Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CFA Level 3 > 16-30 Execution > Flashcards

16-30 Execution Flashcards

0
Q

Formula.

Effective spread for a sell order

A

= 2 x ( Midquote - Execution price)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
1
Q

Formula.

Effective Spread for a buy order

A

Effective Spread for buy order
= 2 x (Execution price - Midquote)

Midquote is average of inside bid and inside ask

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What is an Effective Spread?

A

The true cost of a round-trip transaction (supposedly a better measure than the quoted bid-ask spread).

If lower than the quoted spread, indicates better liquidity for a security or superior (i.e. lower cost) execution

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Purpose of securities markets

A

Provide liquidity, transparency and assurity of completion

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

4 types of securities markets

A
  1. Quote driven market
  2. Order driven market
  3. Brokered market
  4. Hybrid market
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

3 Types of Order-Driven Market

Characteristics of each

A
  1. Electronic crossing network
    - institutional trades
    - guarantees anonymity
    - no price discovery so prices can’t adjust according to supply and demand
    - low liquidity so leads to unfilled orders
    - trades at one point in time
  2. Auction market
    - trades at one moment or throughout day
    - provides price discovery so more filled orders
  3. Automated auction market (i.e. electronic communication network or electronic limit-order market)
    - provides anonymity
    - provides price discovery
    - trades throughout day
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Characteristics of Broker’s agency relationship (fiduciary duty) with Trader

A
  • Represent order and advise trader
  • Find counterparty to trade
  • Provide market information
  • Provide anonymity
  • Other services like safe keeping of security and cash management (but not liquidity)
  • Support market (i.e. helps market function)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

3 characteristics of liquid market

A
  1. small bid-ask spread (lets traders find capital cheaply and quickly)
  2. depth (market can accept large volume trades without much price impact)
  3. resilience (deviations from intrinsic prices are minimized quickly)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Factors necessary to have a liquid market

A
  • Abundance of buyers and sellers
  • Diverse investor base with diverse needs and information
  • Convenient place to trade
  • Market integrity which means all investors are treated fairly
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Components of execution costs: explicit and implicit

A
  1. explicit cost
  2. implicit cost
    - market impact cost
    - delay cost
    - opportunity cost
    - bid-ask spread
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Potential benchmarks for implicit costs

A
  • midquote
  • VWAP
  • opening and closing prices
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is VWAP

Formula

A

Weighted average of execution prices during a day where weights are proportion of day’s trading volume (% of number of shares traded that day)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

4 Advantages of VWAP

A
  • easily understood
  • computationally simple
  • can be applied quickly to make trading decisions
  • most appropriate for comparing small trades in nontrending markets
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

4 disadvantages of VWAP

A
  • not informative for traders that dominate trading volume
  • can be gamed by traders
  • doesn’t evaluate delayed or unfilled orders
  • doesn’t account for market movements or trade volume
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

5 advantages of Implementation Shortfall

A
  • not subject to gaming by traders
  • decomposes and identifies costs
  • can see cost of implementing ideas
  • shows trade off between quick execution and market impact
  • can use to optimize trading costs and performance
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

2 disadvantages of Implementation Shortfall

A
  • unfamiliar to some traders

- requires considerable data and analysis

16
Q

Describe 4 components of Implementation Shortfall

Include formulas

A
  1. Explicit cost = commissions or fees
  2. Market impact cost = I EP - DP or BP*I x shares executed = impact on market of seeking quick execution
  3. Opportunity cost aka missed trade aka unrealized profit/loss = I CP - DP I x shares cancelled = change in market price on any part of order never executed
  4. Delay cost = I BP* - DP I x shares later executed = change in market price if order is not executed quickly on shares later executed
17
Q

What is Market-adjusted implementation shortfall?

Formula

A

IS removed of the effect of the return on the market, i.e., post-trade IS

= IS - expected return on market

If negative, it’s a benefit to the portfolio and the shortfall is actually negative

18
Q

What is an econometric model?

A

A model used to forecast transaction costs using market microstructure theory

19
Q

Based on the Econometric model, trading costs are nonlinearly related to 5 factors:

A
  • security’s liquidity
  • risk
  • trading style (more aggressive trading results in higher cost)
  • size of trade relative to liquidity
  • momentum (e.g. it’s more costly to buy when market is trending up)
20
Q

4 types of traders based on motivation to trade, time vs price preferences and preferred order types

A

1 information-motivated traders (time-sensitive info, time preference, market order)

  • have time sensitive information so need to trade quickly before value of info expires
  • prefer quick trades and large block size with guarantee of execution, so willing to bear higher trading cost
  • timing cost low but market impact cost high

2 value motivated traders (security misvaluations, price preference, limit order)

  • uncovered mispricings through research and analysis
  • prefer to parcel out large block trade and wait for market to come to them
  • market impact cost low but timing cost high - may take a long time to execute

3 liquidity motivated traders (realloc & liquidity, market order, crossing networks and electronic communication networks)

  • need to convert securities to cash or reallocate portfolio from cash
  • often are counterparts to information motivated or value motivated traders
  • ant to execute within a day
  • timing cost low but market impact cost high

4 passive traders (realloc & liquidity, limit order, crossing networks)

  • trading to convert to cash or allocate cash
  • similar to liquidity motivated traders but more focused on reducing costs so can afford to be patient
21
Q

5 trading tactics

  • strengths
  • weaknesses
  • usual trade motivation
A

Liquidity-at-any-cost

  • quick, certain execution
  • high cost and leakage of information
  • information

Costs-are-not-important

  • quick, certain execution at market price
  • loss of control of trade costs
  • variety of motivations

Need-trustworthy-agent

  • broker uses skill and time to obtain lower price
  • higher commission and potential leakage of trade intention
  • not information

Advertise-to-draw-liquidity

  • market-determined price
  • higher admin costs and possible front running
  • not information

Low-cost-whatever-the-liquidity

  • lower trading costs
  • uncertain timing of trade and possibly trading into weakness
  • passive and value

CFA Level 3 (8 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions