Free CAIA Level I Real Assets Practice Questions

A is correct. Contango describes a market condition where futures prices are higher than the current spot price, creating an upward-sloping forward curve. This typically occurs when storage costs and financing costs exceed the convenience yield.
Choice C is incorrect because when spot prices exceed futures prices, the market is in backwardation, which is the opposite of contango.
Choice B is incorrect because while futures prices do converge toward the spot price as expiration approaches (convergence), this convergence phenomenon is distinct from the definition of contango, which refers to the relationship between spot and futures prices at a given point in time.
Choice D is incorrect because when the convenience yield exceeds storage costs, the forward curve tends to slope downward (backwardation), not upward. Contango occurs when storage and financing costs dominate the convenience yield.

D is correct. Tranching in a CMBS structure redistributes the credit risk of the underlying mortgage pool among different classes (tranches) of bondholders. Senior tranches have first claim on cash flows and are protected by subordination from junior tranches, which absorb losses first. This allows different investors to select risk-return profiles that match their preferences.
Choice A is incorrect because tranching does not increase the total interest collected from the mortgage pool. The aggregate cash flows from the underlying loans remain the same; tranching only determines how those flows and associated risks are allocated among investors.
Choice B is incorrect because tranching does not eliminate credit risk. It reallocates credit risk so that senior tranches bear less risk and junior tranches bear more, but the total credit risk in the pool remains unchanged.
Choice C is incorrect because tranching primarily addresses credit risk allocation, not interest rate conversion. While some CMBS structures may include floating-rate tranches, the primary purpose of tranching is credit risk redistribution, not interest rate transformation.

B is correct. Tracking error relative to CPI measures how closely the portfolio return matches inflation over time. The optimal approach combines portfolio construction principles with inflation sensitivity. Assets with moderate inflation betas but low cross-correlations (e.g., farmland, commodities, and infrastructure have different fundamental drivers) create a portfolio where idiosyncratic deviations from inflation offset each other. Concentrating in the single highest-inflation-beta asset exposes the portfolio to that asset's idiosyncratic risk (e.g., commodity-specific supply shocks), increasing tracking error. The diversified approach smooths these deviations, producing more consistent inflation-tracking returns.
Choice A is incorrect because selecting only the highest individual inflation betas without considering cross-correlations ignores portfolio construction fundamentals. If the top inflation hedges are highly correlated with each other, the portfolio gains concentration risk without additional inflation-tracking benefit, and their shared non-inflation risk factors increase tracking error.
Choice C is incorrect because low volatility does not imply inflation tracking; a low-volatility asset with zero inflation beta (e.g., short-term investment-grade bonds) would have high tracking error to CPI despite its low risk. Inflation tracking requires positive inflation sensitivity, not merely low volatility.
Choice D is incorrect because publicly traded real assets exhibit mark-to-market volatility driven by equity market sentiment, which introduces noise relative to CPI and can increase tracking error. Private market valuations, while smoothed, may actually track inflation more closely in measured terms due to their appraisal-based pricing being linked to fundamental values.