Transaction Costs

Question 1

Which are the three main costs associated with transaction costs?

Answer 1

• Commissions
• Bid/Ask Spread
• Market (price) impact

Question 2

which is the fourth type of cost that relates to all other transaction costs?

Answer 2

• Opportunity costs

Question 3

What is the trade off between transaction and opportunity costs?

Answer 3

if you trade you have to pay transaction costs

if you don’t trade you have to pay opportunity costs

Question 4

What inhibits constant rebalancing of portfolios?

Answer 4

transaction costs

Question 5

what does a buy and hold strategy imply? what are the benefits? (2)

Answer 5

Do nothing strategy (assume 60/40 mix)
Floor of investment based on initial bond investment
Unlimited upside potential

Question 6

what does a Constant proportion strategy imply?

Answer 6

proportion of investment exposed through risky assets is always constant. if value of risky assets drop, rf assets are converted to risky assets to maintain proportion.

Question 7

When does the Constant proportion strategy perform well/badly?

Answer 7

preforms well in volatile or flat markets

performs badly in constantly changing bull and bear markets

Question 8

what type of investment strategy is the Constant proportion strategy?

Answer 8

a contrarian strategy – buy in cold market and sell in hot market.

Question 9

What is a portfolio insurance strategy?

Answer 9

Similar to buy-and-hold but with higher preference for risk above floor
As value of risky asset decreases, reduce proportion of risky assets to riskfree asset. max decrease to floor value

Question 10

what type of investment strategy is the portfolio insurance strategy?

Answer 10

Essentially a momentum strategy.

Question 11

When does the portfolio insurance strategy perform well/badly?

Answer 11

bull markets, but poorly in flat markets

Question 12

Which type of portfolio strategy out perform the other when the market is trending strongly upward or downward?

Answer 12

CPPI

– Increases (decreases) at an increasing (decreasing) rate as market value of risky assets increases (decreases).

Question 13

according to Grinold & Kahn: Rule of thumb, how can you increase you “value-added”?

Answer 13

(1) prioritize trades based on alpha

(2) can identify differential T-costs across securities

Question 14

when there is a buyer and a seller for stock who pays brokerage commission fees?

Answer 14

both parties will pay this transaction cost

Question 15

between a momentum and contrarian investor, who is the liquidity demander?

Answer 15

the momentum investor

Question 16

between a momentum and contrarian investor, who pays the bid ask spread?

Answer 16

the momentum investor

Question 17

who pays the market impact cost?

Answer 17

the liquidity demander/momentum investor, if they can’t fill their initial order they will have to move to the second best price.

Question 18

what is the opportunity cost if the liquidity demander decides to split his order to reduce market impact cost?

Answer 18

if he only fills part of the order and then the prices move unfavourably he will have lost the opportunity to complete the total trade.

Question 19

when do bid-ask spread costs increase?

Answer 19

when there is low volume of stock traded, stocks aren’t liquid or there is an increase in volatility.

Question 20

What are bid-ask spread costs?

Answer 20

the difference in prices between the trader willing to sell for the lowest amount and the trader willing to buy for the highest price.

Question 21

What is market impact cost?

Answer 21

The cost of taking a long or short position to fill a trading order

Question 22

when do market impact costs increase?

Answer 22

when there is low volume of stock traded, stocks aren’t liquid or there is an increase in volatility.