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LOS g: Calculate, interpret, and explain the importance of implementation shortfall as a measure of transaction costs. ffice ffice" />
Q1. As the senior portfolio manager for the Calvert Pension Fund, Jill Hohlman is responsible for the investment decisions as well as the execution of trades. Debbie Walker is responsible for the equity portion of the Calvert Pension Fund portfolio. It is Hohlman’s belief that her portfolio managers should be able to measure trading costs as well as have a complete understanding of available trading techniques.
Discussing the types of trading cost benchmarks, Hohlman states that the volume-weighted average price (VWAP) is a weighted average of security prices during a day, where the weight applied is the proportion of the day’s trading volume. She states further that the volume-weighted average price is preferred to the trading cost benchmark alternative of the opening day’s stock price because the opening price can be gamed to a greater extent by traders, relative to the volume-weighted average price. She also mentions that the effective spread is another useful alternative to the opening price because the effective spread cannot be gamed.
Discussing the types of trading cost benchmarks further, ffice:smarttags" />Walker states that the implementation shortfall, which is the difference between the actual portfolio’s return and a paper portfolio’s return, is probably the most accurate measure of trading costs. She states that the paper portfolio’s return is based on the security price when the decision to trade is originally made. She mentions that it is not subject to gaming, and incorporates both explicit and implicit trading costs.
Hohlman asks Walker to evaluate a trade made last week for the Calvert Pension Fund, using the implementation shortfall measure. The trade was a buy order for the stock of Brucker Industries. Brucker Industries is a small cap stock, which Hohlman thinks is a timely buy given recent announcement about the firm’s prospects. On Wednesday, Brucker Industries stock price closed at $20.00 a share. On Thursday morning before the market opened, the portfolio manager for the Calvert Pension Fund decided to buy Brucker Industries and transferred a limit order for $19.97 a share for 1000 shares to the trader. The order expired unfilled. The Brucker Industries stock closed at $20.03 on Thursday. On Friday, the order was revised to a limit of $20.07. The order was partially filled that day as 800 shares were bought at $20.07. The commission was $14. The stock closed at $20.09 on Friday and the order was cancelled.
Regarding Hohlman’s statement concerning trading cost benchmarks:
A) Hohlman is correct.
B) Hohlman is incorrect because the effective spread can be gamed.
C) Hohlman is incorrect because the opening price cannot be gamed more than the volume-weighted average price.
Correct answer is B)
Hohlman is incorrect because the effective spread can be gamed. A trader may wait for other traders to come to them, i.e. when another trader is seeking liquidity. By doing so, the trader can trade at favorable bid and ask prices. However, the trader’s delay may cost the investor foregone profits. She is correct though that the volume-weighted average price is preferred to the opening day’s stock price because the opening price can be gamed to a greater extent by traders, relative to the volume-weighted average price. This is because the opening price is known with more certainty than the VWAP.
Q2. Regarding Walker’s statement concerning the implementation shortfall:
A) Walker is incorrect because the implementation shortfall does not incorporate implicit trading costs.
B) Walker is correct.
C) Walker is incorrect because the implementation shortfall is subject to gaming.
Correct answer is B)
Walker is correct. The implementation shortfall is perhaps the most accurate measure of trading costs, it is not subject to gaming, and incorporates both explicit and implicit trading costs.
Q3. What is the realized profit and loss component of the implementation shortfall measure Walker should calculate for the Brucker Industries trade?
A) 0.09%.
B) 0.16%.
C) 0.12%.
Correct answer is B)
The realized profit and loss is calculated using the execution price minus the decision price, which is usually measured as the previous day’s closing price. This is divided by the original price and weighted by the proportion of the order filled. It is (800/1000) x ($20.07-$20.03)/$20.00 = 0.16%. The positive value means that there is a loss (a cost) here.
Q4. What is the delay costs component of the implementation shortfall measure Walker should calculate for the Brucker Industries trade?
A) 0.18%.
B) 0.12%.
C) 0.24%.
Correct answer is B)
The delay costs are calculated using the difference between the closing price on the day an order was not filled and the previous day closing price. It is weighted by the portion of the order filled. It is (800/1000) x ($20.03-$20.00)/$20.00 = 0.12%.
Q5. What is the missed trade opportunity cost component of the implementation shortfall measure Walker should calculate for the Brucker Industries trade?
A) 0.12%.
B) 0.09%.
C) 0.18%.
