Cant remember the components and calculations for the life of me. Anyone have any suggestions?
IS = return of paper portfolio - return of real portfolio
if return of paper portfolio is negative, then this reduces IS which is a good thing. if return of real portfolio is negative, then this increases IS which is a bad thing.
return from paper portfolio is simply (Pend x Qdecision) - (Pdecision x Qdecision) the tricky part is what price to use as Pdecision (also known as benchmark price).
from one of the practice lessons, it is implied that if not stated in the question, use midpoint quote at the time of decision or order entry.
return of real portfolio is simply (Pend x Qfilled-total) - sum of [(Pfilledx Qfilled)+ trading costs]
quick example, you enter a limit order buy of 1,000 shares at $1, these will be your Qdecision and Pdecision.
order is not filled today and you leave it for tomorrow. tomorrow, you decide to increase the limit order price to $1.2 and get a hit for 500 shares with $50 in commissions, these will be your Pfilled1, Qfilled1 and trading costs1. the third day, you decide to increase the limit to $1.4 and your order gets executed for 500 shares for a $50 commission (Pfilled2, Qfilled2 and trading costs2). at the end of the third day, the share price closes at $1.5.
return of paper portfolio: 1000x$1.5 - 1000x$1 = $500
return of real portfolio: 1000x$1.5 - [(500x$1.2 + $50) + (500x$1.4 + $50)] = $100
IS is: $500 - $100 = $400
now the next tricky part is sometimes you’re asked to express the IS as bps. divide the IS by the Pdecision x Qdecision (which is $1000) and you get 40% or 40bps