Reading 31 Execution of Portfolio Decisions FinQuiz.com FinQuiz.com CFA Level III Item-set - Solution Study Session 16 June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2018 - All rights reserved Reading 31 Execution of Portfolio Decisions FinQuiz.com FinQuiz Level III 2018 – Item-sets Solution Reading 31: Execution of Portfolio Decisions Question ID: 13346 Correct Answer: C The effective spread is calculated as the difference between the execution price and the midpoint of the bid-ask spread Effective Spread100 Shares = × [1.460 – {(1.456 + 1.462)/2}] = $0.002 Effective Spread250 Shares = × [1.472 – {(1.466 + 1.472)/2}] = $0.006 Effective Spread350 Shares = × [1.490 – {(1.478 + 1.480)/2}] = $0.022 The average effective spread is $0.010 [($0.002 + $0.006 + $0.022)/3] Question ID: 13347 Correct Answer: A The average quoted bid-ask spread is calculated as follows: The quoted spread for the first order is $0.006 ($1.462 – $1.456) The quoted spread for the second order is $0.006 ($1.472 – $1.466) The quoted spread for the third order is $0.002 ($1.480 – $1.478) The average quoted bid-ask spread is thus $0.0047 [($0.006 + $0.006 + $0.002)/3] By comparing the average effective (see solution to Part 1) and quoted bid-ask spreads, the following conclusions can be derived: • • • • there was a price improvement in the first trade as the execution price was lower than the ask price Therefore the effective spread is lower than the bid-ask spread there was no price improvement in the second trade as the shares were purchased at the execution price Accordingly quoted and effective spreads were equal In the third order, the effective spread was greater than the quoted spread because the order size was greater than the ask size and the order had to walk up the limit order book, resulting in a high average price for the purchase and thus a higher effective spread The market has a relatively lower level of liquidity as the average effective spread is greater than the average quoted spread Question ID: 13348 Correct Answer: B Realized profit/loss reflects the difference between the execution price and the relevant decision price (the closing price of the previous day) The calculation of this profit/loss is as follows: 45% × 6,000 17.00 − 16.15 = 2.55% 15.00 6,000 FinQuiz.com © 2018 - All rights reserved Reading 31 Execution of Portfolio Decisions FinQuiz.com Question ID: 13349 Correct Answer: C Although the size of the ABC trade order relative to average trade volume (88%) is high, the low spread associated with trade and high level of urgency both mean that ABC should be executed using an implementation shortfall strategy The proportion of DEF’s shares traded relative to average daily volume is relatively small (20%) However it has a high spread of 0.43 which makes this stock inappropriate for algorithmic trading and should instead be traded using a broker The proportion of GHI’s shares traded is low relative to average daily volume (20%) and its associated spread is low These two factors, in addition to its low level of urgency, make a VWAP strategy most appropriate for the order Question ID: 13350 Correct Answer: B Based on the statement made by Berome Inc to EA, the pension fund management firm reflects the ‘need-trustworthy-agent’ trading focus This is because the pension fund manager emphasizes broker skills as important and stresses that time is not of essence Orders executed under a need-trustworthy-agent trading focus, are completed through a series of partial trades In addition, immediate execution is not of primary importance Furthermore such a trading focus is used for large-scale trades This trading focus places a high degree of trust on the broker’s skills Question ID: 13351 Correct Answer: A The most appropriate market platform for executing Jeromine Tait Manufacturers’ trade orders is an order-driven market This is because trades on this market can be executed without using an intermediary such as a dealer Additionally, order driven markets such as electronic crossing networks and ECNs provide anonymity when executing trades Additionally, using electronic crossing networks, the effects a large order can have on execution prices and information leakage is considerably reduced which allows for large trades to be executed Furthermore, electronic crossing networks allow buyers and sellers to avoid the costs of dealer services (the bid-ask spread) Although the specialized nature of emerging market equities might call for a brokered market to skillfully handle the transactions in smaller less developed emerging markets, the manufacturing firm has expressed its desire to avoid the use of an intermediary when executing its trades which effectively rules out the use of a brokered market FinQuiz.com © 2018 - All rights reserved .. .Reading 31 Execution of Portfolio Decisions FinQuiz. com FinQuiz Level III 2018 – Item- sets Solution Reading 31 : Execution of Portfolio Decisions Question ID: 133 46 Correct Answer:... 16.15 = 2.55% 15.00 6,000 FinQuiz. com © 2018 - All rights reserved Reading 31 Execution of Portfolio Decisions FinQuiz. com Question ID: 133 49 Correct Answer: C Although the size... 1.472)/2}] = $0.006 Effective Spread350 Shares = × [1.490 – {(1.478 + 1.480)/2}] = $0.022 The average effective spread is $0.010 [($0.002 + $0.006 + $0.022) /3] Question ID: 133 47 Correct Answer: A The