2019 CFA level 3 qbank reading 35 execution of portfolio decisions answers

10/12/2018 Learning Management System Question #1 of 68 Which of the following characterizes a need-trustworthy-agent trading focus? A) High commissions and potential leakage of information B) High commissions and concealment of information C) Low commissions and concealment of information Explanation (Study Session 18, Module 35.5, LOS 35.j) Related Material Question #2 of 68 bo ok c SchweserNotes - Book en tre in In a need-trustworthy-agent trading focus, the trader employs a broker to skillfully execute a large trade The broker may need to trade over a period of time, so such orders are not appropriate for information traders This strategy allows the broker to learn their trade intentions, which may not be in the trader's best interests It also requires high commissions A) Commissions w w B) Stamp duties .o m Which of the following trading costs is NOT an explicit cost? C) Market impact costs w Explanation The explicit costs in a trade are readily discernable and include commissions, taxes, stamp duties, and fees Implicit costs sometimes cannot be measured as easily but exist They include the bid-ask spread, market or price impact costs, opportunity costs, and delay costs (a.k.a slippage costs) (Study Session 18, Module 35.4, LOS 35.e) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 1/39 10/12/2018 Learning Management System Question #3 of 68 Which of the following is least accurate regarding the CFA Institute's Trade Management Guidelines? They state that investment management rms should: A) have policies and procedures that assist in best execution B) provide general information on their trading techniques, markets, and brokers C) hire independent outside consultants to ensure best execution Explanation in The CFA Institute's Trade Management Guidelines not require that investment management rms hire independent outside consultants to ensure best execution (Study Session 18, Module 35.7, LOS 35.n) en tre Related Material Question #4 of 68 bo ok c SchweserNotes - Book Jack Steele has just determined using analysis that the prospects for Titan Steel are favorable He would like to trade before other investors realize Titan's prospects What type of trade o B) limit w w A) participate m should he use? C) market w Explanation Steele is an information-motivated trader These traders have information that is time sensitive, and if they not trade quickly, the value of their information will expire They use market orders to execute quickly and because these orders are less noticeable (Study Session 18, Module 35.5, LOS 35.i) Related Material SchweserNotes - Book Question #5 of 68 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 2/39 10/12/2018 Learning Management System Which of the following statements best characterizes a limit order? A limit order has: A) reduced price uncertainty but retains execution uncertainty B) price uncertainty but not execution uncertainty C) price uncertainty and execution uncertainty 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 lled immediately and may even go un lled or partially un lled A limit order thus has execution uncertainty .in (Study Session 18, Module 35.1, LOS 35.a) Related Material bo ok c Question #6 of 68 en tre SchweserNotes - Book In which of the following markets would the calculation of market impact costs be inappropriate? o B) Auction markets m A) Electronic limit-order markets w w C) Electronic crossing networks Explanation w In an electronic crossing network, orders are executed at the average of the bid and ask quotes Prices not adjust based on supply and demand (Study Session 16, Module 35.1, LOS 35.c) Related Material SchweserNotes - Book Question #7 of 68 A trader must trade an entire portfolio of stocks Which of the following would be the best strategy to pursue? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 3/39 10/12/2018 Learning Management System A) An implementation shortfall strategy B) A simple logical participation strategy based on VWAP C) A simple logical participation percent-of-volume strategy Explanation Implementation shortfall strategies minimize trading costs as de ned by the implementation shortfall measure Because opportunity costs result from non-trading, this strategy trades heavier early in the day to ensure order completion An implementation shortfall strategy is useful when an entire portfolio must be traded Simple logical participation strategies patiently trade throughout the day and may not be able to ll the order (Study Session 18, Module 35.6, LOS 35.k) in Related Material en tre SchweserNotes - Book bo ok c Question #8 of 68 Which of the following is least accurate regarding VWAP? VWAP: A) does not account for market movements or trade volume B) does not evaluate