CFA LEVEL-III, PRACTICE QUESTIONS (LOS # 30) Reading 30: (Execution of Portfolio Decisions) | Questions Question - #92088 Which of the following implementation shortfall components is NOT influenced by market-wide movements? A) Explicit costs B) Missed trade opportunity cost C) Realized profit and loss Question - #92255 Which of the following is NOT one of the three components of the CFA Institute’s Trade Management Guidelines? A) Disclosures B) Processes C) Measurement tools Question - #92611 A trader must trade an entire portfolio of stocks Which of the following would be the best strategy to pursue? A) A simple logical participation percent-of-volume strategy B) A simple logical participation strategy based on VWAP C) An implementation shortfall strategy Question - #92827 Which of the following statements regarding a buy-side trader’s priority is CORRECT? A) Their relationships with their broker, the client, and sell-side traders are of equal priority B) Their relationship with sell-side trader must come first C) Their relationship with the client must come first Question - #126891 As the senior portfolio manager for the Tabler Industries Pension Fund, Nancy Wienke is responsible for investment decisions and execution of trades It is Wienke's belief that her portfolio managers be able to measure trading costs (including explicit and implicit costs) as well as have a complete understanding of available trading techniques Tammy Brooks, a junior portfolio manager, assists Weinke with her decisions Wienke has placed a strong emphasis on trade execution efficiency Wienke asks Brooks to evaluate a trade made last week for the Tabler Industries Pension Fund, using the implementation shortfall measure The trade was a buy order for the stock of Allen Materials Allen Materials is a mid-cap stock, which Wienke thinks is a timely buy given a recent announcement about the firm's prospects The details of the trade are as follows On Wednesday, Allen Materials stock price closed at $60.00 a share On Thursday morning before the market opened, the portfolio manager for the Tabler Industries Pension Fund decided to buy Allen Materials and transferred a limit order for $59.75 a share for 1,000 shares to the trader The order expired unfilled The Allen Materials stock closed at $60.05 on Thursday On Friday, the order was revised to a limit of $60.07 The order was partially filled that day as 700 shares were bought at $60.07 The commission was $19 The stock closed at $60.08 on Friday and the remaining order was cancelled The market return was 0.5% over the time period of this trading and the beta for Allen Materials is 1.3 Discussing the types of trading cost benchmarks, Wienke states that the volume-weighted average price (VWAP) is a weighted average of security prices during a day, where the weight applied to each price is the proportion of the day's trading volume She states further that the volume-weighted average price is useful because it can be applied quickly and easily Brooks mentions that, although that is true, a trader who is interested in buying a stock may try to game the volume-weighted average price by delaying the trade until the ask price is greater than the volume-weighted average price Wienke and Brooks next discuss the order management system for a series of trades that the Tabler Industries Pension Fund would like to execute The characteristics of the trades are provided in the following table Average Stock Trade Daily Spread Daily Trading Pattern Urgency Ticker Size Volume Lower at the beginning of the ABCD 75,000 125,000 0.48% Low day Lower at the beginning of the FGHI 230,000 4,200,000 0.11% High day LMNO 120,000 2,000,000 0.15% Even throughout the day High WXYZ 30,000 900,000 Even throughout the day Low 0.06% Part 1) The realized profit and loss component of the implementation shortfall measure Brooks should calculate for the Allen Materials trade is closest to: A) 0.02% B) -0.02% C) 0.01% Part 2) The missed trade opportunity cost component of the implementation shortfall measure Brooks should calculate for the Allen Materials trade is closest to: A) 0.01% B) 0.04% C) 0.02% Part 3) The market-adjusted implementation shortfall Brooks should calculate for the Allen Materials trade is closest to: A) 0.15% B) 0.65% C) -0.50% Part 4) Regarding their statements concerning trading cost benchmarks, are Wienke and Brooks correct or incorrect? A) Both are correct B) Both are incorrect C) Only one is correct Part 5) For the stocks listed in the table, which of them should be traded using a crossing network? A) FGHI B) LMNO C) ABCD Part 6) For the stocks listed in the table, which of them should be traded using an implementation shortfall strategy? A) FGHI B) WXYZ C) LMNO Question - #93157 Market A has average bid and ask sizes of 400 shares Market B has average bid and ask sizes of 600 shares Market C has average effective spreads of $0.034 Market D has average effective spreads of $0.039 Comparing A to B and C to D, which markets are of the highest quality? A) B and D B) B and C C) A and C Question - #91869 Which of the following trades would be predicted to have the highest trading costs using an econometric model? A) A small buy order in an upward trending market B) A large buy order in a downward trending market C) A large buy order in an upward trending market Question - #91597 Which of the following trade motivations would most likely use a low-cost-whatever-the-liquidity trading focus? A) Liquidity and information-motivated B) Liquidity and value-motivated C) Passive and value-motivated Question - #91972 Which of the following is least accurate regarding VWAP? VWAP: A) does not evaluate delayed or unfilled orders B) does not account for market movements or trade volume C) is applicable to small and large trades Question 10 - #92012 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 effective spread? A) $0.050 B) $0.025 C) $0.090 Question 11 - #92434 A trade’s