Correct answer is B)
The missed trade opportunity cost is calculated using the difference between the price at which the order is cancelled and the original price. It is weighted by the portion of the order that is not filled. It equals (200/1000) x ($20.09-$20.00)/$20.00 = 0.09%.
Q6. What is the implementation shortfall Walker should calculate for the Brucker Industries trade?
A) 0.51%.
B) 0.44%.
C) 0.37%.
Correct answer is B)
To calculate the implementation shortfall, we must also add in the explicit costs, which are the commission as a percent of the paper portfolio investment: $14/$20,000 = 0.07%. The total implementation cost is the sum of the explicit costs, the realized profit and loss, the delay costs component, and the missed trade opportunity cost component: 0.07%+0.16%+0.12%+0.09% = 0.44%.
Q7. Which of the following implementation shortfall components is NOT influenced by market-wide movements?
A) Missed trade opportunity cost.
B) Realized profit and loss.
C) Explicit costs.
Correct answer is C)
The realized profit and loss and missed trade opportunity cost are all affected by market movements that the manager should not be held accountable for. For example, if the security increases due to market-wide movements, the trader should not be held responsible for this non-security specific change in price. Market-wide movements can be adjusted for by the market model.
Q8. Use the following information to calculate the implementation shortfall components:
- On Wednesday, the stock price closes at $40 a share.
- On Thursday morning before market open, the portfolio manager decides to buy Megawidgets and transfers a limit order for $39.95 a share, for 1,000 shares. The price never falls to $39.95 during the day and the order expires unfilled. The stock closes at $40.04.
- On Friday, the order is revised to a limit of $40.05. The order is partially filled that day as 700 shares are bought at $40.05. The commission is $17. The stock closes at $40.08 and the order is cancelled.
A) The opportunity costs are 0.06% and the total implementation shortfall is 0.19%.
B) The opportunity costs are 0.06% and the total implementation shortfall is 0.15%.
C) The opportunity costs are 0.07% and the total implementation shortfall is 0.19%.
Correct answer is A)
To decompose the implementation shortfall, we calculate the following:
§ Explicit costs – the commission as a percent of the paper portfolio investment is $17/$40,000 = 0.04%.
§ Realized profit and loss is calculated using the execution price minus the decision price, which is usually measured as the previous day’s closing price. This is divided by the original price and weighted by proportion of the order filled. It is (700/1000) × ($40.05 - $40.04)/$40.00 = 0.02%.
§ Delay costs are calculated using the difference between the closing prices on the day an order was not filled and the previous day closing price. It is weighted by the portion of the order filled. It is (700/1,000) × ($40.04 - $40.00)/$40.00 = 0.07%.
§ Missed trade opportunity cost is calculated using the difference between the price at which the order is cancelled and the original price. It is weighted by the portion of the order that is not filled. It equals (300/1,000) × ($40.08 - $40.00)/$40.00 = 0.06%.
The sum of the components is the total implementation cost: 0.04% + 0.02% + 0.07% + 0.06% = 0.19%.
Q9. Which of the following statements regarding the implementation shortfall components is least accurate?
A) Missed trade opportunity cost is weighted by the portion of the order that is filled.
B) Missed trade opportunity cost represents the difference between the price at which the order is cancelled and the original price.
C) Realized profit and loss represents the difference between the execution price and the previous day's closing price.
Correct answer is A)
Missed trade opportunity cost is weighted by the portion of the order that is not filled. It is calculated using the difference between the price at which the order is cancelled and the original price. Realized profit and loss uses the difference between the execution price and the previous day's closing price. This is divided by the original price and weighted by the portion of the order filled.
Q10. If the market return was 1.2% over the time period of trading, the risk-free rate was 0.1%, the stock beta was 1.3, and the shortfall implementation cost is 0.48% for trading in the stock, then what is the shortfall implementation cost to which the manager should be held accountable?
A) -1.07%.
B) 1.07%.
C) -1.08%.
Correct answer is C)
The realized profit and loss, delay costs, and missed trade opportunity cost of the implementation shortfall are all affected by market movements that the manager should not be held accountable for. The implementation shortfall should be adjusted for market-wide movements, resulting in the a market-adjusted implementation shortfall. Over a few days, the alpha term is assumed to be zero, so no adjustment for the risk-free rate is necessary. If the market return was 1.2% over the time period of this trading and the beta was 1.3 for the stock, then the expected return for it would be 1.2% ×1.3 = 1.56%. Subtracting this from the 0.48% results in a market-adjusted implementation shortfall of 0.48% - 1.56% = -1.08%.
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发表于 2009-4-10 11:36
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