Transaction Costs

Question 1

List the different transaction costs

Answer 1

1. Bid-ask spread
2. Price impact of a trade
3. Opportunity cost
4. Brokerage commissions
5. Taxes and other charges

Question 2

Explain “bid-ask spread” in terms of transaction costs

Answer 2

Set by the dealer to cover their own costs and make a profit

Costs include processing the order and holding the stock

Small, riskier, less liquid and less frequently traded stocks carry a larger spread

Question 3

Explain “price impact of a trade” in terms of transaction costs

Answer 3

A large volume of stock when bought creates an imbalance in demand and supply

Large volumes of trade can mean that market makers can change the price of the stock (usually higher) but, this wouldn’t have happened if the transaction never occurred

The cost arises when the order size is large relative to the market liquidity

Question 4

Explain “opportunity cost” in terms of transaction costs

Answer 4

1. This is the “cost of waiting” or the cost of not executing a trade
2. It’s the potential returns you miss out on due to the costs associated with executing a trade or investment

Question 5

Explain “brokerage commissions” in terms of transaction costs

Answer 5

The price to execute a trade. Usually is a fixed %

Question 6

Explain “taxes and other charges” in terms of transaction costs

Answer 6

SDRT - stamp duty reserve tax. Buyer pays 0.5% of the purchase amount

PTM Levy - panel of takeovers and mergers. Both buyer and seller pay £1.50 on purchases/ sales in excess of £10,000

Market makers are exempt from paying SDRT and PTM Levy

Question 7

List the transaction costs for trading equities / equity securities on LSE

Answer 7

1. Commission charged by brokers 10-20 basis points for large orders
2. 100-150 basis points for small trades
3. SDRT - 0.5% on the purchase amount (buyers only)
4. PTM Levy - £1.50 on all purchases in excess of £10,000 (buyers and sellers)

Question 8

List the transaction costs for purchasing gilts

Answer 8

1. Commission rates vary between 0.5% - 1% of the value of the purchase for purchases below £5,000
2. Purchases over £1m attract no commission charge
3. Purchases on gilts are exempt from SDRT
4. Settled on T+1

Question 9

List the transaction costs for derivatives (both exchange traded and OTCs)

Answer 9

1. Transaction costs are included in the transaction price
2. Transaction costs for exchange traded derivatives are much lower than OTC derivatives

Question 10

List the transaction costs for pooled investments like unit trusts and OEICs

Answer 10

1. Entry cost
2. Ongoing charges figure (OCF) - increases over time for actively managed pooled investments/ funds

Question 11

List the transaction costs for direct property investments

Answer 11

1. Stamp duty
2. Legal costs
3. Ongoing maintenance costs

Question 12

Explain broker commissions

Answer 12

1. Traders will pay the brokers “commission” for arranging their trades.
2. Commissions are usually a fixed % of the transaction value OR a fixed price per share
3. Brokers also pay exchange, regulation and cleaning fees

Question 13

What is the formula to calculate the bid-ask spread

Answer 13

(Bid price - ask/ offer price) x 100

Question 14

Define round-trip transaction costs

Answer 14

Total costs of completing a transaction, including bid-ask spread, commission and taxes.