Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

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What is the interest coverage ratio of a property with a net operating income of $93,000 and a $450,000 interest-only commercial mortgage at 7.25%

2.85
4.05
1.75
3.10

The correct answer is: 2.85

To determine the interest coverage ratio, you first need to calculate the annual interest payment on the commercial mortgage. The interest-only loan amount is $450,000, and the interest rate is 7.25%. The calculation for the annual interest payment is as follows: Annual Interest Payment = Loan Amount × Interest Rate Annual Interest Payment = $450,000 × 0.0725 = $32,625 Now, to find the interest coverage ratio, you divide the net operating income (NOI) by the annual interest payment: Interest Coverage Ratio = Net Operating Income / Annual Interest Payment Interest Coverage Ratio = $93,000 / $32,625 ≈ 2.85 This result indicates that the property's net operating income is 2.85 times greater than the interest expense, suggesting a relatively comfortable ability to cover its interest obligations. A ratio above 1 implies that the property generates enough income to cover its interest payments, which is a key indicator of financial health in real estate investments. The answer of 2.85 is correct because it accurately represents the calculation and demonstrates a positive financial metric regarding the property's ability to service its debt.