Execution of Portfolio Decisions Flashcards
Market-not-held order
A variation of the market order designed to give the agent greater discretion than a simple market order would allow. Not held means that the floor broker is not required to trade at any specific price or in any specific time interval
Participate (do not initiate) order
A variant of the market-not-held order. The broker is deliberately low-key and waits for and responds to the initiatives of more active traders
Undisclosed limit order (also known as a reserve, hidden, or iceberg order)
A limit order that includes an instruction not to show more than some maximum quantity of the unfilled order
Principal trade
A trade with a broker in which the broker commits capital to facilitate the prompt execution of the trader’s order to buy or sell
Portfolio trade (or program trade or basket trade)
An order that requires the execution of purchases (or sales) in a specified basket (list) of securities as close to the same time as possible
Straight-through processing
Systems that simplify transaction processing through the minimization of manual and/or duplicative intervention in the process from trade placement to settlement
Effective spread
Effective spread = 2× (Actual execution price - Mid-point of market quote at time of order entry)
Price discovery
Adjustment of transaction prices to balance supply and demand
Adverse selection risk
The risk associated with information asymmetry; in the context of trading, the risk of trading with a more informed trader
Resilient market
A market is resilient if any discrepancies between market price and intrinsic value tend to be small and corrected quickly
Transactions cost components
- Bid-ask spread
- Market impact
- Missed trade opportunity costs
- Delay costs
Implementation shortfall components
- Commissions (commissions/original paper portfolio value)
- Realized profit/loss (execution price - closing price of the prior day)
- Delay (closing price of the prior day - closing price of the decision day)
- Missed trade opportunity (final price - closing price of the decision day)
Sunshine trades
Public display of a transaction (usually high-volume) in advance of the actual order
- Constant-Mix Strategy
- Constant-Proportion Strategy: CPPI
- Target investment in stocks = m × Portfolio value
- Target investment in stocks = m × (Portfolio value – Floor value)
Buy-and-hold vs rebalancing
Perold-Sharpe analysis clearly illustrates that a buy-and-hold strategy can be expected to outperform a rebalancing discipline in an upward trending market
Missed trade opportunity cost
= (closing price) – (ask price at order entry)
Risk tolerance for a buy-and-hold strategy
A buy-and-hold strategy implies that an investor’s risk tolerance is positively related to wealth. Such an approach is most effective in trending markets. Buy-and-hold provides a portfolio value that is a linear function of the stocks’ value
A constant-mix strategy - trending vs reverting markets
This strategy is least successful when markets are trending but does offer superior returns when markets are characterized by reversals
Perold–Sharpe Rebalancing Strategies
- When m is greater than 1, the strategy is called constant-proportion portfolio insurance (CPPI)
- When m equals than 1, the strategy is equivalent to a buy-and-hold strategy
- When m is less than 1, an investor desires to hold stocks at all levels of wealth
Summary of Perold–Sharpe Strategies
A Need-Trustworthy-Agent-Focus appropriateness
A Need-Trustworthy-Agent-Focus is appropriate when low-level advertising is required during execution and the trades are sensitive to possible information leaks. It is least appropriate when a trade requires a high certainty of execution
VWAP attempts to measure
- The price benchmark for a trade with greater precision than other measures
- Missed trade opportunity costs are difficult to measure, and VWAP does little to resolve those difficulties
- Market impact costs are similarly difficult to measure
Summary of Trading Motivations, Time Horizons, and Time versus Price Preferences
Objectives in trading
Determining if dealers/specialists provide price improvement
Price improvement is provided when the effective spread is lower than the quoted spread
Disavandtages of shopping the order
- Delay costs
- Information leakage
Costs and market impact of trading a basket of stocks versus trading these stocks individually
- The price of tradings a basket of stocks is lower because:
- There is less information leakage as other participants will not believe that this transaction is information-motivated
- A single quoted can be obtained for the entire basket by a broker
Comparison of VWAP and Implementation Shortfall
Portfolio turnover
Is the lower of total purchases or total sales divided by the average monthly assets
Slippage costs
- Are usually more important than commission costs
- Are greater for small-cap than for large-cap
Factors affecting the optimal corridor width of an asset class