delayed or un lled orders .o Explanation m C) is applicable to small and large trades w w w 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 un lled orders, and does not account for market movements or trade volume (Study Session 18, Module 35.4, LOS 35.g) Related Material SchweserNotes - Book Question #9 of 68 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 4/39 10/12/2018 Learning Management System A trade's volume is a small percentage of average daily trading volume The trade has low spreads and is urgent Which of the following would be the best method of lling the trade? A) Placing the trade in a crossing system B) The use of a simple logical participation strategy based on VWAP C) The use of an implementation shortfall strategy Explanation Trades that are a small portion of average daily trading volume, with low spreads, and high urgency should be traded with an implementation shortfall strategy These strategies trade early in the day and would accommodate an urgent trade .in (Study Session 18, Module 35.6, LOS 35.l) Related Material bo ok c Question #10 of 68 en tre SchweserNotes - Book Which of the following is NOT a relevant measure of market quality? A) Market prevalence w w Explanation o C) Liquidity m B) Assurity of completion A security market should be judged on the basis of its liquidity and assurity of completion w (Study Session 18, Module 35.3, LOS 35.d) Related Material SchweserNotes - Book George White, CFA, and Elizabeth Plain, CFA, manage an account for Briggs and Meyers Securities In managing the account, White and Plain use a variety of strategies, and they trade in di erent markets They use econometric analysis to estimate costs, for example, and algorithmic methods to execute the strategies White and Plain also use both market orders and limit orders Their supervisor has asked them to compose a summary of their trading records to see how the various strategies have worked https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 5/39 10/12/2018 Learning Management System The supervisor asks about how to assess the costs and risks of the various types of trades The supervisor speci cally asks White and Plain to explain the di erence in the risks associated with market and limit orders After White and Plain explain how limit orders can give a better price, the supervisor asks why they wouldn't always use limit orders White explains the details of execution uncertainty and price uncertainty and how they relate to market and limit orders As part of the discussion, Plain explains the principle of the e ective spread that is associated with market orders She uses a recent example where the quoted bid and ask price of GHT stock was $25.40 and $25.44 respectively When White and Plain put in a buy order for 300 shares of GHT stock, at that quoted spread, the order was immediately executed at $25.45 She then calculates the e ective spread .in In summarizing transactions costs, White explains how transactions costs include both implicit and explicit costs He describes a recent situation where he and Plain placed a large buy order en tre for CRD stock Only half of the trade was executed on the day the order was made, and the second half of the buy order for CRD was executed on the following day This occurred because the order was for a large number of shares and CRD stock traded in a relatively illiquid market bo ok c The supervisor asks if there are methods for analyzing and predicting costs associated with the size of the order and the liquidity of the market White and Plain use an econometric model as part of their pre-trade analysis to estimate implicit transactions costs Their econometric models use the following inputs: market capitalization, volume, and measures of momentum White says that linear econometric models have proven the most e ective because the inputs m are fairly normally distributed Plain says that in addition to simply estimating the costs of a o proposed trade, the model can also indicate the optimal size of the trade w w White and Plain also explain their algorithmic methods of trading They engage in passive trading combined with pegging and discretion strategies that are designed to seize liquidity They recently decided to trade GHT stock using algorithmic methods White said that GHT was a w good stock to trade this way because their trades of the stock are very small in relation to the volume of the stock in the whole market Plain adds by saying that GHT has a large spread, and this also makes algorithmic trading ideal for this stock Question #11 of 68 Which of the following statements regarding market orders is most accurate? Market orders: A) have price uncertainty, and limit orders have execution uncertainty B) have execution uncertainty, and limit orders have price uncertainty https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 6/39 10/12/2018 Learning Management System C) and limit orders both have execution uncertainty and no price uncertainty Explanation This is true because a market order can be executed at any price The limit order may never get executed if the price does not fall into the speci ed range (Study Session 18, Module 35.6, LOS 35.k) Related Material SchweserNotes - Book in Question #12 of 68 en tre In the example given by Plain, what was the e ective spread for the order of 300 shares of GHT stock? A) $0.04 bo ok c B) $0.06 C) $0.02 Explanation m The e ective spread is twice the di erence between the execution price and the average of the bid/ask spread at the time of the order: $0.06=2 × [$24.45 –($24.44 + $24.40)/2] w w Related Material o (Study Session 18, Module 35.6, LOS 35.k) w SchweserNotes - Book Question #13 of 68 In the example given by White, the term that describes the costs associated with the purchase of CRD stock is: A) volume-weighted costs B) delay costs C) missed trade opportunity Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 7/39 10/12/2018 Learning Management System The term delay costs refers to the inability to complete the desired trade immediately because of its size and the liquidity of markets Delay costs are often measured on the portion of the order carried over from one day to the next (Study Session 18, Module 35.6, LOS 35.k) Related Material SchweserNotes - Book Question #14 of 68 in In the discussion concerning the use of econometric methods in estimating trading costs, White commented on the use of linear methods, and Plain commented on using the models to A) both White and Plain were correct B) White was incorrect and Plain was correct bo ok c C) White was correct and Plain was incorrect en tre estimate the optimal trade size With respect to these statements: Explanation White was wrong because non-linear models can be more e ective than linear models Plain is correct because the models can estimate the optimal size of the trade .o Related Material m (Study Session 18, Module 35.6, LOS 35.k) w w w SchweserNotes - Book Question #15 of 68 With respect to the reasons given for using algorithmic methods for trading GHT stock: A) White was correct and Plain was incorrect B) White and Plain were both correct C) Plain was correct and White was incorrect Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 8/39 10/12/2018 Learning Management System Algorithmic trading is ideal for a stock that has a low bid/ask spread The trades should have a low urgency level and be small with respect to the average volume of that stock (Study Session 18, Module 35.6, LOS 35.k) Related Material SchweserNotes - Book Question #16 of 68 in The best classi cation of the algorithmic method used by White and Plain is: B) opportunistic participation strategies C) implementation shortfall strategy Explanation en tre A) simple logical participation strategy bo ok c Opportunistic participation strategies involve passive trading combined with the opportunistic seizing of liquidity The most common examples are pegging and discretion strategies In these strategies, the potential buyer posts a bid and hopes others will sell to him and that this will yield negative implicit trading costs Related Material w w o SchweserNotes - Book m (Study Session 18, Module 35.6, LOS 35.k) w Question #17 of 68 A market order has: A) price uncertainty but not execution uncertainty B) both price uncertainty and execution uncertainty C) execution uncertainty but not price uncertainty Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 9/39 10/12/2018 Learning Management System 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 (Study Session 18, Module 35.1, LOS 35.a) Related Material SchweserNotes - Book in Question #18 of 68 Which of the following trades would be predicted to have the highest trading costs using an en tre econometric model? A) A large buy order in an upward trending market B) A small buy order in an upward trending market bo ok c C) A large buy order in a downward trending market Explanation m Econometric models use momentum and trade size relative to available liquidity to predict trading costs Buying a stock in an upward trending market will incur more costs as will a larger order Related Material o (Study Session 18, Module 35.5, LOS 35.h) w w w SchweserNotes - Book Question #19 of 68 Which of the following variables is NOT typically used in econometric models to assess trading costs? A) Risk B) Market model alpha C) Momentum Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 10/39 10/12/2018 Learning Management System The quoted spread for each order is the di erence between the ask and bid prices: Time of Trade Ask minus Bid Price Quoted Spread 10 a.m $10.07 - $10.00 $0.07 12 