CFA LEVEL-III, PRACTICE QUESTIONS (LOS # 30) Reading 30: (Execution of Portfolio Decisions) | Solution Question - #92088 Your answer: B was incorrect The correct answer was A) Explicit costs 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 This question tested from Session 16, Reading 30, LOS g Question - #92255 Your answer: B was incorrect The correct answer was C) Measurement tools The CFA Institute’s Trade Management Guidelines are split into three parts: processes, disclosures, and record keeping These guidelines are meant to assist investment management firms in achieving best execution and maximum portfolio value for their clients This question tested from Session 16, Reading 30, LOS o Question - #92611 Your answer: B was incorrect The correct answer was C) An implementation shortfall strategy Implementation shortfall strategies minimize trading costs as defined 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 fill the order This question tested from Session 16, Reading 30, LOS l Question - #92827 Your answer: B was incorrect The correct answer was C) Their relationship with the client must come first The buy-side trader should always be acting in the best interests of their clients Buy-side traders and portfolio managers have a fiduciary duty to maximize the value of their client’s portfolio The buyside trader’s relationships with sell-side traders must never come before the interests of their clients This question tested from Session 16, Reading 30, LOS p Question - #126891 Part 1) Your answer: B was incorrect The correct answer was A) 0.02% The realized profit and loss is calculated using the execution price minus the previous day's closing price This is divided by the original benchmark price and weighted by the proportion of the order filled It is (700 / 1,000) × ($60.07 − $60.05) / $60.00 = 0.02% The positive value means that there is a loss (a cost) here (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 2) Your answer: B was correct! The missed trade opportunity cost is calculated using the difference between the price at which the order is cancelled and the original benchmark price It is weighted by the portion of the order that is not filled It equals (300 / 1,000) × ($60.08 − $60.00) / $60.00 = 0.04% (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 3) Your answer: B was incorrect The correct answer was C) -0.50% To calculate the implementation shortfall, we must also add in the delay costs and the explicit costs The delay costs are calculated using the difference between the closing price on the day an order was not filled and the benchmark price It is weighted by the portion of the order filled It is (700 / 1,000) × ($60.05 − $60.00) / $60.00 = 0.06% The explicit costs are the commission as a percent of the paper portfolio investment: $19 / $60,000 = 0.03% 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: 0.03% + 0.02% + 0.06% + 0.04% = 0.15% If the market return was 0.5% over the time period of this trading and the beta was 1.3 for Allen Materials, then the expected return for it would be 0.5% × 1.3 = 0.65% Subtracting this from the 0.15% results in a market-adjusted implementation shortfall of 0.15% − 0.65% = -0.50% With this adjustment, the manager's trading costs are actually negative In other words, in the trading process, the manager "lost out" on a return of 0.15%, which is less than the expected return of 0.65% So relatively speaking, the manager did not incur costs from trading (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 4) Your answer: B was incorrect The correct answer was C) Only one is correct Wienke is correct 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 It is useful because it can be applied quickly and easily Brooks is incorrect Although it is true that a trader may try to game the volume-weighted average price by delaying the trade, the trader would wait until the ask price is less than the volume-weighted average price Although it would appear that the trader has minimized trading costs in this case, the level of overall prices could have increased so that the trade should have been executed earlier (Study Session 16, LOS 39.f) This question tested from Session 16, Reading 30, LOS g Part 5) Your answer: B was incorrect The correct answer was C) ABCD The trade for stock ABCD is large relative to average daily trading volume (75,000 / 125,000 = 60%) 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 (Study Session 16, LOS 39.m) This question tested from Session 16, Reading 30, LOS g Part 6) Your answer: B was incorrect The correct answer was C) LMNO The LMNO trade is of small relative size (120,000 / 2,000,000 = 6%), has a small spread, and has high urgency It should be traded quickly using an implementation shortfall strategy Furthermore, an implementation shortfall strategy trades a large volume early in the day, thus stock LMNO is suitable and stock FGHI is not suitable for an implementation shortfall strategy The trade for stock WXYZ is relatively small (30,000 / 900,000 = 3.3%) and the spread is low The WXYZ 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 (Study Session 16, LOS 39.m) This question tested from Session 16, Reading 30, LOS g Question - #93157 Your answer: B was correct! Lower quoted and effective spreads as well as higher bid and ask sizes indicate greater liquidity and greater market quality This question tested from Session 16, Reading 30, LOS e Question - #91869 Your answer: B was incorrect The correct answer was C) A large buy order in an upward trending market 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 This question tested from Session 16, Reading 30, LOS i Question - #91597 Your answer: B was incorrect The correct answer was C) Passive and value-motivated In a low-cost-whatever-the-liquidity trading focus, the trader places a limit order outside of the current bid-ask quotes in order to minimize trading costs The strength of this strategy is that commissions, spreads, and market impact costs tend to be low Passive and value-motivated traders will often purse this patient strategy Information and liquidity motivated trades need more immediate execution and thus would not use this strategy This question tested from Session 16, Reading 30, LOS k Question - #91972 Your answer: B was incorrect The correct answer was C) is applicable to small and large trades 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 This question tested from Session 16, Reading 30, LOS h Question 10 - #92012 Your answer: B was incorrect The correct answer was A) $0.050 If a trader placed a buy order, a dealer may offer 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 effective 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) This question tested from Session 16, Reading 30, LOS b Question 11 - #92434 Your answer: B was correct! Trades that are a small portion of average daily trading volume, with low spreads, and low urgency should be traded with a simple participation strategy Simple logical participation strategies patiently trade throughout the day This question tested from Session 16, Reading 30, LOS m Question 12 - #91600 Your answer: B was incorrect The correct answer was C) High commissions and potential leakage of information 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 This question tested from Session 16, Reading 30, LOS k Question 13 - #92004 Part 1) Your answer: B was incorrect The correct answer was C) Benson is correct Benson is correct In an electronic crossing network, the costs of trading are low because commissions are low and traders not pay a dealer’s bid-ask spread A trade may not be filled or may be only partially filled if there are insufficient traders on the opposite side of the trade Prices not adjust to supply and demand conditions This results in trades being unfilled or partially filled because prices not respond to fill the traders’ orders (Study Session 16, LOS 39.c) This question tested from Session 16, Reading 30, LOS b Part 2) Your answer: B was incorrect The correct answer was A) Wortek is incorrect because brokered markets allow traders to remain anonymous Wortek is incorrect In brokered markets, brokers find the counterparties to a trade This service is valuable when the trader has a large block to sell, when they want to remain anonymous, and/or when the market for the security is small or illiquid Brokered markets are particularly important in countries where public capital markets are not well developed (Study Session 16, LOS 39.c) This question tested from Session 16, Reading 30, LOS b Part 3) Your answer: B was incorrect The correct answer was A) $0.0633 The quoted spread for each order is the difference 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 16, LOS 39.b) This question tested from Session 16, Reading 30, LOS b Part 4) Your answer: B was correct! The effective 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 effective spread for each sell order is: Time of Trade x (Midquote – Execution Price) = Effective 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 The average effective spread is ($0.11 + $0.02 + $0.00) / = $0.0433 (Study Session 16, LOS 39.b) This question tested from Session 16, Reading 30, LOS b Part 5) Your answer: B was incorrect The correct answer was C) $0.0641 The weighted average effective spread weights the effective 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 16, LOS 39.b) This question tested from Session 16, Reading 30, LOS b Part 6) Your answer: B was incorrect The correct answer was C) Two of the trades resulted in price improvement but the third did not 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 effective spread was lower than the quoted spread In the first trade, the trade size was larger than the bid size The effective spread in this case was higher than that quoted due to the market impact of the large order Overall, the simple average effective spreads was lower than the average quoted spread, reflecting the price improvement in the last two trades The weighted average effective spread was higher than the average quoted spread, reflecting the market impact of the first trade, which was relatively larger in volume than either of the last two trades (Study Session 16, LOS 39.b) This question tested from Session 16, Reading 30, LOS b Question 14 - #92338 Your answer: B was incorrect The correct answer was A) Best execution can be measured for a single trade Although best execution can be measured ex post over time, it cannot be measured for a single trade Best execution cannot be judged independently of the investment decision Best execution cannot be known with certainty ex ante, it depends on the particular circumstances of the trade Each party to a trade determines what best execution is This question tested from Session 16, Reading 30, LOS n Question 15 - #92334 Your answer: B was incorrect