volume is a small percentage of average daily trading volume The trade has low spreads and is not urgent Which of the following would be the best method of filling 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 Question 12 - #91600 Which of the following characterizes a need-trustworthy-agent trading focus? A) Low commissions and concealment of information B) High commissions and concealment of information C) High commissions and potential leakage of information Question 13 - #92004 Patty Benson and Terry Wortek are portfolio managers of a life insurance fund, Arbutus Insurance Benson is the more experienced of the two, and oversees all investment decisions as well as the execution of trades Wortek assists her with her decisions Benson has placed a strong emphasis on trade execution efficiency because her analysis of trades during last year suggests that Arbutus Insurance is not receiving best trade execution Discussing the types of trading venues, Benson remarks that electronic crossing networks are types of order-driven markets In these markets, she states that their advantage is that trading costs are low She states that their disadvantage is that an order may not be filled Wortek notes that Arbutus has positions in several international stocks, several of which are illiquid She states that in these markets where public capital markets are not well developed, Arbutus would likely trade in a brokered market Wortek notes that a disadvantage of these markets is that Arbutus could lose their anonymity, especially when they have a large block to sell Benson asks Wortek to analyze a series of trades for the firm so that she can evaluate the firm’s trading effectiveness The bid and ask volumes as well as bid and ask quotes are provided in the table below The trading data below represents the quotes for a single stock, Papineau Pharmaceuticals, on a single day Time of Trade Bid Price Bid Size Ask Price Ask Size 10 a.m $10.00 800 $10.07 700 12 p.m $9.90 500 $9.96 600 p.m $9.88 400 $9.94 500 At 10 a.m the trader for Arbutus Insurance placed an order to sell 900 shares of Papineau Pharmaceuticals The execution price was $9.98 At 12 p.m the trader for Arbutus Insurance placed an order to sell 500 shares of Papineau Pharmaceuticals The execution price was $9.92 At p.m the trader for Arbutus Insurance placed an order to sell 300 shares of Papineau Pharmaceuticals The average execution price was $9.91 Part 1) Regarding Benson’s statement concerning electronic crossing networks: A) Benson is incorrect because orders are necessarily filled in electronic crossing networks B) Benson is incorrect because trading costs are high in electronic crossing networks C) Benson is correct Part 2) Regarding Wortek’s statement concerning brokered markets: A) Wortek is incorrect because brokered markets allow traders to remain anonymous Wortek is incorrect because auction markets are more common in lesser developed capital B) markets C) Wortek is correct Part 3) What is the average quoted spread Wortek should calculate for the Arbutus Insurance trades? A) $0.0633 B) $0.0200 C) $0.0433 Part 4) What is the average effective spread Wortek should calculate for the Arbutus Insurance trades? A) $0.0233 B) $0.0433 C) $0.0200 Part 5) What is the weighted average effective spread Wortek should calculate for the Arbutus Insurance trades? A) $0.0266 B) $0.0633 C) $0.0641 Part 6) Which of the following best represents the analysis Wortek should provide for the Arbutus Insurance trades? A) One of the trades resulted in price improvement but the other two did not B) None of the trades resulted in price improvement C) Two of the trades resulted in price improvement but the third did not Question 14 - #92338 Which of the following is least accurate regarding best execution? A) Best execution can be measured for a single trade B) Each party to a trade determines what best execution is C) Best execution cannot be judged separately of the investment decision Question 15 - #92334 Which of the following is least accurate regarding best execution? A) Best execution can determine a trader’s effectiveness over time B) Best execution can be measured after the fact for a series of trades C) Best execution prevents high cost trades from taking place Question 16 - #92588 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, 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 Part 1) Regarding Hohlman’s statement concerning trading cost benchmarks: A) Hohlman is incorrect because the effective spread can be gamed B) Hohlman is correct Hohlman is incorrect because the opening price cannot be gamed more than the volumeC) weighted average price Part 2) Regarding Walker’s statement concerning the implementation shortfall: Walker is incorrect because the implementation shortfall does not incorporate implicit A) trading costs B) Walker is incorrect because the implementation shortfall is subject to gaming C) Walker is correct Part 3) What is the realized profit and loss component of the implementation shortfall measure Walker should calculate for the Brucker Industries trade? A) 0.16% B) 0.09% C) 0.12% Part 4) What is the delay costs component of the implementation shortfall measure Walker should calculate for the Brucker Industries trade? A) 0.18% B) 0.24% C) 0.12% Part 5) 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% Part 6) What is the implementation shortfall Walker should calculate for the Brucker Industries trade? A) 0.44% B) 0.51% C) 0.37% Question 17 - #91931 Which of the following statements regarding econometric models is CORRECT? Econometric models: A) are used to forecast trading costs and assess trading effectiveness B) are only useful for forecasting trading costs C) are not useful for forecasting trading costs or assessing trading effectiveness Question 18 - #91982 Suppose a trader is quoted a market bid price of $16.00 and an ask of $16.10 The execution price of a sell order is $16.03 What is