2019 CFA level 3 qbank reading 35 execution of portfolio decisions questions

White explains the details of execution uncertainty and price uncertainty and how they relate to market and limit orders.. Market orders: A have price uncertainty, and limit orders have

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Question #1 of 68

Which of the following characterizes a need-trustworthy-agent trading focus?

A) High commissions and potential leakage of information.

B) High commissions and concealment of information.

C) Low commissions and concealment of information.

Which of the following is least accurate regarding the CFA Institute's Trade Management

Guidelines? They state that investment management rms should:

A) have policies and procedures that assist in best execution.

B) provide general information on their trading techniques, markets, and brokers.

C) hire independent outside consultants to ensure best execution.

Jack Steele has just determined using analysis that the prospects for Titan Steel are favorable

He would like to trade before other investors realize Titan's prospects What type of trade

should he use?

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A) participate.

B) limit.

C) market.

Which of the following statements best characterizes a limit order? A limit order has:

A) reduced price uncertainty but retains execution uncertainty.

B) price uncertainty but not execution uncertainty.

C) price uncertainty and execution uncertainty.

A) An implementation shortfall strategy.

B) A simple logical participation strategy based on VWAP.

C) A simple logical participation percent-of-volume strategy.

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Which of the following is least accurate regarding VWAP? VWAP:

A) does not account for market movements or trade volume.

B) does not evaluate delayed or un lled orders.

C) is applicable to small and large trades.

A trade's volume is a small percentage of average daily trading volume The trade has low

spreads and is urgent Which of the following would be the best method of lling the trade?

A) Placing the trade in a crossing system.

B) The use of a simple logical participation strategy based on VWAP.

C) The use of an implementation shortfall strategy.

George White, CFA, and Elizabeth Plain, CFA, manage an account for Briggs and Meyers

Securities In managing the account, White and Plain use a variety of strategies, and they trade

in di erent markets They use econometric analysis to estimate costs, for example, and

algorithmic methods to execute the strategies White and Plain also use both market orders

and limit orders Their supervisor has asked them to compose a summary of their trading

records to see how the various strategies have worked

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The supervisor asks about how to assess the costs and risks of the various types of trades The

supervisor speci cally asks White and Plain to explain the di erence in the risks associated with

market and limit orders After White and Plain explain how limit orders can give a better price,

the supervisor asks why they wouldn't always use limit orders White explains the details of

execution uncertainty and price uncertainty and how they relate to market and limit orders As

part of the discussion, Plain explains the principle of the e ective spread that is associated with

market orders She uses a recent example where the quoted bid and ask price of GHT stock

was $25.40 and $25.44 respectively When White and Plain put in a buy order for 300 shares of

GHT stock, at that quoted spread, the order was immediately executed at $25.45 She then

calculates the e ective spread

In summarizing transactions costs, White explains how transactions costs include both implicit

and explicit costs He describes a recent situation where he and Plain placed a large buy order

for CRD stock Only half of the trade was executed on the day the order was made, and the

second half of the buy order for CRD was executed on the following day This occurred because

the order was for a large number of shares and CRD stock traded in a relatively illiquid market

The supervisor asks if there are methods for analyzing and predicting costs associated with the

size of the order and the liquidity of the market White and Plain use an econometric model as

part of their pre-trade analysis to estimate implicit transactions costs Their econometric

models use the following inputs: market capitalization, volume, and measures of momentum

White says that linear econometric models have proven the most e ective because the inputs

are fairly normally distributed Plain says that in addition to simply estimating the costs of a

proposed trade, the model can also indicate the optimal size of the trade

White and Plain also explain their algorithmic methods of trading They engage in passive

trading combined with pegging and discretion strategies that are designed to seize liquidity

They recently decided to trade GHT stock using algorithmic methods White said that GHT was a

good stock to trade this way because their trades of the stock are very small in relation to the

volume of the stock in the whole market Plain adds by saying that GHT has a large spread, and

this also makes algorithmic trading ideal for this stock

Which of the following statements regarding market orders is most accurate? Market orders:

A) have price uncertainty, and limit orders have execution uncertainty.

