Execution of Portfolio Decisions

Question 1

Market-not-held order

Answer 1

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

Question 2

Participate (do not initiate) order

Answer 2

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

Question 3

Undisclosed limit order (also known as a reserve, hidden, or iceberg order)

Answer 3

A limit order that includes an instruction not to show more than some maximum quantity of the unfilled order

Question 4

Principal trade

Answer 4

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

Question 5

Portfolio trade (or program trade or basket trade)

Answer 5

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

Question 6

Straight-through processing

Answer 6

Systems that simplify transaction processing through the minimization of manual and/or duplicative intervention in the process from trade placement to settlement

Question 7

Effective spread

Answer 7

Effective spread = 2× (Actual execution price - Mid-point of market quote at time of order entry)

Question 8

Price discovery

Answer 8

Adjustment of transaction prices to balance supply and demand

Question 9

Adverse selection risk

Answer 9

The risk associated with information asymmetry; in the context of trading, the risk of trading with a more informed trader

Question 10

Resilient market

Answer 10

A market is resilient if any discrepancies between market price and intrinsic value tend to be small and corrected quickly

Question 11

Transactions cost components

Answer 11

• Bid-ask spread
• Market impact
• Missed trade opportunity costs
• Delay costs

Question 12

Implementation shortfall components

Answer 12

• 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)

Question 13

Sunshine trades

Answer 13

Public display of a transaction (usually high-volume) in advance of the actual order

Question 14

• Constant-Mix Strategy
• Constant-Proportion Strategy: CPPI

Answer 14

• Target investment in stocks = m × Portfolio value
• Target investment in stocks = m × (Portfolio value – Floor value)

Question 15

Buy-and-hold vs rebalancing

Answer 15

Perold-Sharpe analysis clearly illustrates that a buy-and-hold strategy can be expected to outperform a rebalancing discipline in an upward trending market

Question 16

Missed trade opportunity cost

Answer 16

= (closing price) – (ask price at order entry)

Question 17

Risk tolerance for a buy-and-hold strategy

Answer 17

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

Question 18

A constant-mix strategy - trending vs reverting markets

Answer 18

This strategy is least successful when markets are trending but does offer superior returns when markets are characterized by reversals

Question 19

Perold–Sharpe Rebalancing Strategies

Answer 19

• 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

Question 20

Summary of Perold–Sharpe Strategies

Answer 20

Question 21

A Need-Trustworthy-Agent-Focus appropriateness

Answer 21

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

Question 22

VWAP attempts to measure

Answer 22

• 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

Question 23

Summary of Trading Motivations, Time Horizons, and Time versus Price Preferences

Answer 23

Question 24

Objectives in trading

Answer 24

Question 25

Determining if dealers/specialists provide price improvement

Answer 25

Price improvement is provided when the effective spread is lower than the quoted spread

Question 26

Disavandtages of shopping the order

Answer 26

• Delay costs
• Information leakage

Question 27

Costs and market impact of trading a basket of stocks versus trading these stocks individually

Answer 27

• The price of tradings a basket of stocks is lower because:
  
  1. There is less information leakage as other participants will not believe that this transaction is information-motivated
  2. A single quoted can be obtained for the entire basket by a broker

Question 28

Comparison of VWAP and Implementation Shortfall

Answer 28

Question 29

Portfolio turnover

Answer 29

Is the lower of total purchases or total sales divided by the average monthly assets

Question 30

Slippage costs

Answer 30

• Are usually more important than commission costs
• Are greater for small-cap than for large-cap

Question 31

Factors affecting the optimal corridor width of an asset class

Answer 31