Week 8 - Evaluating trading strats & performance Flashcards

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1
Q

What is the investment cycle for a fund manager?

A
  1. Asset allocation
  2. Portfolio construction
  3. Implementation
  4. Portfolio attribution
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2
Q

Define best execution

A

trader receiving the most favourable terms for their trades

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3
Q

What are the three components of transaction costs?

A
  1. Explicit costs
    - fees of trade
  2. Implicit costs
    - Price effects
  3. Missed opportunity costs
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4
Q

What are the two approaches to analyse transaction costs?

A
  1. Benchmark comparisons
    - Difference between benchmark prices and traded price
  2. Implementation shortfall method
    - Transaction costs if order executes
    +
    - Missed opportunity costs if order does not execute
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5
Q

What are the common benchmark prices?

A
  1. Arrival price
  2. VWAP
  3. Closing/opening prices
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6
Q

How is arrival price calculated

What are the issues?

A

calculated by the midpoint of bid-ask spread at the time of trade (bid-ask*0.5)

issues:
1. does not evaluate the effectiveness of timing
2. Large orders require multiple quotes at different prices

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7
Q

How are transaction costs caluclated from a benchmark for buy side and sell side?

A

Buy side
TP-BP = TC/unit

Sell Side
BP-TP = TC/unit

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8
Q

How is VWAP calculated?
What are the pros and cons?

A

VWAP = Total traded value / total volume

Pros
- simple summary of all trades in a day

Cons
- If only one trade => TC = 0
- Large orders push TC/unit closer to 0

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9
Q

What is the trading strategy for a momentum trader?

What is the issues of using the VWAP method?

A

buy in upward trend and sell in downward trends

Issues
positive transaction costs as TP > VWAP

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10
Q

What is the trading strategy for a contrarian trader?

What is the issues of using the VWAP method?

A

buy in downward trends and sell in upward trends

issues
Negative transaction costs as TP < VWAP

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11
Q

How is the closing price benchmark calculated?

What are the pros and cons?

Why is it gaining popularity?

A

Transaction costs = TP - closing price

Pros
Closing price is publicly available

Cons
informed traders = negative transaction costs
Brokers can execute at closing price= 0 TC

Gaining popularity as fund managers can gain lower transaction costs estimates easily

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12
Q

What is included in the implementation short fall method?

What are the pros and cons?

A

Measures
1. Transaction costs
2. Opportunity costs if not executed

Pros
- Separates portfolio selection performance from implementation performance
- Brokers cannot game the method

Cons
- Requires data relating to decision time and order size
- Estimates large opportunity costs for large orders

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