The correct answer was C) Best execution prevents high cost trades from taking place Some strategies might have high trading costs but that does not mean they should not be pursued if in net they enhance portfolio value Best execution can be measured after the fact for a series of trades This question tested from Session 16, Reading 30, LOS n Question 16 - #92588 Part 1) Your answer: B was incorrect The correct answer was A) Hohlman is incorrect because the effective spread can be gamed 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 volumeweighted average price This is because the opening price is known with more certainty than the VWAP (Study Session 16, LOS 39.f) This question tested from Session 16, Reading 30, LOS g Part 2) Your answer: B was incorrect The correct answer was C) Walker is correct 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 (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 3) Your answer: B was incorrect The correct answer was A) 0.16% 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 (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 4) Your answer: B was incorrect The correct answer was C) 0.12% 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% (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 5) Your answer: B was correct! 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% (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Part 6) Your answer: B was incorrect The correct answer was A) 0.44% 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% (Study Session 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS g Question 17 - #91931 Your answer: A was correct! 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 effectiveness by comparing actual trading costs to forecasted trading costs from the models This question tested from Session 16, Reading 30, LOS i Question 18 - #91982 Your answer: B was correct! If a trader placed a sell order, a dealer may offer a better bid price than the previous bid to earn the trader’s business The midquote of the quoted bid and ask prices is $16.05 The effective spread for this sell order would then be calculated as: × ($16.05 - $16.03) = $0.04, which is cents better than the quoted spread of $0.10 ($16.10 - $16.00) This question tested from Session 16, Reading 30, LOS b Question 19 - #92168 Your answer: B was incorrect The correct answer was C) Placing the trade with a broker 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 This question tested from Session 16, Reading 30, LOS m Question 20 - #93178 Your answer: B was correct! The factors contributing to liquidity are an abundance and diversity of traders, convenience, and integrity Homogenous traders are not diverse This question tested from Session 16, Reading 30, LOS e Question 21 - #92285 Your answer: B was incorrect The correct answer was C) hire independent outside consultants to ensure best execution The CFA Institute’s Trade Management Guidelines not require that investment management firms hire independent outside consultants to ensure best execution This question tested from Session 16, Reading 30, LOS o Question 22 - #92514 Your answer: A was correct! Buy-side traders and portfolio managers have a fiduciary 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 There is no evidence that Smith has done anything improper, so reporting him to the exchange regulators is unnecessary This question tested from Session 16, Reading 30, LOS p Question 23 - #93082 Your answer: B was incorrect The correct answer was C) The relationship between buy-side and sell-side traders is becoming less adversarial Brokerage commissions have fallen dramatically The temptation is to shift costs to those that are implicit, rather than explicit Thus, trading between buy-side and sell-side traders is becoming more adversarial Furthermore, the disclosure of information in a trade can be used against a trader later on, especially with the advent of electronic trading venues where trader identity can be kept confidential Thus, trust has become more important given the potential negative ramifications of trading with an unscrupulous trader This question tested from Session 16, Reading 30, LOS p Question 24 - #92135 Your answer: B was correct! 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 This question tested from Session 16, Reading 30, LOS a Question 25 - #92122 Your answer: B was incorrect The correct answer was C) reduced price uncertainty but retains execution uncertainty 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 filled immediately and may even go unfilled or partially unfilled A limit order thus has execution uncertainty This question tested from Session 16, Reading 30, LOS a Question 26 - #91598 Your answer: B was incorrect The correct answer was C) Market prevalence A security market should be judged on the basis of its liquidity and assurity of completion This question tested from Session 16, Reading 30, LOS e Question 27 - #92106 Your answer: B was incorrect The correct answer was C) A limit order 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 This question tested from Session 16, Reading 30, LOS a Question 28 - #91607 Your answer: B was correct! In an electronic crossing network, trades are executed at the average of the bid and ask quotes They not adjust based on supply and demand As such, prices not adjust to fill orders In an auction market and automated auctions (also known as