the effective spread? A) $0.02 B) $0.04 C) $0.03 Question 19 - #92168 A trade’s volume is a large percentage of average daily trading volume and has high spreads Which of the following would be the best method of filling the trade? A) A simple logical participation strategy based on VWAP B) A simple logical participation percent-of-volume strategy C) Placing the trade with a broker Question 20 - #93178 Which of the following is NOT a characteristic of a liquid market? A) Integrity B) Homogenous traders C) An abundance of traders Question 21 - #92285 Which of the following is least accurate regarding the CFA Institute’s Trade Management Guidelines? They state that investment management firms should: A) provide general information on their trading techniques, markets, and brokers B) have policies and procedures that assist in best execution C) hire independent outside consultants to ensure best execution Question 22 - #92514 Frank Rolle is a portfolio manager who works for a firm that offers 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 firm Rolle knows that Smith’s firm 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 the interests of his clients come first B) Not trade with Smith because his research is of no better quality C) Trade with Smith because he may have better research Question 23 - #93082 Which of the following is least accurate regarding the role of ethics in trading? A) Trust has become more important B) Buy-side traders have a fiduciary duty to maximize the value of the client’s portfolio C) The relationship between buy-side and sell-side traders is becoming less adversarial Question 24 - #92135 A market order has: A) both price uncertainty and execution uncertainty B) price uncertainty but not execution uncertainty C) execution uncertainty but not price uncertainty Question 25 - #92122 Which of the following statements best characterizes a limit order? A limit order has: A) price uncertainty and execution uncertainty B) price uncertainty but not execution uncertainty C) reduced price uncertainty but retains execution uncertainty Question 26 - #91598 Which of the following is NOT a relevant measure of market quality? A) Liquidity B) Assurity of completion C) Market prevalence Question 27 - #92106 A trader submits a buy order that specifies 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? A) A market order B) A principal order C) A limit order Question 28 - #91607 In which of the following markets is an order most likely to go unfilled or partially filled? A) Auction markets B) Electronic crossing networks C) Electronic limit-order markets Question 29 - #91844 Which of the following markets does NOT provide price discovery? A) Electronic crossing networks B) Electronic limit-order markets C) Auction markets Question 30 - #92372 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 0.15% B) The opportunity costs are 0.07% and the total implementation shortfall is 0.19% C) The opportunity costs are 0.06% and the total implementation shortfall is 0.19% Question 31 - #92309 Which of the following is least accurate regarding best execution? Best execution: A) depends on relationships and practices B) is similar to the prudence concept C) should be judged independently of the investment decision Question 32 - #91599 Which of the following relationships is adversarial? A) Broker and dealer B) Trader and broker C) Trader and dealer Question 33 - #92297 Which of the following is least accurate regarding the CFA Institute’s Trade Management Guidelines? They state that investment management firms: A) must disclose their conflicts of interest related to trading B) should strive for best execution C) must not disclose documentation concerning policies and procedures to outside parties Question 34 - #91985 Suppose a trader is quoted a market bid price of $30.00 and an ask of $30.07 The execution price of a buy order is $30.04 What is the effective spread? A) $0.06 B) $0.01 C) $0.02 Question 35 - #92457 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 different 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 The supervisor asks about how to assess the costs and risks of the various types of trades The supervisor specifically asks White and Plain to explain the difference 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 effective 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 effective spread 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 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 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 effective because the inputs are fairly normally distributed Plain says that in addition to simply estimating the costs of a proposed trade, the model can also indicate the optimal size of the trade 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 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 Part 1) Which of the following statements regarding market orders is most accurate? Market orders: A) have execution uncertainty, and limit orders have price uncertainty B) have price uncertainty, and limit orders have execution uncertainty C) and limit orders both have execution uncertainty and no price uncertainty Part 2) In the example given by Plain, what was the effective spread for the order of 300 shares of GHT stock? A) $0.02 B) $0.06 C) $0.04 Part 3) In the example given by White, the term that describes the costs associated with the purchase of CRD stock is: A) delay costs B) missed trade opportunity C) volume-weighted costs Part 4) 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 estimate the optimal trade size With respect to these statements: A) White was correct and Plain was incorrect B) White was incorrect and Plain was correct C) both White and Plain were correct Part 5) With respect to the reasons given for using algorithmic methods for trading GHT stock: A) White and Plain were both correct B) White was correct and Plain was incorrect C) Plain was correct