Free CFA Level III: Private Markets Infrastructure Practice Questions
Study infrastructure investing for CFA Level III. Questions cover infrastructure fund structures, public-private partnerships, valuation approaches, and the risk-return profile of infrastructure assets.
Sample Questions
Question 1
Easy
Political risk in infrastructure investing refers to:
Solution
A is correct. Political risk encompasses the range of government actions that can adversely affect infrastructure investments: (1) Regulatory changes — modifying allowed returns, tariff structures, or environmental requirements. (2) Contract renegotiation — governments pressuring concession holders to accept less favorable terms. (3) Tax changes — imposing new taxes on infrastructure revenues. (4) Expropriation — in extreme cases, government seizure of private infrastructure assets. This risk is particularly relevant for infrastructure because: long concession periods span multiple political administrations, and essential services are politically sensitive.
Choice C is incorrect because government investment in competing projects describes competitive or market risk, not political risk. Political risk specifically relates to adverse government actions affecting existing investments through regulatory, contractual, or legal changes.
Choice B is incorrect because increased political popularity of infrastructure would generally benefit investors through supportive policies and increased investment. Political risk refers to adverse government actions that reduce returns, not positive developments that enhance the asset class's attractiveness.
Choice C is incorrect because government investment in competing projects describes competitive or market risk, not political risk. Political risk specifically relates to adverse government actions affecting existing investments through regulatory, contractual, or legal changes.
Choice B is incorrect because increased political popularity of infrastructure would generally benefit investors through supportive policies and increased investment. Political risk refers to adverse government actions that reduce returns, not positive developments that enhance the asset class's attractiveness.
Question 2
Medium
Compared to private equity, infrastructure investments typically offer:
Solution
C is correct. Infrastructure typically offers lower but more stable returns compared to PE: (1) Target returns of 8-14% for infrastructure versus 15-25% for PE. (2) Greater cash flow predictability from regulation and long-term contracts. (3) Longer holding periods (20-99 years for infrastructure assets vs. 3-7 years for PE). (4) Inflation linkage that PE does not inherently provide. (5) Lower return volatility due to essential service demand and regulated pricing.
A is incorrect. Infrastructure returns are generally lower than PE, holding periods are much longer (not shorter), and infrastructure is not more liquid — both are illiquid private market investments.
B is incorrect. Infrastructure and PE have distinct risk-return profiles. Infrastructure is lower risk/return with income orientation; PE is higher risk/return with capital appreciation orientation.
A is incorrect. Infrastructure returns are generally lower than PE, holding periods are much longer (not shorter), and infrastructure is not more liquid — both are illiquid private market investments.
B is incorrect. Infrastructure and PE have distinct risk-return profiles. Infrastructure is lower risk/return with income orientation; PE is higher risk/return with capital appreciation orientation.
Question 3
Hard
An infrastructure fund acquires a brownfield airport concession for 2 billion. The airport generates annual EBITDA of 200 million with a long-term growth rate of 2.5%. The fund uses 50% leverage at 4% interest rate. If the fund targets a 12% equity IRR over a 10-year hold, and EBITDA grows as expected, the minimum exit EBITDA multiple required to meet the target return is closest to:
Solution
B is correct. Entry: EV = 2,000M. Debt = 1,000M at 4%. Equity = 1,000M. Entry multiple = 2,000/200 = 10x.
Year 10 EBITDA = 200 x 1.025^10 = 200 x 1.280 = 256M. Interest = 1,000 x 4% = 40M per year. Annual cash flow to equity ≈ EBITDA - Interest - Maintenance capex. Assuming reinvestment maintains the asset and debt stays constant for simplicity.
Target equity value at year 10: 1,000 x (1.12)^10 = 1,000 x 3.106 = 3,106M (ignoring interim cash flows). To achieve this from exit equity: Exit EV - 1,000 (debt) = 3,106. Exit EV = 4,106M. Required exit multiple = 4,106 / 256 = 16x.
But this ignores interim cash distributions which reduce the required exit value. With annual cash flow to equity of approximately 200 - 40 = 160M (growing), the present value of distributions over 10 years is significant. The required exit multiple drops materially.
A rough estimate: interim distributions total approximately 1,800M (undiscounted). Required exit equity ≈ 3,106 - FV of distributions ≈ 3,106 - 1,800 x growth factor ≈ a lower number, suggesting an exit multiple around 10-12x. Given the choices, 12x is the closest reasonable answer for the minimum exit multiple required.
A is incorrect. 10x would be the same as the entry multiple, providing no multiple expansion. With the debt structure and interim cash flows, achieving a 12% equity IRR likely requires some multiple expansion above the 10x entry.
C is incorrect. 8x would represent multiple contraction, making it nearly impossible to achieve a 12% equity IRR.
Year 10 EBITDA = 200 x 1.025^10 = 200 x 1.280 = 256M. Interest = 1,000 x 4% = 40M per year. Annual cash flow to equity ≈ EBITDA - Interest - Maintenance capex. Assuming reinvestment maintains the asset and debt stays constant for simplicity.
Target equity value at year 10: 1,000 x (1.12)^10 = 1,000 x 3.106 = 3,106M (ignoring interim cash flows). To achieve this from exit equity: Exit EV - 1,000 (debt) = 3,106. Exit EV = 4,106M. Required exit multiple = 4,106 / 256 = 16x.
But this ignores interim cash distributions which reduce the required exit value. With annual cash flow to equity of approximately 200 - 40 = 160M (growing), the present value of distributions over 10 years is significant. The required exit multiple drops materially.
A rough estimate: interim distributions total approximately 1,800M (undiscounted). Required exit equity ≈ 3,106 - FV of distributions ≈ 3,106 - 1,800 x growth factor ≈ a lower number, suggesting an exit multiple around 10-12x. Given the choices, 12x is the closest reasonable answer for the minimum exit multiple required.
A is incorrect. 10x would be the same as the entry multiple, providing no multiple expansion. With the debt structure and interim cash flows, achieving a 12% equity IRR likely requires some multiple expansion above the 10x entry.
C is incorrect. 8x would represent multiple contraction, making it nearly impossible to achieve a 12% equity IRR.
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