13
Which one of the following is not factor that an institutional investor should take into account?
See Question 2, page 6
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Question 14
What factors impacts the asset allocation?
•
Age:
Your age is an important factor that you must consider while deciding your asset allocation. If you
are a young investor of say 20-30 years, you should consider allocating a large percentage of your
portfolio in risky assets, such as equities. Being young gives you ample amount of time and
opportunities to recover from any possible setbacks in the value of the portfolio.
•
Income:
The amount you invest is a function of the amount of income you earn. Any appraisal in earnings, will
impact your discretionary income and hence the amount of investment. If you are into service or
employment, drawing a fixed salary every month, you can allocate your savings systematically to
both risk and safe instruments depending on your age. However if you are in the business industry,
your profits and losses are not fixed in nature.
•
Expenses:
In order to keep your financial health in pink in the long-term, it is important that you live within
means and curtail your unnecessary expenses. It is this strategy which will enable you save a large
portion of your monthly earnings, which can be deployed in suitable asset classes (depending upon
your age, income, risk appetite and nearness to goal).
•
Nearness to goal
Your nearness to your financial goal is also relevant while doing financial planning. If you are many
years away from the financial goal, you should ideally allocate maximum allocation to the equity asset
class and less towards fixed income instruments.
•
Risk Appetite
Your willingness to take risk which is a function of your age, income, expenses, nearness to goal, will
be an important determinant while framing your financial plan. So, if your willingness to take risk is
high (aggressive), you can skew your portfolio more towards the equity asset class.
•
Liabilities:
If you as an investor have high liabilities, then even though you may be willing to take high amount
of risk, your financial condition would make you a risk-averse investor. Irrespective of age, willingness
to invest, nearness to his goals, risk tolerance or any other factor, you will be forced to only make
safe investments as you cannot afford to let your investments suffer any setbacks due to market
swings.
Assets:
As an investor, it is imperative to first analyse your existing portfolio before allocating funds further.
For instance, if a huge chunk of your portfolio is dominated by real estate, then you must diversify
your assets in a manner that reduces your allocation to risk assets such as real estate or equities and
increase investments in safe instruments such as debt and cash.
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Question 15
Increasing risk of the property life cycle consists of which of the following (in order):
GLITAMAD
1. Ground floor
2. Loan commitment
3. Interim
4. Tenancy
5. Absorption
6. Maturing Process
7. Ageing process
8. Demise
Question 16
Which of the following is are the main drivers of property?
The real estate industry, much like the business world in general, has historically performed in a cyclical
fashion, driven primarily by
• the laws of supply and demand.
• Levels of construction activity,
• absorption of space in office buildings, shopping centers, and apartment complexes,
• rental rates and
• interest rates
Question 17
Which of the following statements is true when it pertains to the Sensitivity analysis?
1. The impact of uncertainties on the investment decision can also be determined by sensitivity
analysis. This is performed by varying the values of input variables (interest rates, rental levels,
etc.) to determine the effect on relevant output variables (project value, profit, NPV, IRR, etc.).
2. Additional risk information is obtained by using ratio analysis (like the debt coverage ratio and
the breakeven point) and by sensitivity analysis (where the relative effect of changes in the input
assumptions on the rate of return or other output variables are determined).
3. All the information and data collected so far are incorporated in the rigorous discounted-cashflow after-tax analysis of the property. The rate-of return and risk parameters are analyzed,
including a detailed sensitivity analysis of key variables.
4. More investors, especially larger firms, are using explicit risk adjustment in their investment
evaluation process. The three most popular techniques are
(a) adjusting upward the rate of return,
(b) adjusting downward the expected cash lows, and
(c) performing a sensitivity analysis.
5. Various techniques have been developed to determine the effect of risk on the expected return
of an investment. These include:
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(a) conservatism,
(b) risk- adjusted discount rates,
(c) the certainty equivalent approach,
(d) the risk-absorption ratio,
(e) decision trees,
(f) sensitivity analysis,
(g) probabilistic risk simulation,
(h) measures of variability, and
(i) modern capital market measures
6. Sensitivity analysis therefore enables the investor to concentrate on the essential variables and
helps prevent waste of time on trying to reduce uncertainty in variables which are not important.
7. The value of the sensitivity analysis is obviously crucially dependent upon the validity of the
assumptions. The assumptions should be as realistic as possible and should be based upon the
best possible information.
