above should equal the implementation shortfall calculated as the difference between the actual portfolio’s return and the paper portfolio’s return as shown in item i... Part B Wider: T
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TRADING
Answers
1 Gain on the paper portfolio
Paper portfolio = 1,000 shares × $535/share = $535,000
Terminal value paper portfolio = 1,000 shares × $537.25/share = $537,250
Gain paper portfolio = 537,250 – 535,000 = $2,250
Gain on the real portfolio
Real portfolio = 750 shares × $536.25 + $402 = $402,590
Terminal value real portfolio = 750 shares × $537.25 = $402,938
Gain real portfolio = 402,938 – 402,590 = $348
Implementation shortfall 0.0036 0.36%
535,000
ii Explicit costs $402 0.00075 0.075%
$535,000
536.25 535.15 750
535.00 1,000
535.15 535.00 750
535.00 1,000
v MTOC 537.25 – 535 250 0.00105 0.105%
Sample Scoring Key:
2 points for each of the five calculations
Partial credit may be given for correctly setting up a calculation even if a math error is made
Candidate Discussion
Summing the four elements of implementation shortfall (items ii through v above) should equal the implementation shortfall calculated as the difference between the actual portfolio’s return and the paper portfolio’s return as shown in item i above Thus total implementation cost = 0.00075 + 0.00154 + 0.00021 + 0.00105 = 00355, or 0.36%, which equals the implementation shortfall calculated in item i above
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Question 2
Part A
Tan is incorrect because a disciplined approach is better able to control risk and
potentially add value
Lewin is correct The constant mix approach supplies market liquidity as securities are bought in a downward trending market and sold in an upward trending market
Sample Scoring Key:
1 point each for identifying each statement as incorrect or correct
2 points each for the justification
Part B
Wider: The plan has higher risk tolerance, and risk tolerance is positively related to optimal corridor width The higher risk tolerance makes it unnecessary to incur the higher transaction costs of frequent rebalancing
Sample Scoring Key:
1 point for wider,
2 points for the explanation,
Part C
25% ± 5% is a corridor width of 20–30% Rebalancing would occur if the asset class
exceeds 30,400,000 × 3 = 9,120,000 or is lower than 30,400,000 × 2 = 6,080,000 Since Developed Country International stocks are 8,816,00, no rebalancing is necessary at this time
Sample Scoring Key:
2 points for the corridor width of 20–30%
2 points for determining no rebalancing necessary at this time
Candidate Discussion
The note in exhibit B specified how to interpret the ±5%
Part D
Fixed income should be narrower
The lower transaction costs make more frequent rebalancing from a narrower range less costly
Hedge funds are more positively correlated with other asset classes This reduces the benefits of rebalancing and leads to setting a wider corridor for hedge funds
Sample Scoring Key:
2 points for narrower corridor for fixed income
2 points each for the two reasons These are the only relevant reasons based on the data provided