Transaction Costs Flashcards
Which are the three main costs associated with transaction costs?
- Commissions
- Bid/Ask Spread
- Market (price) impact
which is the fourth type of cost that relates to all other transaction costs?
- Opportunity costs
What is the trade off between transaction and opportunity costs?
if you trade you have to pay transaction costs
if you don’t trade you have to pay opportunity costs
What inhibits constant rebalancing of portfolios?
transaction costs
what does a buy and hold strategy imply? what are the benefits? (2)
Do nothing strategy (assume 60/40 mix)
Floor of investment based on initial bond investment
Unlimited upside potential
what does a Constant proportion strategy imply?
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.
When does the Constant proportion strategy perform well/badly?
preforms well in volatile or flat markets
performs badly in constantly changing bull and bear markets
what type of investment strategy is the Constant proportion strategy?
a contrarian strategy – buy in cold market and sell in hot market.
What is a portfolio insurance strategy?
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
what type of investment strategy is the portfolio insurance strategy?
Essentially a momentum strategy.
When does the portfolio insurance strategy perform well/badly?
bull markets, but poorly in flat markets
Which type of portfolio strategy out perform the other when the market is trending strongly upward or downward?
CPPI
– Increases (decreases) at an increasing (decreasing) rate as market value of risky assets increases (decreases).
according to Grinold & Kahn: Rule of thumb, how can you increase you “value-added”?
(1) prioritize trades based on alpha
(2) can identify differential T-costs across securities
when there is a buyer and a seller for stock who pays brokerage commission fees?
both parties will pay this transaction cost
between a momentum and contrarian investor, who is the liquidity demander?
the momentum investor
between a momentum and contrarian investor, who pays the bid ask spread?
the momentum investor
who pays the market impact cost?
the liquidity demander/momentum investor, if they can’t fill their initial order they will have to move to the second best price.
what is the opportunity cost if the liquidity demander decides to split his order to reduce market impact cost?
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.
when do bid-ask spread costs increase?
when there is low volume of stock traded, stocks aren’t liquid or there is an increase in volatility.
What are bid-ask spread costs?
the difference in prices between the trader willing to sell for the lowest amount and the trader willing to buy for the highest price.
What is market impact cost?
The cost of taking a long or short position to fill a trading order
when do market impact costs increase?
when there is low volume of stock traded, stocks aren’t liquid or there is an increase in volatility.