8. Note that although a sensitivity analysis provides the investor with ranges of possible returns, it
does not indicate the probabilities that these different returns will actually occur
9. A logical extension of sensitivity analysis is to incorporate probability estimates to the values of
input variables
10. The Monte Carlo technique is an extremely sophisticated technique for analysing the risk of an
investment, but requires extensive data which often does not exist. A simplified procedure can be
used, in which probabilities are assigned to the optimistic, most likely, and pessimistic forecasts
used in the sensitivity analysis
11. The wide range of risk available analysis techniques discussed (in Chapter 10) include elementary
risk analysis, sensitivity analysis, probability analysis using Monte Carlo simulation, decision trees
(and) utility functions.... The choice of technique usually depends on the type of problem, the
available experience and expertise and the computer software and hardware available"
Question 18
Which of the following are part of the classification of risk?
1.
2.
3.
4.
5.
6.
7.
8.
Business Risk
Financial Risk
Political Risk
Interest Rate Risk
Purchasing Power Risk
Management Risk
Liquidity Risk
Environmental Risk
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Question 19
The distribution of funds (dividends) from a company or CC is subject to a secondary tax rate on
companies of
1. Secondary Tax on companies is calculated on a net amount of dividends declared by a company.
The net amount is the amount by which the dividends declared exceed the dividends received
during a specific cycle ('dividend cycle')
2. The dividend cycle is the period commencing after the end of the previous dividend cycle and
ending on the date that the current dividend accrues to the shareholder/s.
3. The rate of 12.5% is payable in respect of all dividends declared on or after 14 March 1996.
Question 20
Which of the following sector has seen its capital values rising over the long-term, in line with the Net
income growth?
Retail has been the best performing sector with annualised returns of 15.0% per year. Retail is the only
sector where capital values have risen over the long-term, in line with net income growth, while vacancy
rates have remained reasonably stable
Other and All Property
See page 298
Question 21
In the Ellwood valuation model, income projections are made over the holding period of the investment
rather than its economic life
1. Income projections are made over the holding period of the investment rather than its economic life.
2. Mortgage financing and mortgage terms are considered explicitly.
3. The residual value of the property is estimated.
4. The time value of money is considered in discounting resale proceeds and mortgage flows.
Question 22
Which of the following is true regarding practicing project managers?
Practicing project managers do not find it useful to distinguish between risk and uncertainty whereas
many researchers and writers do seek to draw a distinction
Question 23
In the case of the investment of smaller sums, it is often not possible to invest in invest in prime property
because of the high cost:
In the case of the investments of smaller sums, it is often not possible to invest in prime property
because of the high cost. In this instance the investor might look at investing through a listed property
investment vehicle
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Question 24
Which of the following is not considered business risk (risk primarily associated with the property)?
Please see Page 1, Business Risk
Question 25
Which of the following describes an older investor:
The older investor generally
• Demonstrates a more conservative behaviour and greater aversion to risk.
• Cash flow may be more important (in order to augment retirement income),
• less management-intensive investments are generally preferred and tax
• Strategies and estate planning become more dominant
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Course (222REF7XE2) REAL ESTATE FINANCE AND INVESTMENT B
Test Case Study 2 Assessment
Question 1
Section 11(o) scrapping allowance applies to
Manufacturing buildings are subject to the S 11(o) scrapping allowance.
• This does not however apply in respect of buildings scrapped within a period of 10 years.
• Essentially if you make a loss on scraping it can be deductible from taxable income.
Question 2
Which of the following is not considered a component of investment management in property?
See Page 4, Question 22
Question 3
A naively diversified portfolio (+) is significantly inferior.
Once again, the naively diversified portfolio (+) is significantly inferior.
Question 4
Which of the following statements about an investor rationale is true?
- to achieve above average performance
- to diversify the asset base and thereby manage risk
- to match assets to liabilities
- to be aware of the risk-averse nature of trustees.
Question 5
In the case of listed investment vehicles, the investment portfolio is valued in terms of terms of the market
price of the units or shares
In the case of the listed investment vehicles, the investment portfolio is valued in terms of the market
price of the units or shares. The value of units or shares in listed property vehicles is thus determinable
at any point in time
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Question 6
How is a sensitivity analysis performed?