p.m $9.96 - $9.90 $0.06 p.m $9.94 - $9.88 $0.06 The average quoted spread is a simple average of the quoted spreads: ($0.07 + $0.06 + $0.06) / = $0.0633 (Study Session 18, Module 35.2, LOS 35.b) in Related Material en tre SchweserNotes - Book bo ok c Question #44 of 68 What is the average e ective spread Wortek should calculate for the Arbutus Insurance trades? A) $0.0433 w w w Explanation o C) $0.0233 m B) $0.0200 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 25/39 10/12/2018 Learning Management System The e ective spread for a sell order is twice the midquote of the market bid and ask prices minus the execution price The midquote for each trade is calculated as: Time of Trade Midquote 10 a.m ($10.07 + $10.00) / = $10.035 12 p.m ($9.96 + $9.90) / 2= $9.93 p.m ($9.94 + $9.88) / = $9.91 The e ective spread for each sell order is: x (Midquote – Execution Price) = E ective Spread 10 a.m x ($10.035 - $9.98) = $0.11 12 p.m x ($9.93 - $9.92) = $0.02 p.m x ($9.91 - $9.91) = $0.00 en tre in Time of Trade bo ok c The average e ective spread is ($0.11 + $0.02 + $0.00) / = $0.0433 (Study Session 18, Module 35.2, LOS 35.b) Related Material o m SchweserNotes - Book w w Question #45 of 68 What is the weighted average e ective spread Wortek should calculate for the Arbutus w Insurance trades? A) $0.0641 B) $0.0633 C) $0.0266 Explanation The weighted average e ective spread weights the e ective spread for each trade by the trade size, relative to the total shares traded, which in this example is 1700: (900/1700)$0.11 + (500/1700)$0.02 + (300/1700)$0.00 = $0.0641 (Study Session 18, Module 35.2, LOS 35.b) Related Material https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 26/39 10/12/2018 Learning Management System SchweserNotes - Book Question #46 of 68 Which of the following best represents the analysis Wortek should provide for the Arbutus Insurance trades? A) None of the trades resulted in price improvement B) Two of the trades resulted in price improvement but the third did not .in C) One of the trades resulted in price improvement but the other two did not en tre Explanation bo ok c In the second and third trades, there was price improvement because the sell orders were executed at bid prices higher than the quoted bid prices Hence the e ective spread was lower than the quoted spread In the rst trade, the trade size was larger than the bid size The e ective spread in this case was higher than that quoted due to the market impact of the large order Overall, the simple average e ective spreads was lower than the average quoted spread, re ecting the price improvement in the last two trades The weighted average e ective spread was higher than the average quoted spread, re ecting the market impact of the rst trade, which was relatively larger in volume than either of the last two trades .o Related Material m (Study Session 18, Module 35.2, LOS 35.b) w w w SchweserNotes - Book Question #47 of 68 Which of the following trading costs results when an order is not lled? A) Market impact costs B) Price impact costs C) Delay costs Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 27/39 10/12/2018 Learning Management System When an order is not lled, delay or slippage costs result These costs can be substantial if information regarding the security is released while the order sits un lled (Study Session 18, Module 35.4, LOS 35.e) Related Material SchweserNotes - Book Question #48 of 68 Which of the following statements regarding econometric models is CORRECT? Econometric in models: en tre A) are used to forecast trading costs and assess trading e ectiveness B) are not useful for forecasting trading costs or assessing trading e ectiveness C) are only useful for forecasting trading costs bo ok c Explanation They can be used to forecast trading costs and assist portfolio managers in determining the size of the trade They can also be used to assess trading e ectiveness by comparing actual trading costs to forecasted trading costs from the models Related Material w w o SchweserNotes - Book m (Study Session 18, Module 35.5, LOS 35.h) w Question #49 of 68 Which of the following measures is least susceptible to gaming by traders? A) Implementation Shortfall B) VWAP C) E ective spread Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 28/39 10/12/2018 Learning Management System 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 e ective spread can also be gamed A trader can trade at favorable bid and asks by waiting for orders to be brought to them (Study Session 18, Module 35.4, LOS 35.g) Related Material SchweserNotes - Book in Question #50 of 68 Which of the following trading tactics would most likely be used by an information-motivated en tre trader? A) Costs-are-not-important C) Need-trustworthy-agent Explanation bo ok c B) Liquidity-at-any-cost