Implementation shortfall

CFA Level III Portfolio Management
#1

Guys, i really need help with this monster. I thought i was on top of this guy when i was listening to the Schweser lectures but EOC questions completely threw me off.

There is this question (Q10) which has me in knots here. A trader decided to sell 30,000 shares of a company. At the time of decision the quoted price was 53.2 - 53.3 . Because of the large size of the order, it was split in to 3 equal orders executed on 3 different days. When the first order was placed the price was 53.2 - 53.3 and the shares were sold at 53.22. Prices declined as a result of the trade and closed at 53.05 - 53.15 when the next order was placed and was executed at 53.06. The prices fell to 52.87 - 52.98 when the last order was placed and was executed at 52.87. Ignore the commissions

A). Calculate total transaction cost if the closing price was used as BM price.

B). Implementation shortfall?

I tried solving part A as 30,000*53.2=1,596,000 (Starting Value) and 30,000*52.87=1,586,100 (ending value). This translates into a loss of 9,900 on our paper folio. For actual folio, I multiplied 10,000 with 53.22, 53.06 and 52.87 which gave me 533,200+530,600+528,700 which means a total folio value of 1,592,500. Therefore the actual gain/loss w.r.t paper folio is 6,400.

I know I am completely wrong here but the solution confused me even further.

For implementation shortfall, its using the numbers on which i simply cant get my head around. P

If someone is generous enough with their time, please help me understand whats going on here. Usually the solutions are very nicely explained but this is not the case here.

I’ll be grateful if someone can help me understand. I am freaking out completely :frowning:

#2

Someone? Anyone? Please?

#3

I think you need to compute the paper portfolio first. And then the Actual portfolio and then add your comissions costs to your actual portfolio. Make sure your paper portfolio is the total # of shares and your Actual portfolio is actually the # of share executed.

#4

i did exactly that. I am confused on which numbers to use.

#5

OK so…

Paper = total # * (Cancel Px - Decision Px)

Actual = [Filled # * (Cancel Px - Execution Px) - Commisions]

#6

You can add commissions at the end if you like. I just have it in my actual since that’s what in the text.

#7

Paper portfolio assumes you sell at the decision price which is 52,25 here (solution uses midpoint of the quote). That’s 30000 times 53,25 = 1597500. Actual portfolio sells 10000 at 53,22 53,06 and 52,87 which makes 1591500. Difference is 6000.

The key here is that you came up with 6400 based on bid price, the solution uses midpoint. This is because as you can see the orders aren’t always executed at bid, look at the first order, bid is 53,20 but execution was at 53,22 which signals price improvement. By taking bid you overestimate cost.

#8

the answer is 5400 and i cant get there even after using midquotes

#9

i was of the view that when we are selling, we should take the bid price (dealer’s bid) and when we are buying, we take ask price (dealer’s ask). That was not the case. I take this learning out of the question. But that still doesnt get me anywhere with respect to getting the correct answer. I am not even starting to whine about the second part. :frowning:

#10

In the 2018 curriculum the answer is 6000, are you using an old book / maybe looking at different question?

The curriculum explains that the effective spread, that is 2 x (midquote - execution price) for a sell order is the actual transaction price of a trade, not versus the bid of the market quote. Effective spread reflects both price improvement such as in this case (execution is done at better than bid) as well as price impact (outside the bid-ask spread).

#11

No bro, I am using 2018 curriculum and i am looking at the right answer. please goto page 101 for the answer. Question could be found at page 93

#12

book 6 obviously!!!

#13

One of those parameters is a really challenging here as I could remember I think this is a market impact parameter and because it is not constant than depends on situation which starting point price was used. If you’re able to solve for this one, you got entire IS concept solved.