Sensitivity analysis is a Six (6) step process as follows:
A. Input variable Assumptions
1. Growth rate of possible growth income (%)
2. Growth rate of operating costs (%)
3. Growth rate of property value (%)
4. Expected occupancy level
B. IRR ON EQUITY INVESTMENT (IRRE)
1. Year 3 (%)
2. Year 7 (%)
3. Year 10(%)
C. IRR ON CAPITAL INVESTMENT (IRRTC)
1. Year 3 (%)
2. Year 7 (%)
3. Year 10(%)
D. NET OPERATING INCOME
1. Year 3 (%)
2. Year 7 (%)
3. Year 10(%)
E. BREAK-EVEN POINT
1. Year 3 (%)
2. Year 7 (%)
3. Year 10(%)
F. DEBT COVERAGE RATIO
1. Year 3 (%)
2. Year 7 (%)
3. Year 10(%)
Question 7
Which of the following describes a middle-aged investor:
The middle-aged investor typically exhibits
• greater financial mobility;
• risk-taking capacity is at its maximum;
• more sophisticated property investments can be contemplated and
• diversification is more important
Question 8
Retention is calculated on the net contract price excluding VAT.
Retention is calculated on the net contract price excluding VAT. In practice, VAT will become payable on
retention monies only once the engineer/architect has authorised or certified the release of the retention.
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Question 9
Studies show that the correlation between the underlying asset and the returns investors achieve is:
A correlation of 0 means that the returns of assets are completely uncorrelated. If two assets are
considered to be non-correlated
A negative correlation indicates that, historically, as one variable has moved up the other has
moved down.
A positive correlation means that historically both variables have generally moved in the same
direction.
We must stress that measuring correlation as such gives us information regarding the linear
relationship between two variables. A correlation of zero means that there is no linear
relationship between the two variables but does not imply that these variables are independent.
Question 10
What is the Probabilistic risk simulation?
A logical extension of sensitivity analysis is to incorporate probability estimates to the values of input
variables. Given the probability distributions of input variables, the probability of various output variables
can be calculated. This approach is known as a probabilistic risk simulation or a Monte Carlo risk
simulation
Question 11
The use of the standard deviations becomes especially important when evaluating portfolio risk.
The use of standard deviations becomes especially important when evaluating portfolio risk.
Question 12
What factors impacts the asset allocation?
See page 9 Question 14
Question 13
Which statement is true?
Question 14
Where VAT is chargeable on any supply of goods or services the price can be shown exclusively with the
VAT or inclusive with a statement to the effect that the amount includes VAT at at 14%.
Question 15
How is risk typically controlled?
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Identification - examine all resources and operations to identify what can go wrong and how it can happen,
i.e. exposures and hazards.
Measurement - calculate the potential financial losses which could result from the identified risks and also
the likelihood of occurrence.
Risk Response - Select and monitor appropriate measures based on effectiveness and economic viability.
This should include the following management options :(i)
avoid the risk or discontinue the loss-causing activity
(ii)
retain the risk and internally fund loss consequences.
(iii)
control the risk with safety programs and loss reduction plans
(iv)
transfer the risk to insurers or to third parties
Question 16
The expected return of a portfolio of properties is equal to the weighted average of the individual returns
of the properties.
Question 17
Which statement is incorrect?
•
•
•
•
Betas are the theoretically correct measure of a firm's market risk.
The correct view of real estate is to regard it as a three-dimensional concept (i.e. as artificially
delineated space),
A third way of distinguishing investment and speculation is to look at the intention of the
investor/speculator: is the primary intention to derive an income from the business venture from
earnings derived from the venture, or is the sole purpose to make a profit upon resale? This is the
distinction drawn by the Receiver of Revenue for tax purposes (cf. Chapter 7). It is suggested that
the latter interpretation is the correct one
The NPV method assumes that such cash flows are invested at the rate of the best alternative
investment, while the IRR method assumes reinvestment at a rate equivalent to the yield of the
entire project. The NPV method therefore seems to be more correct under these circumstances.
Question 18
What is the most important step in attempting to deal with risk exposure?
