THROUGH 18 RELATE TO MONITORING AND REBALANCING. HIGH-RI...

Questions 13 through 18 relate to Monitoring and Rebalancing.

High-Rise Investment Management (HRIM) Case Scenario

High-Rise Investment Management (HRIM) is a Canadian asset management firm with a

reputable standing in the financial community. Bill Coss is the head of the trading

division at the firm, and supervises more than twenty financial experts at his department.

Due an expansion in the firm’s business, Coss has recently hired a few portfolio

managers to support the trading activities of the firm. One of the new employees is Bruce

Block, an equity portfolio manager who worked for a small Canadian equity firm for two

years. During his job interview, Coss mentioned the various types of orders that traders

use and that portfolio managers need to understand. Block made the following comments:

Statement 1: “A variation of the market order designed to give the agent of the trader

greater discretion than a simple market order is the market-not-held order.

An order type that gives the trader’s agent even more discretion is the

‘best efforts order’.”

Statement 2: “Sometimes traders with a buying motive, post bids, hoping others would

sell to them, yielding negative implicit trading costs. However if bid-ask

spread is small, they may buy at the ask. Such trading is termed a pegging

strategy which typically utilizes iceberg orders.”

At his first day at work, Block was instructed by Coss to work with the firm’s most senior

traders, Mike Gentile, to purchase 1,650 shares of Altec Corporation. The trade was

executed in a single day and was split into three parts of different trade sizes. Exhibit 1

displays information about the dealers who make a market in Altec Corp’s stock, and

their quoted bid-ask prices. Exhibit 2 displays information about the three trades executed

by Block.

Exhibit 1

Bid-Ask Prices of Dealers

Dealer

Bid Price (C$)

Bid Size

Ask Price (C$)

Ask Size

Dealer A

45.74

750

47.88

800

Dealer B

45.76

500

47.56

450

Dealer C

45.68

200

48.90

350

Exhibit 2

Trading transactions in Altec stock

Trade

Shares Bought

Execution Price (C$)

Trade 1

750

47.70

Trade 2

500

47.56

Trade 3

400

49.10

Dealer A’s quote was in effect at the time of trade 1, Dealer B’s quote was in effect at the

time of trade 2, and Dealer C’s quote was in effect at the time of trade 3.

Coss came over to analyze the costs of the trade. After his analysis he made the following

comments:

Statement 3: “The inside bid-ask spread is lower than any individual dealer’s spread.”

Statement 4: “The average effective spread of the transactions in Altec Corp’s stock is

C$2.4.”

Gentile works with many of the firm’s portfolio managers towards selecting the

appropriate execution strategy for portfolio decisions. As a part of this process, Gentile is

assessing the execution of orders in three stocks. Exhibit 3 displays information in the

order management system, including trade sizes, market attributes, and the urgency levels

from the portfolio managers, for the three stocks.

Exhibit 3

Order Management System

Stock

Size (shares)

Avg. Daily Vol.

Price

Spread (%)

Urgency

A

15,000

45,000

65.78

0.45

Low

B

89,000

1,500,000

102.34

0.03

Low

C

47,000

1,000,000

39.02

0.02

Low

Gentile sold 500 shares of Star Energy Inc. for a pension fund at a price of $50.00 per

share. All the trades that occurred during the day in Star Energy Inc. are shown in Exhibit

4.

Exhibit 4

Shares traded in Star Energy Inc.

Trade Price ($)

Shares Traded

53.45

300

49.77

400

50.00

500

50.10

650

Coss is working with Gentile to rebalance his own portfolio in order to keep the asset

class weights within their specified corridors. Coss has specified a corridor for each asset

class as a common multiple of the standard deviation of the asset class’s returns.

Gentile is determining the appropriate execution strategy for the stock of Pyramid

Enterprise, a thinly traded stock with irregular volume patterns. He has decided to use a

simple logical participation strategy but is not sure which one to use.

13. Block is least accurate with respect to:

A.

Statement 1 only.

B.

Statement 2 only.

C.

neither Statement 1 nor Statement 2.

14. Coss is most accurate with respect to:

A.

Statement 3 only.

B.

Statement 4 only.

C.

both statements 3 and 4.

15. Which of the following is most accurate about the orders in the Order

Management System?

A.

The order in Stock A is most suited for a VWAP algorithm and the order

in Stock B should be traded using an implementation shortfall algorithm.

B.

The orders in Stock B and C are most suited for a logical participation

strategy, whereas the order in Stock A should be traded on a crossing

system.

C.

The order in Stock B should be traded on a crossing system, whereas the

order in Stock C is most suitable for trading through a broker.

16. The implicit transaction cost of the trade in Star Energy Inc., using the VWAP as

the price benchmark, is closest to:

A.

$212.39

B.

$230.95

C.

$272.43

17. Which of the following is most accurate about the rebalancing strategy that Coss

is using for his own portfolio?

A.

Each asset class will have a different probability of triggering rebalancing

if the normal distribution describes the asset class returns.

B.

The rebalancing strategy does not account for differences in transaction

costs or asset correlations.

C.

Such a strategy requires less frequent rebalancing when the market is

trending and more frequent rebalancing when the market is characterized

by reversals.

18. Which of the following simple logical participation strategy will be most

appropriate for trading in Pyramid Enterprise’s stock?

A.

TWAP.

B.

VWAP.

C.

Percentage of volume strategy.