B) have execution uncertainty, and limit orders have price uncertainty.

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C) and limit orders both have execution uncertainty and no price uncertainty.

In the discussion concerning the use of econometric methods in estimating trading costs, White

commented on the use of linear methods, and Plain commented on using the models to

estimate the optimal trade size With respect to these statements:

A) both White and Plain were correct.

B) White was incorrect and Plain was correct.

C) White was correct and Plain was incorrect.

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With respect to the reasons given for using algorithmic methods for trading GHT stock:

A) White was correct and Plain was incorrect.

B) White and Plain were both correct.

C) Plain was correct and White was incorrect.

The best classi cation of the algorithmic method used by White and Plain is:

A) simple logical participation strategy.

B) opportunistic participation strategies.

C) implementation shortfall strategy.

A market order has:

A) price uncertainty but not execution uncertainty.

B) both price uncertainty and execution uncertainty.

C) execution uncertainty but not price uncertainty.

Which of the following trades would be predicted to have the highest trading costs using an

econometric model?

A) A large buy order in an upward trending market.

B) A small buy order in an upward trending market.

C) A large buy order in a downward trending market.

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Which of the following trade motivations would most likely use a

low-cost-whatever-the-liquidity trading focus?

A) Passive and value-motivated.

B) Liquidity and information-motivated.

C) Liquidity and value-motivated.

Where would an illiquid security in a developing country most likely trade?

A) Broker markets.

B) Electronic limit-order markets.

C) Electronic crossing networks.

Which of the following is least accurate regarding best execution?

A) Each party to a trade determines what best execution is.

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B) Best execution can be measured for a single trade.

C) Best execution cannot be judged separately of the investment decision.

Which of the following is least accurate regarding best execution?

A) Best execution can determine a trader’s e ectiveness over time.

B) Best execution prevents high cost trades from taking place.

C) Best execution can be measured after the fact for a series of trades.

Market A has average bid and ask sizes of 400 shares Market B has average bid and ask sizes

of 600 shares Market C has average e ective spreads of $0.034 Market D has average e ective

spreads of $0.039 Comparing A to B and C to D, which markets are of the highest quality?

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Which of the following is least accurate regarding the CFA Institute's Trade Management

Guidelines? They state that investment management rms:

A) should strive for best execution.

B) must not disclose documentation concerning policies and procedures to outside

parties

C) must disclose their con icts of interest related to trading.

In which of the following markets is an order most likely to go un lled or partially lled?

A) Electronic crossing networks.

B) Electronic limit-order markets.

C) Auction markets.

As the senior portfolio manager for the Calvert Pension Fund, Jill Hohlman is responsible for

the investment decisions as well as the execution of trades Debbie Walker is responsible for

the equity portion of the Calvert Pension Fund portfolio It is Hohlman's belief that her portfolio

managers should be able to measure trading costs as well as have a complete understanding of

available trading techniques

Discussing the types of trading cost benchmarks, Hohlman states that the volume-weighted

average price (VWAP) is a weighted average of security prices during a day, where the weight

applied is the proportion of the day's trading volume She states further that the

volume-weighted average price is preferred to the trading cost benchmark alternative of the opening

day's stock price because the opening price can be gamed to a greater extent by traders,

relative to the volume-weighted average price She also mentions that the e ective spread is

another useful alternative to the opening price because the e ective spread cannot be gamed

Discussing the types of trading cost benchmarks further, Walker states that the implementation

shortfall, which is the di erence between the actual portfolio's return and a paper portfolio's

return, is probably the most accurate measure of trading costs She states that the paper

portfolio's return is based on the security price when the decision to trade is originally made

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She mentions that it is not subject to gaming, and incorporates both explicit and implicit

trading costs

Hohlman asks Walker to evaluate a trade made last week for the Calvert Pension Fund, using

the implementation shortfall measure The trade was a buy order for the stock of Brucker