The first (and perhaps the most important step) in attempting to deal with exposure to risk is to identify
it. Many decision makers believe that the principal benefits of risk management come from the
identification rather than the analysis stage
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Question 19
The most sophisticated approach to risk is the
The most sophisticated approach to risk is the Monte Carlo risk simulation model. In this approach,
probability distributions are estimated for each uncertain input variable to determine a range of possible
outcomes and the probability of each
Question 20
Phase III of the real estate cycle is:
The real estate cycle is a four-phase series that reports on the status of both commercial and residential
real estate markets. The four phases are:
a. Recovery,
b. Expansion,
c. Hyper supply, and
d. Recession
Phase 1: Recovery
Low vacancies
Favourable tax
legislation
Favourable publicity
Large amounts of new capital
for development
Phase 2: Expansion
Increasing new construction
Increasing vacancies
Phase 3: Hyper-Supply
Anti-real estate tax
legislation
High vacancies Bad press
Capital flees from new
development
Phase 4: Recession
Vacancies decrease
Rents rise
Little new
construction
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Question 21
Which statement is correct pertaining to the results presented by the Decision tree approach?
•
Decision tree analysis requires the analyst to estimate the likelihood of each outcome at every
expected decision point in the future.
•
A 'tree' of choices is built up, with each of the 'branches' being successive decision points.
•
To each branch should be allocated a probability of occurrence, as well the value of that
outcome.
•
By multiplying the probability with the value of that specific alternative, one arrives at the value
of that alternative.
•
The decision tree is a graphical means of bringing together the information needed to make
alternative investment decisions. It shows the present possible courses of action and all future
outcomes, each with a probability value indicating its likelihood of occurrence.
•
Decision tree analysis has formed the basis of a number of developments in risk analysis
techniques.
•
Project risk models have been developed which combine this approach with other analytical
methods such as probability analysis
Question 22
What is best describes the relationship between the degree of risk and the level of return on an investment?
Return and risk are fundamental concepts to the financing of a property investment. There is usually an
inverse correlation between the degree of risk and the level of return on an investment
Question 23
The equity-cash flow model is a one-year model model
The equity-cash flow valuation model is also a one-year model. It does not explicitly consider the time
value of money, equity buildup, changing revenues and expenses, income taxes, or property value
increases or decreases over time. It is, however, quite useful as a preliminary evaluation technique.
Question 24
Which of the following statements is false?
Question 25
A real estate investor must continually analyse the basic:
A real estate investor must continually analyze the basic social, cultural and political changes occurring
in society and their possible effects on changing real estate needs, returns and risks.
Page 19 of 34
Course (222REF7XE2) REAL ESTATE FINANCE AND INVESTMENT B
Test Case Study 3 Assessment
Question 1
Institutional investors are entrusted with __________ or ____________.
Institutional investors are entrusted with insurance premium income or pension fund contributions for
the ultimate benefit of the policy holders on retirement, or in favour of their dependants upon the
death of the policy holder.
Question 2
Which of the following is a difficulty of using the conservatism approach to risk analysis?
The difficulties in using this approach are
• firstly that it is difficult to decide the degree to which the income and costs should be revised
downwards and upwards respectively, and
• secondly that an overly-conservative approach can lead to a possible investment being turned
down. One can make such conservative assumptions that no investment is regarded as being
acceptable, and to do nothing at all is contrary to the goal of wealth maximisation.
Question 3
The rate of return method involves comparing the expected rate of return with the
•
Competition would force prices of properties to their correct levels and the net present values of
all investments would be zero; investors would purchase properties and would earn the market
rate of return on each property. In this case, the rate of return would equal the risk-free rate.
•
The relation between the required return on the 305 Chapter 10 Risk analysis investment and
the market portfolio return is therefore a straight line
Question 4
The chance or probability that the investor will not receive the expected or required rate of return on the
investment is a description of …
The chance or probability that the investor will not receive the expected or required rate of return on the
investment is called Risk
Question 5
Which statement is incorrect:
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Question 6
What are variables that are regarded fixed called under Probabilistic risk simulation?
This approach is known as a probabilistic risk simulation or a Monte Carlo risk simulation. Those variables
that are regarded as fixed are called control variables (single-value estimates), while the variables to
which probability distributions are assigned, are called state variables
Question 7
A large sums of capital allows the Institutional Investor to invest in is called?
The larger institutions generally prefer placing larger sums of money. In most cases they would be in a
position to invest in prime property directly. Where the investment is particularly large and the institution
wishes to share the risk, then it may elect to invest in partnership with other large institutions
Question 8
Repairs for aesthetic improvements are regarded as capital improvements.
Question 9
Section 11(o) scrapping allowance applies to
Manufacturing buildings are subject to the S 11(o) scrapping allowance.