electronic limit-order markets), orders compete for execution and prices can adjust to fill orders This question tested from Session 16, Reading 30, LOS c Question 29 - #91844 Your answer: B was incorrect The correct answer was A) Electronic crossing networks In an electronic crossing network, there is no price discovery because trades are executed at the average of the bid and ask quotes The trader usually does not know the identity of their counterparty or of their trade size In an auction market and automated auctions (also known as electronic limitorder markets), orders compete for execution and provide price discovery This question tested from Session 16, Reading 30, LOS c Question 30 - #92372 Your answer: B was incorrect The correct answer was C) The opportunity costs are 0.06% and the total implementation shortfall is 0.19% 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% This question tested from Session 16, Reading 30, LOS g Question 31 - #92309 Your answer: B was incorrect The correct answer was C) should be judged independently of the investment decision Best execution cannot be judged independently of the investment decision Prudence and best execution both attempt to improve portfolio performance and meet fiduciary responsibilities Relationships and practices are integral to best execution This question tested from Session 16, Reading 30, LOS n Question 32 - #91599 Your answer: B was incorrect The correct answer was C) Trader and dealer The relationship between a trader and a dealer is adversarial The dealer would like to maximize the trade spread and the trader would like to minimize it Also, when a trader has information that the dealer does not, the trader profits at the dealer’s expense This question tested from Session 16, Reading 30, LOS d Question 33 - #92297 Your answer: A was incorrect The correct answer was C) must not disclose documentation concerning policies and procedures to outside parties Documentation concerning policies and procedures to outside parties should be disclosed to outside regulators, not held within the firm The CFA Institute’s Trade Management Guidelines state that in regard to record keeping, investment management firms should maintain the documentation supporting: 1) the firm’s compliance with its policies and procedures; and 2) disclosures made to its clients In doing so, the firm provides evidence to regulators as to how the firm pursues best execution for its clients This question tested from Session 16, Reading 30, LOS o Question 34 - #91985 Your answer: B was correct! If a trader placed a buy order, a dealer may offer a better ask price than the previous ask to earn the trader’s business The midquote of the quoted bid and ask prices is $30.035 The effective spread for this buy order would then be calculated as: × ($30.04 - $30.035) = $0.01, which is cents better than the quoted spread of $0.07 ($30.07 - $30.00) This question tested from Session 16, Reading 30, LOS b Question 35 - #92457 Part 1) Your answer: B was correct! 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 specified range (Study Session 16, LOS 39.a) This question tested from Session 16, Reading 30, LOS l Part 2) Your answer: A was incorrect The correct answer was B) $0.06 The effective spread is twice the difference 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] (Study Session 16, LOS 39.b) This question tested from Session 16, Reading 30, LOS l Part 3) Your answer: B was incorrect The correct answer was A) delay costs 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 16, LOS 39.g) This question tested from Session 16, Reading 30, LOS l Part 4) Your answer: B was correct! White was wrong because non-linear models can be more effective than linear models Plain is correct because the models can estimate the optimal size of the trade (Study Session 16, LOS 39.i) This question tested from Session 16, Reading 30, LOS l Part 5) Your answer: B was correct! 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 16, LOS 39.l) This question tested from Session 16, Reading 30, LOS l Part 6) Your answer: B was incorrect The correct answer was C) opportunistic participation strategies 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 (Study Session 16, LOS 39.l) This question tested from Session 16, Reading 30, LOS l Question 36 - #92063 Your answer: B was correct! 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 This question tested from Session 16, Reading 30, LOS a Question 37 - #93093 Your answer: B was incorrect The correct answer was A) early in the day and attempts to minimize opportunity costs Implementation shortfall strategies trade heavier early in the day to ensure order completion, reduce opportunity costs, and minimize the volatility of trading costs This question tested from Session 16, Reading 30, LOS l Question 38 - #91606 Your answer: B was incorrect The correct answer was C) price in their trading and use limit orders Passive traders can afford to be very patient and price, not time is their emphasis They favor limit orders This question tested from Session 16, Reading 30, LOS j Question 39 - #92454 Your answer: B was incorrect The correct answer was 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 with a broker 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 This question tested from Session 16, Reading 30, LOS m Question 40 - #91804 Your answer: B was incorrect The correct answer was A) time in their