Free CFA Level III: Private Markets Practice Questions

A is correct. The appraisal ratio is calculated as the portfolio's alpha (the return earned beyond what is explained by systematic risk exposure) divided by the portfolio's unsystematic (residual or idiosyncratic) risk. It measures the manager's ability to generate abnormal returns per unit of diversifiable risk taken.

B is incorrect because the total return divided by total volatility describes a variant of the return-to-volatility ratio. The Sharpe ratio uses excess return (over the risk-free rate) divided by total standard deviation.

C is incorrect because the excess return over the risk-free rate divided by beta describes the Treynor ratio, which measures risk-adjusted performance per unit of systematic risk, not the appraisal ratio.

A is correct. A credit bid is a powerful tool available to secured creditors in bankruptcy auctions. It allows the secured lender to bid for the debtor's assets using the face value of their debt claim as currency, rather than cash. For example, a lender owed 100 million in secured debt can submit a credit bid of up to 100 million without spending cash. This effectively converts their debt position into an equity (ownership) position in the acquired assets. Credit bidding is a key mechanism for loan-to-own strategies.

B is incorrect. While third parties can bid with cash, the credit bid is specifically a right of secured creditors to use their claims as consideration, which is a unique advantage.

B is incorrect. Management cannot use employment contracts as bidding currency. Credit bids are exclusively for creditors with valid secured claims against the debtor's assets.

A is correct. The Sortino ratio uses downside deviation in the denominator while the Sharpe ratio uses total standard deviation. When the Sortino ratio exceeds the Sharpe ratio, it indicates that downside deviation is less than total standard deviation (assuming the same numerator, which differs slightly by MAR vs. risk-free rate). This occurs when returns are positively skewed — there is more upside variation than downside variation, meaning the total standard deviation captures upside volatility that is not penalized by the Sortino ratio.

B is incorrect because if the distribution were negatively skewed (more downside variation), the downside deviation would be relatively larger, making the Sortino ratio lower than (or closer to) the Sharpe ratio, not higher.

C is incorrect because the Sortino and Sharpe ratios measure different things and commonly differ. The Sharpe ratio uses total standard deviation (both upside and downside) while the Sortino ratio uses only downside deviation. They will be equal only when the return distribution is perfectly symmetric around the MAR/risk-free rate.