CFA Level I · CFA Level I Exam · Alternative Investment Features, Methods, and Structures
An analyst notes that reported returns of a private real estate fund are based on periodic appraisals. Relative to the true underlying volatility, the reported volatility is most likely:
Reported volatility is most likely understated. Appraisal-based values lag market movements and smooth returns across periods, which reduces measured standard deviation and correlation with other assets, making the investment appear less risky and more diversifying than it truly is.
- Aunderstated, because appraisals smooth returnsCorrect
- Baccurate, because appraisals reflect fair value
- Coverstated, because appraisals are updated infrequently
Explanation
Appraisal-based valuations lag market prices and smooth changes over time, which dampens measured variance and correlations with other assets. This makes risk look lower and diversification benefits look larger than they are.
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