• This does not however apply in respect of buildings scrapped within a period of 10 years.
• Essentially if you make a loss on scraping it can be deductible from taxable income.
Question 10
Income earnings potential is guaranteed by:
Property values are influenced by their income earning potential which, to a large extent, is guaranteed
by contractual lease agreements.
Question 11
Which of the following is not a benefit of risk management?
Benefits of risk management are:
•
•
•
•
•
it enables decision making to be more systematic and less subjective
it allows the robustness of projects to specific uncertainties to be compared
it makes the relative importance of each risk readily apparent
it gives an improved understanding of the project through identifying the risks and thinking
through response scenarios
it has a powerful impact on management by forcing a realisation that there is a range of possible
outcomes for a project.
Question 12
Which of the following statements correctly describes The Risk – absorption ratio?
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The risk-absorption (RA) ratio measures
• The amount of risk a project can absorb while still remaining acceptable to the investor.
• The ratio is calculated by dividing the annualized net present value (ANPV) of equity cash flows by
the required equity investment The ANPV is the maximum amount by which the cash flow each
year could be reduced without reducing the net present value below zero (a NPV < 0 would make
the investment unacceptable).
• Like the profitability index, the RA ratio is a relative measure used to compare projects of different
sizes.
• If all other risk and return measures are equal, the investment with the greatest risk-absorbing
capacity will be preferred.
Question 13
The expected return of a portfolio of properties is equal to the
The expected return of a portfolio of properties, is equal to the weighted average of the individual
returns of the properties.
Question 14
In terms of Section 13, tax deductions granted are
Residential building allowance - Section 13 (ter)
- Residential building initial allowance - 10% of cost
- Residential building annual allowance - 2% of cost
Question 15
Which investment is preferred according to the Risk absorption ratio?
If all other risk and return measures are equal, the investment with the greatest risk-absorbing capacity
will be preferred.
Question 16
Once the general economy picks up:
Once the general economy picks up, vacancy levels fall and rentals rise faster than building cost.
Question 17
Currently the practice has developed that the transferring attorney has to guarantee to the _______ that
the VAT will be paid over in the correct tax period of the seller. Fill in the gap.
Currently the practice has developed that the transferring attorney has to guarantee to the South African
Revenue Service that the VAT will be paid over in the correct tax period of the seller.
Question 18
Inability to adapt and make effective decisions in response to economic events(changes) is?
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The MIRR has attracted a wide following. However, Pyhrr et al (1989:224) caution that "...both the FMRR
and the MIRR are said to examples of mathematical overkill. The investor might better spend his or her
time worrying about the underlying economic and market assumptions than worrying about multiple
reinvestment rate assumptions that will rarely change an investment decision in the real world the IRR
(or PV) is only one of many pieces of information that will be used to make the
investment decision.
Too exclusive a focus on any single investment criterion is generally a mistake
Question 19
The efficient frontier can be described as:
The efficient market hypothesis expounds a theory that reflects the view that shares are always in
equilibrium, and that it is not possible to consistently do better than the market. According to Reekie and
Lingard (1986 53) "if a share price fully reflects all available information pertaining to that security and
the benefits which can be expected to accrue from holding it, the market is said to be efficient
Question 20
With ____________ the institutional investor will receive a monthly income stream.
With direct property investment the institutional investor will receive a monthly income stream.
Question 21
Risk identification is susceptible to which of the following biases?
1. Quite apart from individual biases and preferences,
2. actors inherent in the human cognitive system which especially contribute to faulty decisionmaking include
a. the undue emphasis on short-term decision frameworks,
b. simplistic generalizations and
c. the inability to deal with uncertainty.
Question 22
In a typical IRR calculation, all future investments are discounted to the present to
Measure the
In a typical IRR calculation, all future investments are discounted to the present to measure the so-called
initial investment
Question 23
The use of the standard deviations becomes especially important when evaluating
The use of standard deviations becomes especially important when evaluating portfolio risk.
Question 24
The present value of improvements over the period of the lease is referred to as
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The Lessors Allowance (section 11(8)) amounts to the present value of improvements over the period of
the lease, discounted currently at 6% per annum. In practice this amount is taxed in the hands of the lessor
when the improvements have been completed.
Question 25
If the distribution of probable rates cannot be estimated then there is…
A distinction is sometimes made between risk and uncertainty, on the basis of whether the probability
distribution of outcomes is known (or can be estimated) or not. If the distribution is known or can be
estimated, risk is said to exist. If the distribution is not known or cannot be estimated, uncertainty is said
to prevail.
