## Module 42.5 LOS 42.m: Financial ratios used to analyze private real estate investments

Lenders often use the debt service coverage ratio (DSCR) and the loan-to-value (LTV) ratio to determine the maximum loan amount on a specific property. The maximum loan amount is based on the measure that results in the lowest debt. DSCR = First year NOI/debt service LTV = loan amount/appraisal value Debt service (loan payment) includes interest and principal. Equity … Read more

## Module 42.4 LOS 42.i: Valuing Real Estate Using the Cost and Sales Comparison Approach

Cost Comparison Approach Estimate the market value of the land. The value of the land is estimated separately, often using the sales comparison approach. Estimate the building’s replacement cost. Replacement cost is based on current construction costs and standards and should include any builder/developer’s profit. Deduct depreciation including physical deterioration, functional obsolescence, locational obsolescence, and economic obsolescence. … Read more

## Module 42.2 LOS 42.g: Direct Capitalization Approach

In the direct capitalization approach to property valuation, we discount or “capitalize” first year NOI by the capitalization rate. NOI is the amount of income remaining after subtracting vacancy and collection losses, and operating expenses (e.g., insurance, property taxes, utilities, maintenance, and repairs) from potential gross income. NOI = full occupancy rental income + other … Read more

## Module 40.1-40.2: Option Binomial Trees

We can apply binomial trees to calculate the value of options. Options generate tree paths by the 2 states that can occur, an up value and a down value. To calculate the value of the option, we first adjust the up and down values in to risk neutral probability rates. If not given, the up … Read more

## Module 40.6: The Black Scholes Merton Model

The BSM model allows us to value options continuously in real time, as long as the no-arbitrage condition holds. The no-arbitrage option price guarantees that the hedge portfolio will yield the risk free rate. There are six underlying assumptions of the BSM Model: The underlying asset price follows a geometric Brownian motion process. The return … Read more

## Module 37.3 LOS 37.c: Expected return on bond given transition in its credit rating

The change in price of a bond when it experiences a change in credit rating is dependent on the modified duration of the bong and the change in spread that is associated with the ratings event. Δ%P = – (modified duration of the bond) × (Δ spread) Table of Contents﻿

## Module 34.1 LOS 34.b: Calculate forward and spot prices using the forward pricing and forward rate models

The forward pricing model states that two investors should be indifferent between paying P for a j+k year zero coupon, \$1 FV contract and paying the PV of a j year zero coupon \$1 FV forward contract maturing in k years at a price of Fj+k­. P(j+k) = PjF(j,k) Or F(j,k) = P(j+k)/Pj The forward rate model relates … Read more

## Module 34.1 LOS 34.c: Bootstrapping Spot Rates

We can derive spot rates from the par rate curve through a process called bootstrapping. Bootstrapping is in iterative process that uses the output of one step as the input to the next. Bootstrapping works on the basis that the one year par rate is the same as the one year spot rate. Using S1 … Read more

## Module 37.1 LOS 37.a: Explain expected exposure, the loss given default, the probability of default, and the credit valuation adjustment

Expected exposure is the amount a investor stands to lose on risky bond before recovery amounts are taken into consideration. Recovery rate, the percent recovered in event of default, is the opposite of loss severity. (1-recovery rate = loss severity). Loss given default is equal to loss severity multiplied by exposure. Probability of default measure … Read more

## Module 30.5 LOS 30.f, 30.g, 30.i, 30.j 30.l: Firm valuation with FCFF and FCFE

In free cash flow valuation models, we have a control perspective that assumers value recognition will be immediate. DDM models take a minority perspective which means that value may not be reflective of the DDM value until dividend policy correctly reflects long-run profitability. Note that share repurchases, share issues and changes in leverage have little … Read more