trading and use market orders 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 This question tested from Session 16, Reading 30, LOS j Question 41 - #91603 Your answer: A was incorrect The correct answer was B) Liquidity-at-any-cost 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 This question tested from Session 16, Reading 30, LOS k Question 42 - #91602 Your answer: B was incorrect The correct answer was C) Trader and dealer A trader is more likely to trade with a dealer when he has information that the dealer does not This results in adverse selection risk for the dealer The trader’s profit is the dealer’s loss once the information is revealed to the market This question tested from Session 16, Reading 30, LOS d Question 43 - #92182 Your answer: B was incorrect The correct answer was A) The use of an implementation shortfall strategy 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 This question tested from Session 16, Reading 30, LOS m Question 44 - #91448 Your answer: B was incorrect The correct answer was C) with market flow and attempts to minimize market impact Simple logical participation strategies seek to trade with market flow to minimize market impact This question tested from Session 16, Reading 30, LOS l Question 45 - #91902 Your answer: B was incorrect The correct answer was C) Market model alpha The following are the variables typically used in econometric models: security liquidity – trading volume, market cap, spread, price; size of the trade relative to liquidity; trading style – more aggressive trading results in higher costs; momentum – e.g., buying stock costs more when the market is trending upward; and risk This question tested from Session 16, Reading 30, LOS i Question 46 - #92042 Your answer: B was correct! 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 This question tested from Session 16, Reading 30, LOS h Question 47 - #91601 Your answer: B was correct! A principal-agent relationship exists between a trader and the broker The broker acts as the trader’s agent and locates the necessary liquidity at the best price The trader can also extract information from the broker regarding the depth of a market and the identity of other traders This question tested from Session 16, Reading 30, LOS d Question 48 - #92729 Your answer: B was incorrect The correct answer was A) Delay costs When an order is not filled, delay or slippage costs result These costs can be substantial if information regarding the security is released while the order sits unfilled This question tested from Session 16, Reading 30, LOS f Question 49 - #92691 Your answer: B was incorrect The correct answer was A) The implicit costs are -$60 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 This question tested from Session 16, Reading 30, LOS f Question 50 - #92498 Your answer: B was incorrect The correct answer was A) Best execution should be measured over short, relevant time periods Although best execution can be measured ex post over time, it should not be used to evaluate trading effectiveness over a short time span Buy-side traders and portfolio managers have a fiduciary duty to maximize the value of their client’s portfolio This question tested from Session 16, Reading 30, LOS p Question 51 - #91868 Your answer: A was correct! 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 This question tested from Session 16, Reading 30, LOS j Question 52 - #91831 Your answer: B was correct! Value-motivated traders are patient and will use limit orders, because price, not time is their main objective This question tested from Session 16, Reading 30, LOS j Question 53 - #91605 Your answer: B was incorrect The correct answer was C) Broker markets In brokered markets, brokers find the counterparties to a trade This service is valuable when the trader has a large block to sell, when they want to remain anonymous, and/or when the market for the security is small or illiquid Brokered markets are important in countries where public capital markets are not well developed This question tested from Session 16, Reading 30, LOS c Question 54 - #92529 Your answer: B was correct! 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% This question tested from Session 16, Reading 30, LOS g Question 55 - #92802 Your answer: B was incorrect The correct answer was C) Market impact costs 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 bidask spread, market or price impact costs, opportunity costs, and delay costs (a.k.a slippage costs) This question tested from Session 16, Reading 30, LOS f Question 56 - #91965 Your answer: B was correct! 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 This question tested from Session 16, Reading 30, LOS h Question 57 - #92496 Your answer: A was incorrect The correct answer was C) Missed trade opportunity cost is weighted by the portion of the order that is filled 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 This question tested from Session 16, Reading 30, LOS g  ... answer: B was incorrect The correct answer was C) is applicable to small and large trades The advantages of VWAP are that it is easily understandable, computationally simple, can be applied quickly... 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... 16, Reading 30 , LOS d Question 43 - #92182 Your answer: B was incorrect The correct answer was A) The use of an implementation shortfall strategy Trades that are a small portion of average daily