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Course (222REF7XE2) REAL ESTATE FINANCE AND INVESTMENT B
Test Case Study 4 Assessment
Question 1
_____ is the total amount, whether in cash or otherwise received by or accrued to a
person in the year on assessment
Gross Income
This is the total amount, whether in cash or otherwise received by or accrued to a
person in the year of assessment.
Question 2
Fund managers and trustees:
Both fund managers and trustees of pension funds act in a fiduciary capacity and therefore need to be
aware of risk
Question 3
Which one of the following statements about institutional investors is most accurate?
Large institutional investors use the opportunity, when buying property directly, to incorporate their
name into the name of the building. This is widely practiced and is undoubtedly a valuable advertising
medium.
The large institutional investors, with their large property portfolios, invariably set up a property and
portfolio management divisions because economies of scale warrant it. Within these property
management divisions there will be several departments which will include legal, leasing, building
management, building maintenance and administration.
The large institutional investors, because of their investment expertise, foresight and investment budgets,
are able to not only invest in prime properties requiring large investment sums, but also in
underdeveloped or undeveloped land which they "land bank" until the market is ripe for a development
to take place on this land.
Large institutional investors, however, are often hamstrung by various levels of decision making, which
may cause an option to lapse should a decision not be made timeously. It is in the interests of these large
institutional investors to streamline their decision-making processes to take advantage of short notice
opportunities.
Large institutional investors use the opportunity, when buying property directly, to incorporate their
name into the name of the building. This is widely practiced and is undoubtedly a valuable advertising
medium.
Question 4
Which statement is incorrect?
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Question 5
The present value of improvements over the period of the lease is referred to as
The Lessors Allowance (section 11(8)) amounts to the present value of improvements over the period of
the lease, discounted currently at 6% per annum. In practice this amount is taxed in the hands of the lessor
when the improvements have been completed.
Question 6
If the distribution of probable rates cannot be estimated then there is…
A distinction is sometimes made between risk and uncertainty, on the basis of whether the probability
distribution of outcomes is known (or can be estimated) or not. If the distribution is known or can be
estimated, risk is said to exist. If the distribution is not known or cannot be estimated, uncertainty is said
to prevail.
Question 7
Which of the following sector has seen its capital values rising over the long-term, in
line with the Net income growth?
Retail has been the best performing sector with annualised returns of 15.0% per year. Retail is the only
sector where capital values have risen over the long-term, in line with net income growth, while vacancy
rates have remained reasonably stable
Other and
All Property
See page 298
Question 8
In order to qualify for a residential building allowance, the following must not be met
In order to qualify for deduction:
- must be a housing project
- consist of at least 5 residential units
- let for purposes of profit or occupied by employees.
Question 9
In bottom-up risk identification what are the core activities of Scenario building?
This usually involves developing two extreme scenarios:
scenario 1 where everything occurs as expected and
scenario 2 where everything goes wrong. This approach attempts to identify project risks by a detail
analysis of both likely and negative factors that might influence the budget.
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Question 10
Which of the following are statements regarding risk and return is true?
If all other risk and return measures are equal, the investment with the greatest risk-absorbing capacity
will be preferred
Question 11
The forward yield of listed property instruments on the stock market refers to
In fixed property, yields refer to a forward yield. In other words, the anticipated before tax net income for
the property for the next 12 months is calculated as a percentage of the purchase price for investment.
This ratio is often referred to as the initial yield or capitalisation rate.
Question 12
Which of the following is not considered an element of property portfolio strategy?
Question 13
An investment is
In general, an investment is the sacrifice of a (certain) present value for a (possibly uncertain) future value.
The investment decision is therefore essentially a choice between having whatever is of value at present,
and having a value sometime in the future (or, consumption now against consumption later).
Question 14
Which one of the following methods of investment provide the investor with limited liability?
An investor's liability through a property unit trust or loan stock company is limited. If, for any reason,
claims are made against the company, the risk is limited purely in terms of the investment
Question 15
A naively diversified portfolio (+) is significantly
Once again, the naively diversified portfolio ( +) is significantly inferior.
Question 16
How many stages of the ownership cycle are there?
