Reading 41: Execution of Portfolio Decisions－LOS a price, market, contrast, including, execution

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 14: Execution of Portfolio Decisions
Reading 41: Execution of Portfolio Decisions
LOS a: Compare and contrast market orders to limit orders, including the price and execution uncertainty of each.

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A market order has:

A) execution uncertainty but not price uncertainty.

B) price uncertainty but not execution uncertainty.

C) both price uncertainty and execution uncertainty.

D) neither price uncertainty nor execution uncertainty.

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Answer and Explanation

A market order is an order to execute the trade immediately at the best possible price. The emphasis in a market order is the speed of execution (the reduction of execution uncertainty). The disadvantage of a market order is that the price it will be executed at is not known ahead of time, it thus has price uncertainty.

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A limit order has:

A) price uncertainty but not execution uncertainty.

B) execution uncertainty but not price uncertainty.

C) both price uncertainty and execution uncertainty.

D) neither price uncertainty nor execution uncertainty.

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Answer and Explanation

A limit order is an order to trade at the best possible price, subject to the price satisfying the limit price. A limit order emphasizes the price of execution (the reduction of price uncertainty). It however, may not be filled immediately and may even go unfilled or partially unfilled. A limit order thus has execution uncertainty.

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A trader submits a buy order that specifies that the trade must be executed at $40 by the end of the day. The execution price is $39.88. What type of order has the trader executed?

A) A limit order.

B) A market order.

C) A principal order.

D) A portfolio order.

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Answer and Explanation

A limit order is an order to trade at the best possible price, subject to the price satisfying the limit price. For buy orders, the execution price (here $39.88) must be lower or equal to the limit price (here $40). Limit orders also have an expiration date, beyond which they expire.

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In which of the following markets would the calculation of market impact costs be inappropriate?

A) Auction markets.

B) Automated auctions.

C) Electronic crossing networks.

D) Electronic limit-order markets.

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Answer and Explanation

In an electronic crossing network, orders are executed at the average of the bid and ask quotes. Prices do not adjust based on supply and demand.