FRM Part II · FRM Exam Part II · Illiquid Assets
An investor with uncertain near-term cash needs is considering a private real estate fund with a ten-year lock-up that offers an expected return premium over listed real estate. Which assessment of the premium is most appropriate?
The premium compensates the investor for bearing illiquidity, so it should be accepted only if the investor can tolerate being locked in without selling when cash is needed. Investors with uncertain near-term needs risk forced sales at deep discounts, which can erase the premium.
- AThe premium compensates for bearing illiquidity and should be accepted only if the investor can tolerate being unable to sell when cash is neededCorrect
- BThe premium is risk-free because private valuations are stable
- CThe premium is irrelevant because lock-ups do not affect investor outcomes
- DThe premium should be accepted by all investors regardless of liquidity needs
Explanation
An illiquidity premium is compensation for bearing the risk of not being able to trade. It suits investors with long horizons and stable liquidity needs. Stable appraisal-based valuations understate risk, and investors with uncertain cash needs may be forced to sell at a discount.
Did you get it right without looking?
One question tells you little. A timed set on Illiquid Assets shows your real accuracy, how long you take and where you lose marks.
More Illiquid Assets questions
- A fund holds a private equity position whose appraisal-based returns show annual volatility of 8%. Analysts believe true economic volatility…
- Observed returns of an illiquid fund follow R_obs,t = 0.6 × R_true,t + 0.4 × R_obs,t-1 (a Geltner-type smoothing). The previous observed ret…
- A fund has a 60% allocation to listed equities and 40% to illiquid assets. During a market stress, it faces capital calls and redemptions th…
- A risk manager wants to unsmooth reported returns of an illiquid hedge fund strategy that exhibit first-order autocorrelation of 0.3. Which …
- A pension fund's investment committee is reviewing its allocation to private real estate and infrastructure funds. A trustee argues that the…
- A fund holds private real estate valued by quarterly appraisals. An analyst notes that its reported returns show strong positive first-order…