Three stages
The life cycle of property consists of three phases: “Acquisition,” “In-Service,” and “Excess
Question 17
Once the general economy picks up:
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Once the general economy picks up, vacancy levels fall and rentals rise faster than building cost.
Question 18
By adding to a portfolio of shares or properties a share or property whose beta is lower than 1, the portfolio's
riskiness is?
By adding to a portfolio of shares or properties a share or property whose beta is lower than 1, the
portfolio's riskiness is reduced.
Question 19
The best fit model is subject to criticism of
The most popular calculation in modern real estate investment analysis is the internal rate of return.
Although this model is subject to criticism about some of its assumptions (as is the net present value model),
this rate of return measure is superior to several others in that it provides a "rate of return per annum" and
properly evaluates the return over the entire period under analysis.
Question 20
Risk identification is susceptible to which of the following biases?
1. Quite apart from individual biases and preferences,
2. actors inherent in the human cognitive system which especially contribute to faulty decisionmaking include
d. the undue emphasis on short-term decision frameworks,
e. simplistic generalizations and
f. the inability to deal with uncertainty.
Question 21
Receipts or accruals of a capital nature are excluded when calculating
Gross Income
This is the total amount, whether in cash or otherwise received by or accrued to a person in the year of
assessment less
(a) -All receipts and accruals of a capital nature
(b) -All receipts and accruals from any source outside the Republic.
Question 22
Section 11(a) and 11(b) can be referred to as the sections that govern
These deductions are governed by what is known as "The general deduction formula". Sections 11(a) and
11(b) can be referred to as the sections that govern the general deduction formula.
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Question 23
Which statement about the Expected return on an investment is false?
It is not possible, however, to completely eliminate risk, as there is always a possibility that certain factors
that may occur in the future will influence the expected return on the investment
The most serious effect of risk on an investment is that the expected return on the investment is not
realised more specifically, that the actual return turns out to be less than the expected return.
The expected return on investment, E(R), is the most likely return when the investor is uncertain about
the actual return the investment will produce. It is the weighted average of all possible returns, where the
weights are the probabilities of occurrence
Question 24
A deduction of leasehold improvements will only be granted if the improvements are included in
Deduction in respect of leasehold improvements to land and buildings, the land and buildings must be
used in the production of income. This deduction will only be granted if the improvements are included
in the lessor's gross income and spread over the lesser of the initial lease or 25 years.
Question 25
The ability of the investor to construct a securities portfolio of assets with varying unsystematic risk allow
for:
An investor may now select a portfolio that eliminates unsystematic risk through diversification and is
equally tailored to provide maximum return for a given level of market or systematic risk
Page 29 of 34
Course (222REF7XE2) REAL ESTATE FINANCE AND INVESTMENT B
•
Question 1
4 out of 4 points
A lessor's allowance is currently discounted at an annual rate of
The Lessors Allowance (section 11(8)) amounts to the present value of improvements over the
period of the lease, discounted currently at 6% per annum
•
Question 2
0 out of 4 points
If the distribution of probable rates cannot be estimated then there is…
. If the distribution is not known or cannot be estimated, uncertainty is said to prevail.
•
Question 3
4 out of 4 points
Fund managers and trustees:
Both fund managers and trustees of pension funds act in a fiduciary capacity and therefore need to
be aware of risk
•
Question 4
4 out of 4 points
Which risk type is considered when there are changes in tax law, zoning and rent controls?
Legislative Risk is considered when Changes in tax law; zoning; rent controls; and other
governmental regulations
•
Question 5
4 out of 4 points
Which of the following is the securities are risk-free?
•
•
•
•
government securities,
the bank or on
fixed deposit. (
Question 6
4 out of 4 points
Decreasing risk of the property life cycle consists of which of the following (in order):
•
•
•
Absorption,
Maturing process,
Ageing Process and
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•
•
Demise
Question 7
4 out of 4 points
Where the shareholder subsequently converts to sectional title, ________ will be payable on the
conversion.
The sale of the shares and loan obligation will both be subject to VAT. Where the shareholder
subsequently converts to sectional title, no transfer duty will be payable on the conversion
•
Question 8
4 out of 4 points
In bottom up risk identification what are the core activities of the questionnaire and check list
approach?
Questionnaire and check-list approach which
• Isolates events and records them by combining the experience of more managers and more
projects
• It produces a check-list of possible events.