Industries Brucker Industries is a small cap stock, which Hohlman thinks is a timely buy given

recent announcement about the rm's prospects On Wednesday, Brucker Industries stock

price closed at $20.00 a share On Thursday morning before the market opened, the portfolio

manager for the Calvert Pension Fund decided to buy Brucker Industries and transferred a limit

order for $19.97 a share for 1000 shares to the trader The order expired un lled The Brucker

Industries stock closed at $20.03 on Thursday On Friday, the order was revised to a limit of

$20.07 The order was partially lled that day as 800 shares were bought at $20.07 The

commission was $14 The stock closed at $20.09 on Friday and the order was cancelled

Regarding Hohlman's statement concerning trading cost benchmarks:

A) Hohlman is incorrect because the opening price cannot be gamed more than the

volume-weighted average price

B) Walker is incorrect because the implementation shortfall is subject to gaming.

C) Walker is incorrect because the implementation shortfall does not incorporate implicit

trading costs

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What is the realized pro t and loss component of the implementation shortfall measure Walker

should calculate for the Brucker Industries trade?

A) 0.16%.

B) 0.12%.

C) 0.09%.

What is the delay costs component of the implementation shortfall measure Walker should

calculate for the Brucker Industries trade?

A) 0.24%.

B) 0.12%.

C) 0.18%.

What is the missed trade opportunity cost component of the implementation shortfall measure

Walker should calculate for the Brucker Industries trade?

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Which of the following is least accurate regarding the role of ethics in trading?

A) The relationship between buy-side and sell-side traders is becoming less adversarial.

B) Trust has become more important.

C) Buy-side traders have a duciary duty to maximize the value of the client’s portfolio.

Suppose a trader is quoted a market bid price of $30.00 and an ask of $30.07 The execution

price of a buy order is $30.04 What is the e ective spread?

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B) Electronic crossing networks.

C) Electronic limit-order markets.

Passive traders emphasize:

A) price in their trading and use market orders.

B) price in their trading and use limit orders.

C) time in their trading and use market orders.

A trade's volume is a small percentage of average daily trading volume The trade has low

spreads and is not urgent Which of the following would be the best method of lling the trade?

A) Placing the trade in a crossing system.

B) The use of a simple logical participation strategy based on VWAP.

C) The use of an implementation shortfall strategy.

Suppose a trader is quoted a market bid price of $16.00 and an ask of $16.10 The execution

price of a sell order is $16.03 What is the e ective spread?

A) $0.03.

B) $0.04.

C) $0.02.

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Patty Benson and Terry Wortek are portfolio managers of a life insurance fund, Arbutus

Insurance Benson is the more experienced of the two, and oversees all investment decisions

as well as the execution of trades Wortek assists her with her decisions Benson has placed a

strong emphasis on trade execution e ciency because her analysis of trades during last year

suggests that Arbutus Insurance is not receiving best trade execution

Discussing the types of trading venues, Benson remarks that electronic crossing networks are

types of order-driven markets In these markets, she states that their advantage is that trading

costs are low She states that their disadvantage is that an order may not be lled

Wortek notes that Arbutus has positions in several international stocks, several of which are

illiquid She states that in these markets where public capital markets are not well developed,

Arbutus would likely trade in a brokered market Wortek notes that a disadvantage of these

markets is that Arbutus could lose their anonymity, especially when they have a large block to

sell

Benson asks Wortek to analyze a series of trades for the rm so that she can evaluate the rm's

trading e ectiveness The bid and ask volumes as well as bid and ask quotes are provided in

the table below The trading data below represents the quotes for a single stock, Papineau

Pharmaceuticals, on a single day

Time of Trade Bid Price Bid Size Ask Price Ask Size

At 10 a.m the trader for Arbutus Insurance placed an order to sell 900 shares of Papineau

Pharmaceuticals The execution price was $9.98

At 12 p.m the trader for Arbutus Insurance placed an order to sell 500 shares of Papineau

Pharmaceuticals The execution price was $9.92

At 1 p.m the trader for Arbutus Insurance placed an order to sell 300 shares of Papineau

Pharmaceuticals The average execution price was $9.91

Regarding Benson's statement concerning electronic crossing networks:

A) Benson is incorrect because trading costs are high in electronic crossing networks.

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