and White was incorrect Part 6) The best classification of the algorithmic method used by White and Plain is: A) implementation shortfall strategy B) simple logical participation strategy C) opportunistic participation strategies Question 36 - #92063 In which of the following markets would the calculation of market impact costs be inappropriate? A) Auction markets B) Electronic crossing networks C) Electronic limit-order markets Question 37 - #93093 A shortfall implementation strategy trades: A) early in the day and attempts to minimize opportunity costs B) with market flow and attempts to minimize opportunity costs C) early in the day and attempts to maximize trading cost volatility Question 38 - #91606 Passive 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 Question 39 - #92454 Use the following information to determine how the trades should be placed for the following shares Stock Trade Size Average Daily Volume Spread Urgency Ticker 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 ABCD should be traded using a simple logical participation strategy, LMNO should be A) traded using a shortfall implementation strategy, and WXYZ should be placed with a broker ABCD should be traded using a shortfall implementation strategy, LMNO should be B) placed with a broker, and WXYZ should be traded using a simple logical participation strategy ABCD should be traded using a shortfall implementation strategy, LMNO should be C) traded using a simple logical participation strategy, and WXYZ should be placed with a broker Question 40 - #91804 Information-motivated traders emphasize: A) time in their trading and use market orders B) price in their trading and use limit orders C) price in their trading and use market orders Question 41 - #91603 Which of the following trading tactics would most likely be used by an information-motivated trader? A) Need-trustworthy-agent B) Liquidity-at-any-cost C) Costs-are-not-important Question 42 - #91602 In which of the following relationships does the adverse selection risk problem pertain? A) Trader and broker B) Trader and investor C) Trader and dealer Question 43 - #92182 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 filling the trade? A) The use of an implementation shortfall strategy B) The use of a simple logical participation strategy based on VWAP C) Placing the trade in a crossing system Question 44 - #91448 A simple logical participation strategy trades: A) early in the day and attempts to minimize market impact B) with market flow and attempts to minimize opportunity costs C) with market flow and attempts to minimize market impact Question 45 - #91902 Which of the following variables is NOT typically used in econometric models to assess trading costs? A) Risk B) Momentum C) Market model alpha Question 46 - #92042 Which of the following measures is least susceptible to gaming by traders? A) VWAP B) Implementation Shortfall C) Effective spread Question 47 - #91601 In which of the following is there a principal-agent relationship? A) Broker and dealer B) Trader and broker C) Trader and dealer Question 48 - #92729 Which of the following trading costs results when an order is not filled? A) Delay costs B) Market impact costs C) Price impact costs Question 49 - #92691 If the volume-weighted average price (VWAP) during a day was $21 and 100 shares were bought at $20.40, which of the following statements regarding the costs of trading is most accurate? A) The implicit costs are -$60 B) The implicit costs are $60 C) The explicit costs are -$60 Question 50 - #92498 Which of the following is least accurate regarding best execution, the CFA Institute’s Trade Management Guidelines, and ethics in trading? A) Best execution should be measured over short, relevant time periods The buy-side trader’s relationship with clients must come before their relationship with B) sell-side traders C) Record keeping is a key component of the CFA Institute’s Trade Management Guidelines Question 51 - #91868 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 should he use? A) market B) limit C) participate Question 52 - #91831 Value-motivated traders emphasize: A) time in their trading and use limit orders B) price in their trading and use limit orders C) price in their trading and use market orders Question 53 - #91605 Where would an illiquid security in a developing country most likely trade? A) Electronic crossing networks B) Electronic limit-order markets C) Broker markets Question 54 - #92529 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% Question 55 - #92802 Which of the following trading costs is NOT an explicit cost? A) Commissions B) Stamp duties C) Market impact costs Question 56 - #91965 Which of the following is least accurate regarding implementation shortfall? Implementation shortfall: A) requires considerable data and analysis B) is subject to gaming C) decomposes and identifies costs Question 57 - #92496 Which of the following statements regarding the implementation shortfall components is least accurate? Missed trade opportunity cost represents the difference between the price at which the A) order is cancelled and the original price Realized profit and loss represents the difference between the execution price and the B) previous day's closing price C) Missed trade opportunity cost is weighted by the portion of the order that is filled  ... trade with a broker Question 20 - # 931 78 Which of the following is NOT a characteristic of a liquid market? A) Integrity B) Homogenous traders C) An abundance of traders Question 21 - #92285... the investment decision Question 32 - #91599 Which of the following relationships is adversarial? A) Broker and dealer B) Trader and broker C) Trader and dealer Question 33 - #92297 Which of the... procedures to outside parties Question 34 - #91985 Suppose a trader is quoted a market bid price of $30 .00 and an ask of $30 .07 The execution price of a buy order is $30 .04 What is the effective