• These can often be further refined into step-by- step procedures such as hierarchical trees
which will guide the decision maker into different paths of thought
•
Question 9
4 out of 4 points
Equal cash flow streams occur when a project is leased for an agreed
Equal cash flow streams occur when a project is leased for an agreed fixed income
•
Question 10
4 out of 4 points
What is the bottom-line approach?
Aggregate or bottom-line approach is essentially the adding-on of a certain percentage for
contingency.
•
Question 11
0 out of 4 points
What is the fundamental issue to consider when judging the plausibility of bubbles theories?
The bubble theory is based on the recognition that market prices, especially commodity, real estate,
and financial asset prices, occasionally experience rapidly rising prices as investors begin
buying beyond what may seem like rational prices.
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The hypothesis includes the idea that the rapid rise in market prices will be followed by a sudden
crash as investors move out of overvalued assets with little or no clear indicators for the
timing of the event.
•
Question 12
4 out of 4 points
The equity-cash flow model is a ________ model
The equity-cash flow valuation model is also a one-year model.
•
Question 13
0 out of 4 points
Which statement is incorrect:
•
Question 14
4 out of 4 points
The quoted companies on the stock exchange are generally not able to react to investment
opportunity at short notice is because:
The quoted companies on the stock exchange are generally not able to react quickly to raise the
necessary cash for an investment at short notice.
•
Question 15
4 out of 4 points
In which market is information most difficult to find accurate find?
"The investor may have noneconomic goals (including some that are irrational!), may work in a
highly imperfect market in which accurate information is difficult to obtain, and may have
considerable power to influence the final outcome.
•
Question 16
4 out of 4 points
IRR is equal to the discount rate when the NPV is equal to
Since the IRR is equal to the discount rate when the NPV is equal to zero
•
Question 17
4 out of 4 points
In bottom up risk identification what are the core activities of the Flow chart approach?
Flow chart approach attempts to identify risks by charting the company operations
•
Question 18
4 out of 4 points
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Another view of risk is that the ___________ the probability distribution of expected future
returns the __________ the total risk of an investment
Another view of risk is that the tighter the probability distribution of expected future
returns the smaller the total risk of an investment.
•
Question 19
0 out of 4 points
What are the risk response steps?
Risk Response - Select and monitor appropriate measures based on effectiveness and economic
viability. This should include the following management options :
•
(i)
avoid the risk or discontinue the loss-causing activity
(ii)
retain the risk and internally fund loss consequences.
(iii)
control the risk with safety programs and loss reduction plans
(iv)
transfer the risk to insurers or to third parties
Question 20
0 out of 4 points
Which of the following is not an approach to determine the investment value of a project?
Three approaches are commonly used to determine the investment value of a project:
• the generalized model of investment value,
• the equity-cash flow valuation model and
• the Ellwood valuation model.
•
Question 21
4 out of 4 points
Provided that the property investment in ungeared as in the case of investments by
institutional investors, there is
Provided the property investment is ungeared as in the case of investments by institutional
investors, there is always an underlying intrinsic value
•
Question 22
0 out of 4 points
Phase IV of the real estate cycle is:
Page 33 of 34
Demand is slow, vacancies reach unacceptable levels
•
•
•
•
•
•
Supply is so great, and demand so soft that rental rates decrease.
This decline may be evidenced by actual rate reductions or by concessions, so called 'free
rent'.
This is a 'tenant's market'.
Constructions slows to a halt or to minimum levels.
Borrowers, especially those who are inexperienced or who have become undercapitalized,
are unable to support property operations and meet debt service.
Question 23
0 out of 4 points
_________ land can be taxed in various ways: the income from land
Due to its visibility and immobility, Land can be taxed in various ways: the income from land (e.g. an
agricultural income tax); ownership or occupation of land (e.g. property tax); acquisition of land (e.g.
transfer duty or stamp duty) and the alienation of land (e.g. VAT). South Africa is no exception to this
rule: "tithes" were introduced in 1677, transfer duty in 1686 and recognition fees in 1714 (Franzsen
1990).
•
Question 24
4 out of 4 points
Equities share values could become worthless should
Equity share values could become worthless should the asset become insolvent.
•
Question 25
0 out of 4 points
When is the case-based approach used in top down risk identification?
The case-based approach uses the assumption that similar projects are often the best starting
point for identifying reasonable risk events. This approach is reasonable when a new investment
with similar characteristics are considered, but is less useful when the new investment is particularly
unique
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