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CFA Level II Alternative Investments Practice Questions

Official outline
CFA Institute 2026 Level II Topic Outlines (learning outcomes)
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8
Updated
Nov 3, 2026

  1. Question 1, medium

    An investor expects a property's net operating income next year to be USD 700,000, growing at 2% a year indefinitely. The investor's required return is 9%. What is the property value using the implied cap rate?

    • A.USD 7.78 million
    • B.USD 10.20 million
    • C.USD 10.00 million
    • D.USD 6.36 million
    Show answer and explanationHide answer

    Correct answer: C. USD 10.00 million

    Cap rate = r - g = 9% - 2% = 7%. Value = NOI1/cap rate = 700,000/0.07 = USD 10.00 million. The implied cap rate is the discount rate less the perpetual growth rate, applied to next year's NOI. Growing the NOI again would double-count a year of growth.

    • A. Capitalises at the full discount rate of 9%, ignoring income growth.
    • B. Grows next year's NOI again (714,000/0.07), double-counting a year of growth.
    • C. Correct: 700,000/(0.09 - 0.02) = 10.00 million.
    • D. Adds growth to the discount rate (11%), the wrong sign.

  2. Question 2, easy

    A property has potential gross income of USD 2.0 million, a vacancy and collection loss of 10% and operating expenses of USD 0.6 million. The market capitalization rate is 6%. What is the value under the direct capitalization approach?

    • A.USD 23.33 million
    • B.USD 20.00 million
    • C.USD 30.00 million
    • D.USD 33.33 million
    Show answer and explanationHide answer

    Correct answer: B. USD 20.00 million

    EGI = 2.0 x 0.90 = 1.8; NOI = 1.8 - 0.6 = 1.2. Value = NOI/cap rate = 1.2/0.06 = USD 20.00 million. Direct capitalization divides first-year stabilized NOI by the market cap rate. NOI excludes financing costs and depreciation, and vacancy reduces potential income first.

    • A. Deducts expenses from potential income but forgets the vacancy loss (1.4/0.06).
    • B. Correct: 1.2/0.06 = 20.00.
    • C. Capitalises effective gross income without deducting operating expenses (1.8/0.06).
    • D. Capitalises potential gross income (2.0/0.06), ignoring both vacancy and expenses.

  3. Question 3, hard

    An analyst constructs a residential real estate price index using the repeat-sales method. Which is a recognized weakness of this method relative to a hedonic index?

    • A.It needs a regression on many property characteristics, which introduces specification and data-availability risk
    • B.It uses appraised values rather than transaction prices, so it understates volatility and lags the market
    • C.It cannot control for location, because the same property is observed in each pair of repeat sales
    • D.Properties that sell more than once may not represent the whole stock, and renovations change quality between sales
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    Correct answer: D. Properties that sell more than once may not represent the whole stock, and renovations change quality between sales

    A repeat-sales index uses only properties that transacted at least twice, a possibly unrepresentative sample, and it assumes quality is unchanged between sales. Hedonic indexes use characteristics regressions and can use all sales, but carry specification risk.

    • A. Wrong: that describes hedonic indexes, not repeat-sales indexes.
    • B. Wrong: repeat-sales indexes use transaction prices, not appraisals.
    • C. Wrong: observing the same property in each pair controls for location, which is a strength.
    • D. Correct: sample selection and unobserved quality changes are recognized repeat-sales limitations.

  4. Question 4, easy

    An investor builds an allocation using the return history of an appraisal-based commercial real estate index. Compared with the true underlying market returns, what bias should the investor expect in that data?

    • A.Understated volatility and understated correlation with equities, which overstates diversification benefits
    • B.Overstated volatility and overstated correlation with equities, which understates diversification benefits
    • C.Understated volatility but overstated correlation with equities, which makes real estate look riskier
    • D.Overstated volatility but understated correlation with equities, which makes real estate look safer
    Show answer and explanationHide answer

    Correct answer: A. Understated volatility and understated correlation with equities, which overstates diversification benefits

    Appraisers rely on past values and comparable sales, which smooths and lags reported returns. This understates volatility and correlation with other asset classes, making real estate appear to offer better risk-adjusted returns and diversification than it does.

    • A. Correct: smoothing damps reported swings and delays co-movement with the stock market.
    • B. Wrong: smoothing reduces, not increases, measured volatility.
    • C. Wrong: volatility is understated, and correlation is understated too.
    • D. Wrong: smoothed data understate volatility, so real estate looks less risky, not more.

  5. Question 5, medium

    Using the cost-of-carry model F = S x (1 + r + storage cost - convenience yield), an analyst prices a one-year commodity futures contract. The spot price is USD 100, the risk-free rate is 3%, storage costs are 2% of spot and the convenience yield is 6%. What is the futures price?

    • A.USD 99.00
    • B.USD 111.00
    • C.USD 105.00
    • D.USD 95.00
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    Correct answer: A. USD 99.00

    F = 100 x (1 + 0.03 + 0.02 - 0.06) = 100 x 0.99 = USD 99.00. A convenience yield higher than the combined financing and storage cost pushes futures below spot, which is backwardation.

    • A. Correct: 100 x (1 + 0.03 + 0.02 - 0.06) = 99.00.
    • B. Adds the convenience yield rather than subtracting it, giving 111.00.
    • C. Leaves out the convenience yield altogether (100 x 1.05), a pure carrying-cost price.
    • D. Subtracts storage costs along with the convenience yield (1 + 0.03 - 0.02 - 0.06), giving 95.00.

  6. Question 6, hard

    A REIT is expected to generate next-twelve-month NOI of USD 50 million. The market cap rate is 5%. The REIT holds USD 40 million of cash and other assets and has USD 340 million of liabilities. There are 20 million shares. What is the NAV per share?

    • A.USD 52.00
    • B.USD 35.00
    • C.USD 33.00
    • D.USD 31.00
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    Correct answer: B. USD 35.00

    Property value = 50/0.05 = 1,000. NAV = 1,000 + 40 - 340 = 700; per share = 700/20 = USD 35.00. Forward NOI is the usual basis for NAV.

    • A. Ignores liabilities ((1,000 + 40)/20).
    • B. Correct: (1,000 + 40 - 340)/20 = 35.00.
    • C. Ignores the cash and other assets ((1,000 - 340)/20).
    • D. Subtracts cash instead of adding it ((1,000 - 40 - 340)/20).

  7. Question 7, medium

    A merger arbitrage manager buys shares of a target and sells short the acquirer in a pending stock-for-stock deal. Which description of the strategy's risk profile is most accurate?

    • A.Large gains if the deal is completed, with losses limited to the premium paid, resembling a long call
    • B.Returns that move with credit spreads, since the arbitrage is on the target's bonds
    • C.Frequent modest gains, with occasional large losses if the deal fails, resembling a short put
    • D.Steady returns that are independent of deal completion, because the short position hedges every risk
    Show answer and explanationHide answer

    Correct answer: C. Frequent modest gains, with occasional large losses if the deal fails, resembling a short put

    Spread capture produces small returns when deals close but sizeable losses when they break, similar to writing insurance or a short put. The short acquirer position hedges market and acquirer risk, not deal-failure risk.

    • A. Wrong: upside is limited to the spread, not large, and there is no premium-limited downside.
    • B. Wrong: that describes a capital-structure or credit arbitrage strategy.
    • C. Correct: the payoff is capped upside and large downside on a failed deal.
    • D. Wrong: the short leg does not remove deal-break risk.

  8. Question 8, medium

    Harlow REIT has FFO per share of USD 2.90, AFFO per share of USD 2.50 and a dividend of USD 3.00 per share. Comparable REITs trade at an average price-to-AFFO multiple of 16. What is the implied value per share?

    • A.USD 46.40
    • B.USD 48.00
    • C.USD 40.00
    • D.USD 6.40
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    Correct answer: C. USD 40.00

    The multiple must be applied to the matching measure: 16 x AFFO per share 2.50 = USD 40.00. Using FFO or dividends mixes measures.

    • A. Applies the AFFO multiple to FFO per share (16 x 2.90), a mismatched measure.
    • B. Applies the multiple to the dividend (16 x 3.00).
    • C. Correct: 16 x 2.50 = 40.00.
    • D. Inverts the ratio (16/2.50) and gets a multiple, not a price.

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