R4 Singer-Terhaar Model Practice Question

CFA Level III Portfolio Management
#1

Problem inputs:
Std Dev US real estate: 0.14
Covariance with GIM: 0.0075
Integration with GIM: 0.60
Sharpe ratio of US real estate: n/a
Sharpe ratio of GIM: 0.36
Rf = 3.1%
Expected return of GIM = 7.2%

Cortez’s colleague Jason Grey notes that US real estate is a partially segmented market. For this reason, Grey recommends using the Singer–Terhaar approach to the international extension of the CAPM and assumes a correlation of 0.39 between US real estate and the GIM.

Question: what is the expected return for US real estate?

Answer: 6.3%

First, calculate the fully integrated risk premium (I got this correct), 14.0% × 0.39 × 0.36 = 1.97%

Second, calculate the fully segmented risk premium, 14.0% × 0.36 = 5.04%. I don’t understand why it uses the sharpe ratio of GIM. It should be the sharpe ratio of the segmented market (which is N/A).

Finally, calculate the weighted average with integration as weight.

Thanks a lot!

#2

This is probably an old question: pre-2019.

Back then − in the dark ages, before the Age of Enlightenment − they used the GIM for everything. A good example of this barbaric practice appears on the 2018 actual CFA Level III morning session exam, question 2-A.

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#3

Thank you!

#4

My pleasure.

#5

I have always written in my notes that if they don’t give the Local Sharpe Ratio you always use the Global one instead. Also don’t forget a sneaky little trick they do is they can add a liquidity premium in the question and this needs to be taken into account in the answer.

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