THROUGH 48 RELATE TO PORTFOLIO EXECUTION DAVID MILLER CAS...
Questions 43 through 48 relate to Portfolio Execution David Miller Case Scenario David Miller, CFA, works as an analyst with U.S based ZM Asset Management Firm. Miller is currently exploring how portfolio execution costs can be minimized when fulfilling trade orders. Miller is considering various price benchmarks with the intention of selecting the most appropriate benchmark. Various price benchmarks are available such as quotation mid-point, volume weighted average price (VWAP), opening price, closing price and implementation shortfall. Miller selects VWAP because he considers it a more satisfactory benchmark compared to quotation mid-point. William Banner is another analyst at ZM. He agrees with Miller with respect to the use of VWAP. However, he makes the following statements regarding the limitations of VWAP. Statement 1: “VWAP is not free from limitations because it can be ‘gamed’.” Statement 2: “To deal with the gaming problem associated with VWAP, a more reliable measure of VWAP can be obtained by measuring VWAP over multiple days instead of a single day.” Banner is evaluating market quality. He gathers necessary information and observes that quoted and effective spreads are high and investors do not have easy access to accurate and reliable information about quotes and trades. In addition, parties to trades do not stand behind their quotes. Based on this information, he concludes that the market has low quality. Based on this conclusion, Banner decides to use implementation shortfall as a price benchmark due to its various advantages over other price benchmarks. Banner mentions two advantages of implementation shortfall. Advantage 1: Implementation shortfall incorporates both explicit and implicit costs and is not vulnerable to gaming. Advantage 2: Implementation shortfall can be used for all types of assets due to its inherent quality of capturing all elements of transaction costs.
CFA Level III Mock Exam 3 – Solutions (PM)
Miller is analyzing a transaction involving Saving Life Drugs Company (SDC) (Exhibit 1). Exhibit 1 Saving Life Drugs Company Transaction (SDC) Benchmark Price: On Monday, April 2nd
, SDC closed at $23.05 a share. Tuesday Morning: Before market opens, a portfolio manager at ZM decides to buy 1,100 shares of SDC using a limit order at $22.95. Tuesday Close of Trading: • Price of SDC does not fall below $23.00 and no part of the order is filled on Tuesday, it expires. • It closes at $23.10. Wednesday: • Limit order is revised to a new limit of $23.11. • The order is partially filled on Wednesday, buying 750 shares incurring commission costs of $15. • The stock closes at $23.15 and order for the remaining 350 shares is cancelled. After analyzing various trades, Miller concludes that the implementation shortfall is always positive for buy orders. Banner is analyzing a trade of Angels Clothing Company (ACC). He has computed an implementation shortfall of 23%. The expected return on ACC’s stock is 25%. Miller is also managing a separate fund for a client. His client is very concerned about minimizing trading costs. Therefore, Miller decides to discuss the issue with head of the trading desk, Abraham Ryan. Ryan makes the following two comments: Comment 1: Both explicit and implicit costs are part of total trading costs and explicit costs constitute a major part of total trading cost. Comment 2: Trading aggressively often leads to the most expensive trade due to higher market impact. Therefore, trading costs can be reduced by avoiding aggressive trades. 37. With respect to the use of VWAP as a price benchmark and the two statements made by Banner, which of the following is most likely correct? A. Banner is correct in agreeing with Miller; Banner is incorrect with respect to both Statements 1 and 2. B. Banner is correct in agreeing with Miller; Banner is correct with respect to both Statements 1 and 2. C. Banner is correct in agreeing with Miller; Banner is correct with respect to Statement 1 only. 38. With regard to Banner’s conclusion regarding market quality and use of implementation shortfall as a price benchmark, which of the following is most likely correct? A. Banner is correct with respect to market quality and correct with respect to the use of implementation shortfall. B. Banner is incorrect with respect to market quality and incorrect with respect to the use of implementation shortfall. C. Banner is correct with respect to market quality but incorrect with respect to the use of implementation shortfall. 39. With regard to the two advantages of implementation shortfall: A. Advantage 1 is correct; Advantage 2 is incorrect. B. Advantage 1 is correct; Advantage 2 is correct. C. Advantage 1 is incorrect; Advantage 2 is correct. 40. Using the data provided in Exhibit 1, the implementation shortfall and delay costs are, respectively, closest to: implementation shortfall: delay costs: A. 0.373% 0.446% B. 0.375% 0.148% C. 0.316% 0.069% 41. With respect to Miller's conclusion regarding implementation shortfall and Banner's analysis of the adjusted implementation shortfall (IS) measure for ACC, respectively, which of the following is most likely correct? Miller is: The adjusted IS is: A. Incorrect – 2% B. Correct + 2% C. Correct – 2% 42. With regard to the comments made by Ryan on trading costs, which of the following is most likely correct? A. Comment 1 is correct; Comment 2 is incorrect. B. Comment 1 is correct; Comment 2 is correct. C. Comment 1 is incorrect; Comment 2 is incorrect.