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CFA Level I · CFA Level I Exam · Investments in Private Capital: Equity and Debt

A private equity fund's general partner reports that a portfolio company's value is unchanged since the last period. Which of the following best describes why reported interim private equity returns may understate true volatility?

Reported volatility is understated because private equity valuations are typically appraisal-based and smoothed rather than set by frequent market trades. This stale, infrequent pricing hides the true variation in value and lowers measured standard deviation.

  1. AValuations are often appraisal-based and smoothed, rather than set by frequent market tradingCorrect
  2. BLimited partners can trade fund interests daily, which dampens price swings
  3. CManagement fees are charged continuously, which removes variation in returns

Explanation

Private holdings lack continuous market prices, so valuations rely on infrequent appraisals and models that tend to be smoothed, which understates measured volatility. Fund interests are illiquid and fees do not remove return variation.

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