CAIA - CHAPTER 10 QUESTIONS AND ANSWERS.

What is a split estate and in what region are split estates uncommon? A split estate is when the surface rights and mineral rights are separately owned. Split estates are relatively uncommon in the U.S. where private land owners tend to own both surface and mineral rights. List the three factors that drive the underlying asset volatility used to price an exchange option. • The volatility of the price of the asset(s) being delivered • The volatility of the price of the asset(s) being received • The covariance or correlation coefficient between the prices. What is the name of an option with no expiration date? Would that option typically be a European option or an American Option? A perpetual option. A perpetual option is an American option because if it were European it would never be able to be exercised and would be worthless What is the name of a lot of land that is vacant and approved for development but for which infrastructure construction has not commenced? Paper Lots When and why are risk-neutral probabilities used? Risk-neutral probabilities are often used in derivative pricing models. A risk-neutral probability may be useful to price derivatives even when investors are risk neutral because the derivative pricing model is being calculated relative to the price of the underlying asset and because the price of the underlying asset can often be viewed as already reflecting risk aversion. What is the role of a timberland investment management organization (TIMO)? Timberland investment management organizations (TIMOs) provide management services to timberland owned by institutional investors such as pension plans, endowments, foundations, and insurance companies. How do agency risks and political risks relate to institutional ownership of farmland? An investor in farmland does not necessarily actively manage the crops. As such, the investor relies on payment from the lessee (the agent) that operates the property. The risk that the lessor (the principal or investor) does not get paid by the agent is agency risk. Political risk is the economic uncertainty due to changes in government policy that may affect returns. The investor in farmland can be hurt by such political issues such as decreases in support payments or changes in land ownership rights Other than moneyness of the best available use, what are the three factors regarding the uses that would cause a multiple-use option to have a low value? • High similarity among the profitability of each alternative • Low volatility of the profitability of each alternative • High correlation between the profitability of each alternative. What is the effect of smoothed asset values on the measured risks of the asset? Smoothed asset values mask risk thereby biasing risk estimates downward. What is contagion in a financial market Contagion is the general term used in finance to indicate any tendency of major market movements, especially declines, to be transmitted from one financial market to other financial markets. Three Factors of Multiple Use Option Prices 1. The current closeness of the profitability of each alternative to each other. 2. The volatility of the profitability of each