FRM Part II · FRM Exam Part II · Illiquid Assets

A fund holds an illiquid asset worth USD 100 million with true annual volatility of 18%. Reported returns are smoothed so that r_reported = (1−θ)·r_true + θ·r_reported(t−1) with θ = 0.5. Using the Geltner unsmoothing formula r_true = (r_reported − θ·r_reported(t−1))/(1−θ), a reported return of 3% follows a prior reported return of 4%. What is the estimated true return?

The estimated true return is 2%. Unsmoothing removes the lagged component: (3% − 0.5×4%) divided by (1 − 0.5) equals 1% over 0.5, which is 2%. Checking, 0.5×2% plus 0.5×4% reproduces the reported 3%.

1. A2%
2. B1%Correct
3. C3.5%
4. D−1%