LOS h: Contrast volume weighted average price (VWAP) and implementation shortfall as measures of transaction costs.

Q1. Which of the following is FALSE regarding implementation shortfall? Implementation shortfall:

A)   requires considerable data and analysis.

B)   decomposes and identifies costs.

C)   is subject to gaming.

Q2. Which of the following is FALSE regarding VWAP? VWAP:

A)   does not evaluate delayed or unfilled orders.

B)   is applicable to small and large trades.

C)   does not account for market movements or trade volume.

Q3. Which of the following measures is least susceptible to gaming by traders?

A)   VWAP.

B)   Effective spread.

C)   Implementation Shortfall.

LOS h: Contrast volume weighted average price (VWAP) and implementation shortfall as measures of transaction costs. fficeffice" />

Q1. Which of the following is FALSE regarding implementation shortfall? Implementation shortfall:

A)   requires considerable data and analysis.

B)   decomposes and identifies costs.

C)   is subject to gaming.

Correct answer is C)

The advantages of implementation shortfall are that portfolio managers can see the cost of implementing their ideas, it demonstrates the tradeoff between quick execution and market impact, it decomposes and identifies costs; it can be used in an optimizer to minimize trading costs and maximize performance, and is not subject to gaming. Its disadvantages are that it may be unfamiliar to traders and requires considerable data and analysis.

Q2. Which of the following is FALSE regarding VWAP? VWAP:

A)   does not evaluate delayed or unfilled orders.

B)   is applicable to small and large trades.

C)   does not account for market movements or trade volume.

Correct answer is B)

The advantages of VWAP are that it is easily understandable, computationally simple, can be applied quickly to enhance trading decisions, and is most appropriate for small trades in nontrending markets. The disadvantages of VWAP are that it is not informative for trades that dominate trading volume, it can be gamed by traders, it does not evaluate delayed or unfilled orders, and does not account for market movements or trade volume.

Q3. Which of the following measures is least susceptible to gaming by traders?

A)   VWAP.

B)   Effective spread.

C)   Implementation Shortfall.

Correct answer is C)

The measurement least susceptible to gaming would be the implementation shortfall measure. VWAP can be gamed by traders, who might time their trades until the VWAP makes their trading costs appear favorable. The effective spread can also be gamed. A trader can trade at favorable bid and asks by waiting for orders to be brought to them.

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