TRADINGAnswers Gain on the paper portfolio Paper portfolio = 1,000 shares × $535/share = $535,000 Terminal value paper portfolio = 1,000 shares × $537.25/share = $537,250 Gain paper portfolio = 537,250 – 535,000 = $2,250 Gain on the real portfolio Real portfolio = 750 shares × $536.25 + $402 = $402,590 Terminal value real portfolio = 750 shares × $537.25 = $402,938 Gain real portfolio = 402,938 – 402,590 = $348 i Implementation shortfall ii Explicit costs 2,250 348 0.0036 0.36% 535,000 $402 0.00075 0.075% $535,000 iii Realized loss 536.25 535.15 750 1,000 0.00154 0.154% 535.00 535.15 535.00 750 1,000 0.00021 0.021% 535.00 iv Delay costs 537.25 – 535 250 1,000 0.00105 0.105% 535 v MTOC Sample Scoring Key: points for each of the five calculations Partial credit may be given for correctly setting up a calculation even if a math error is made Candidate Discussion Summing the four elements of implementation shortfall (items ii through v above) should equal the implementation shortfall calculated as the difference between the actual portfolio’s return and the paper portfolio’s return as shown in item i above Thus total implementation cost = 0.00075 + 0.00154 + 0.00021 + 0.00105 = 00355, or 0.36%, which equals the implementation shortfall calculated in item i above Question Part A Tan is incorrect because a disciplined approach is better able to control risk and potentially add value Lewin is correct The constant mix approach supplies market liquidity as securities are bought in a downward trending market and sold in an upward trending market Sample Scoring Key: point each for identifying each statement as incorrect or correct points each for the justification Part B Wider: The plan has higher risk tolerance, and risk tolerance is positively related to optimal corridor width The higher risk tolerance makes it unnecessary to incur the higher transaction costs of frequent rebalancing Sample Scoring Key: point for wider, points for the explanation, Part C 25% ± 5% is a corridor width of 20–30% Rebalancing would occur if the asset class exceeds 30,400,000 × = 9,120,000 or is lower than 30,400,000 × = 6,080,000 Since Developed Country International stocks are 8,816,00, no rebalancing is necessary at this time Sample Scoring Key: points for the corridor width of 20–30% points for determining no rebalancing necessary at this time Candidate Discussion The note in exhibit B specified how to interpret the ±5% Part D Fixed income should be narrower The lower transaction costs make more frequent rebalancing from a narrower range less costly Hedge funds are more positively correlated with other asset classes This reduces the benefits of rebalancing and leads to setting a wider corridor for hedge funds Sample Scoring Key: points for narrower corridor for fixed income points each for the two reasons These are the only relevant reasons based on the data provided ... explanation, Part C 25% ± 5% is a corridor width of 20 30 % Rebalancing would occur if the asset class exceeds 30 ,400,000 × = 9,120,000 or is lower than 30 ,400,000 × = 6,080,000 Since Developed Country.. .Question Part A Tan is incorrect because a disciplined approach is better able to control risk and... no rebalancing is necessary at this time Sample Scoring Key: points for the corridor width of 20 30 % points for determining no rebalancing necessary at this time Candidate Discussion The note in