m In a liquidity-at-any-cost trading focus, the trader must transact a large block of shares quickly, typically because they possess time-sensitive information The liquidity-focused trader must be ready to pay a high price for trading in the form of market impact and/or commissions w w Related Material o (Study Session 18, Module 35.5, LOS 35.j) w SchweserNotes - Book Question #51 of 68 Information-motivated traders emphasize: A) time in their trading and use market orders B) price in their trading and use market orders C) price in their trading and use limit orders Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 29/39 10/12/2018 Learning Management System Information-motivated traders have information that is time sensitive, and if they not trade quickly, the value of their information will expire They, therefore, emphasize time in their trades They use market orders to execute quickly and because these orders are less noticeable (Study Session 18, Module 35.5, LOS 35.i) Related Material SchweserNotes - Book in Question #52 of 68 A trade's volume is a large percentage of average daily trading volume and has high spreads en tre Which of the following would be the best method of lling the trade? A) A simple logical participation percent-of-volume strategy B) A simple logical participation strategy based on VWAP bo ok c C) Placing the trade with a broker Explanation If a trade is of relatively large size and has a large spread, it should be traded through a skilled broker or through a crossing system to minimize the spread .o Related Material m (Study Session 18, Module 35.6, LOS 35.l) w w w SchweserNotes - Book Question #53 of 68 Suppose a trader is quoted a market bid price of $40.40 and an ask of $40.49 The execution price of a buy order is $40.47 What is the e ective spread? A) $0.050 B) $0.025 C) $0.090 Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 30/39 10/12/2018 Learning Management System If a trader placed a buy order, a dealer may o er a better ask price than the previous ask to earn the trader's business The midquote of the quoted bid and ask prices is $40.445 The e ective spread for this buy order would then be calculated as: × ($40.47 - $40.445) = $0.05, which is cents better than the quoted spread of $0.09 ($40.40 - $40.49) (Study Session 18, Module 35.2, LOS 35.b) Related Material SchweserNotes - Book in Question #54 of 68 en tre Which of the following is least accurate regarding best execution? Best execution: A) should be judged independently of the investment decision B) is similar to the prudence concept bo ok c C) depends on relationships and practices Explanation Best execution cannot be judged independently of the investment decision Prudence and best execution both attempt to improve portfolio performance and meet duciary responsibilities Relationships and practices are integral to best execution m (Study Session 18, Module 35.7, LOS 35.m) o Related Material w w SchweserNotes - Book w Question #55 of 68 A simple logical participation strategy trades: A) with market ow and attempts to minimize opportunity costs B) early in the day and attempts to minimize market impact C) with market ow and attempts to minimize market impact Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 31/39 10/12/2018 Learning Management System Simple logical participation strategies seek to trade with market ow to minimize market impact (Study Session 18, Module 35.6, LOS 35.k) Related Material SchweserNotes - Book Question #56 of 68 If the volume-weighted average price (VWAP) during a day was $21 and 100 shares were bought in at $20.40, which of the following statements regarding the costs of trading is most accurate? en tre A) The implicit costs are -$60 B) The implicit costs are $60 C) The explicit costs are -$60 bo ok c Explanation m Implicit costs are usually measured using some benchmark, such as the VWAP VWAP is a weighted average of security prices during a day, where the weight applied is the proportion of the day's trading volume If the VWAP during a day was $21 and 100 shares were bought at $20.40, then the estimate of the implicit cost would be 100 × ($20.40-$21.00) = -$60 The explicit costs in a trade are the commissions, taxes, stamp duties, and fees Related Material o (Study Session 18, Module 35.4, LOS 35.e) w w w SchweserNotes - Book Question #57 of 68 Which of the following is NOT a characteristic of a liquid market? A) An abundance of traders B) Homogenous traders C) Integrity Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 32/39 10/12/2018 Learning Management System The factors contributing to liquidity are an abundance and diversity of traders, convenience, and integrity Homogenous traders are not diverse (Study Session 18, Module 35.3, LOS 35.d) Related Material SchweserNotes - Book Question #58 of 68 Which of the following is least accurate regarding best execution, the CFA Institute's Trade in Management Guidelines, and ethics in trading? en tre A) Record keeping is a key component of the CFA Institute’s Trade Management Guidelines B) Best execution should be measured over short, relevant time periods bo ok c C) The buy-side trader’s relationship with clients must come before their relationship with sell-side traders Explanation m Although best execution can be measured ex post over time, it should not be used to evaluate trading e ectiveness over a short time span Buy-side traders and portfolio managers have a duciary duty to maximize the value of their client's portfolio w w Related Material o (Study Session 18, Module 35.7, LOS 35.o) w SchweserNotes - Book Question #59 of 68 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) -1.08% C) 1.07% https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 33/39 10/12/2018 Learning Management System Explanation The realized pro t and loss, delay costs, and missed trade opportunity cost of the implementation shortfall are all a ected 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% (Study Session 18, Module 35.4, LOS 35.f) Related Material en tre in SchweserNotes - Book Question #60 of 68 Which of the following statements regarding the implementation shortfall components is least bo ok c accurate? A) Realized pro t and loss represents the di erence between the execution price and the previous day's closing price m B) Missed trade opportunity cost is weighted by the portion of the order that is lled C) Missed trade opportunity cost represents the di erence between the price at which w w Explanation o the order is cancelled and the original price w Missed trade opportunity cost is weighted by the portion of the order that is not lled It is calculated using the di erence between the price at which the order is cancelled and the original price Realized pro t and loss uses the di erence 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 lled (Study Session 18, Module 35.4, LOS 35.f) Related Material SchweserNotes - Book Question #61 of 68 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 34/39 10/12/2018 Learning Management System Frank Rolle is a portfolio manager who works for a rm that o ers comprehensive portfolio management and employs buy-side traders Rolle and his buy-side trader are considering shifting their business to a sell-side trader, Jack Smith Smith has promised that Rolle and his traders will gain access to investment research put out by his rm Rolle knows that Smith's rm tends to charge higher commissions Rolle does not believe the quality of Smith's research to be any better than he is currently receiving from other sell-side traders What should Rolle do? A) Not trade with Smith because his research is of no better quality C) Trade with Smith because he may have better research en tre Explanation in B) Not trade with Smith because the interests of his clients come rst Buy-side traders and portfolio managers have a duciary duty to maximize the value of their client's portfolio Smith's higher commissions should prevent Rolle from trading with him The buy-side trader's relationships with sell-side traders must never come before the interests of their clients bo ok c (Study Session 18, Module 35.7, LOS 35.o) Related Material m SchweserNotes - Book o Question #62 of 68 w w A trader submits a buy order that speci es 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? w A) A market order B) A limit order C) A principal order 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 (Study Session 18, Module 35.1, LOS 35.a) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 35/39 10/12/2018 Learning Management System Question #63 of 68 Use the following information to determine how the trades should be placed for the following shares Trade Size Average Daily Volume Spread Urgency ABCD 20,000 400,000 0.04% Low LMNO 60,000 1,000,000 0.07% High WXYZ 75,000 150,000 0.60% Low in Stock Ticker en tre A) ABCD should be traded using a simple logical participation strategy, LMNO should be traded using a shortfall implementation strategy, and WXYZ should be placed ih b k B) ABCD should be traded using a shortfall implementation strategy, LMNO should be bo ok c placed with a broker, and WXYZ should be traded using a simple logical i i i C) ABCD should be traded using a shortfall implementation strategy, LMNO should be traded using a simple logical participation strategy, and WXYZ should be placed ih b k m Explanation w w w o The trade for stock WXYZ is large relative to average daily trading volume (75,000/150,000 = 50%) and has a large spread Because of these characteristics, it should be traded through a skilled broker or through a crossing system to minimize the spread The trade for stock ABCD is relatively small (20,000/400,000 = 5%) and the spread is low The ABCD trade is of low urgency and can be traded over time It is thus suitable for a simple participation strategy based on VWAP or other benchmark The LMNO trade is of small relative size (60,000/1,000,000 = 6%), has small spreads, and high urgency It should be traded more quickly using an implementation shortfall strategy (Study Session 18, Module 35.6, LOS 35.l) Related Material SchweserNotes - Book Question #64 of 68 Which of the following statements regarding a buy-side trader's priority is CORRECT? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 36/39 10/12/2018 Learning Management System A) Their relationships with their broker, the client, and sell-side traders are of equal priority B) Their relationship with the client must come rst C) Their relationship with sell-side trader must come rst Explanation The buy-side trader should always be acting in the best interests of their clients Buy-side traders and portfolio managers have a duciary duty to maximize the value of their client's portfolio The buy-side trader's relationships with sell-side traders must never come before the interests of their clients .in (Study Session 18, Module 35.7, LOS 35.o) Related Material bo ok c Question #65 of 68 en tre SchweserNotes - Book A shortfall implementation strategy trades: A) early in the day and attempts to maximize trading cost volatility m B) with market ow and attempts to minimize opportunity costs Explanation o C) early in the day and attempts to minimize opportunity costs w w Implementation shortfall strategies trade heavier early in the day to ensure order completion, reduce opportunity costs, and minimize the volatility of trading costs w (Study Session 18, Module 35.6, LOS 35.k) Related Material SchweserNotes - Book Question #66 of 68 Which of the following implementation shortfall components is NOT in uenced by market-wide movements? A) Explicit costs https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 37/39 10/12/2018 Learning Management System B) Realized pro t and loss C) Missed trade opportunity cost Explanation The realized pro t and loss and missed trade opportunity cost are all a ected 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 speci c change in price Market-wide movements can be adjusted for by the market model (Study Session 18, Module 35.4, LOS 35.f) Related Material Question #67 of 68 bo ok c Value-motivated traders emphasize: en tre in SchweserNotes - Book A) time in their trading and use limit orders B) price in their trading and use limit orders m C) price in their trading and use market orders Explanation w w o Value-motivated traders are patient and will use limit orders, because price, not time is their main objective (Study Session 18, Module 35.5, LOS 35.i) w Related Material SchweserNotes - Book Question #68 of 68 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 38/39 10/12/2018 Learning Management System 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 un lled The stock closes at $40.04 On Friday, the order is revised to a limit of $40.05 The order is partially lled 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 .in A) The opportunity costs are 0.06% and the total implementation shortfall is 0.19% B) The opportunity costs are 0.07% and the total implementation shortfall is 0.19% en tre C) The opportunity costs are 0.06% and the total implementation shortfall is 0.15% Explanation To decompose the implementation shortfall, we calculate the following: w w o m bo ok c Explicit costs – the commission as a percent of the paper portfolio investment is $17/$40,000 = 0.04% Realized pro t 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 lled It is (700/1000) × ($40.05 - $40.04)/$40.00 = 0.02% Delay costs are calculated using the di erence between the closing prices on the day an order was not lled and the previous day closing price It is weighted by the portion of the order lled It is (700/1,000) × ($40.04 - $40.00)/$40.00 = 0.07% Missed trade opportunity cost is calculated using the di erence 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 lled It equals (300/1,000) × ($40.08 - $40.00)/$40.00 = 0.06% w The sum of the components is the total implementation cost: 0.04% + 0.02% + 0.07% + 0.06% = 0.19% (Study Session 18, Module 35.4, LOS 35.f) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448395/print 39/39 ... (Study Session 18, Module 35 .2, LOS 35 .b) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 4 839 5/print 23/ 39 10/12/2018 Learning... Module 35 .4, LOS 35 .f) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 4 839 5/print 39 /39 ... $0.0 433 w w w Explanation o C) $0.0 233 m B) $0.0200 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 4 839 5/print 25 /39 10/12/2018