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<!doctype html>
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<title>Study Session 16 | Reading 39 | Execution of Portfolio Decisions</title>
<meta name="description" content="Chartered Financial Analyst Level 3 Study Materials">
<meta name="author" content="MacLane Wilkison">
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<div class="reveal">
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<div class="slides">
<section>
<h1>Reading 39</h1>
<h3>Execution of Portfolio Decisions</h3>
<p>
<small>Created for <a href="http://alchemistsacademy.com">Alchemists Academy</a> by <a href="http://alchemistsacademy.com/about">MacLaneWilkison</a></small>
</p>
</section>
<section>
<h2>Introduction</h2>
<ul>
<li>Investment process "3-legged stool"</li>
<ul>
<li>Securities research</li>
<li>Portfolio management</li>
<li>Securities trading</li>
</ul>
</ul>
<aside class="notes">
Traders are tasked with executing desired trades quickly, without error, and at favorable prices.
</aside>
</section>
<section>
<section>
<h2>Market Microstructure</h2>
<p><em>Definition: The market structures and processes that affect how the manager's interest in buying or selling an asset is translated into executed trades</em></p>
</section>
<section>
<h2>Order Types</h2>
<ul>
<li>Market order</li>
<li>Limit order</li>
<li>Market-not-held order, participate order, best efforts order, undiscolsed limit order, market on open/close order</li>
<li>Principal trade vs. portfolio trade</li>
</ul>
<aside class="notes">
A market order is an instruction to execute an order promptly in the public markets at the best available price. It places a premium on the immediacy of execution at the cost of price uncertainty. A limit order is an instruction to trade at the best price available but only if the price is at least as good as the limit price specified in the order. It places an emphasis on price while risking execution uncertainty. A principal trade is a trade with a broker in which the broker commits capital to facilitate the prompt execution of the trader's order. Portfolio trades involve orders that require the purchase/sale of a specified basket of securities at as close to the same time as possible.
</section>
<section>
<h2>Types of Markets</h2>
<ul>
<li>Quote-driven markets - traders trade with dealers</li>
<li>Order-driven markets - traders trade directly with one another</li>
<li>Brokered markets - traders rely on a broker to find the other side of a trade</li>
</ul>
<aside class="notes">
Markets are organized to provide liquidity, transparency, and assurity of completion.
</aside>
</section>
<section>
<h2>Quote-Driven Markets</h2>
<ul>
<li>Rely on dealers to esablish firm prices at which securities can be bought and sold</li>
<li>Bid-ask spread and size indicate liquidity</li>
<li>Effective spread</li>
</ul>
<aside class="notes">
The effective spread is two times the deviation of the actual execution price from the midpoint of the market quote at the time an order is entered. It captures price improvement and market impact.
</aside>
</section>
<section>
<h2>Order-Driven Markets</h2>
<ul>
<li>Electronic crossing networks (ECNs)</li>
<li>Auction markets</li>
<ul>
<li>Periodic vs. batch vs. continuous</li>
</ul>
<li>Automated auctions (electronic limit-order markets)</li>
</ul>
<aside class="notes">
Order-driven markets are markets in which transaction prices are established by public limit orders to buy or sell a security at specified prices. ECNs are markets in which buy and sell orders are batched (accumulated) and crossed at a specific point in time (no price discovery). Auction markets are markets in which the orders of multiple buyers compete for execution. Automated markets are markets are computer based auctions that operate continuously within the day using a specified set of rules to execute orders.
</aside>
</section>
<section>
<h2>Brokered Markets</h2>
<p><em>Definition: A market in which transactions are largely effected through a search-brokerage mechanism away from public markets</em></p>
<ul>
<li>Block order</li>
<ul>
<li>Position a trade</li>
<li>Front-run</li>
</ul>
</ul>
<aside class="notes">
A block order is an order to buy or sell in a quantity that is large relative to the liquidity ordinarily available from dealers in the security or in other markets. Positioning a trade occurs when a broker takes the opposide side of a trade as a principal. To front-run a trade is to trade ahead of the initiator, exploiting priviliged information in the process. Hybrid markets are combinations/permutations of the previously described markets.
</aside>
</section>
<section>
<h2>Roles of Brokers and Dealers</h2>
<p>As the agent of an investor, brokers should:</p>
<ul>
<li>Represent the order</li>
<li>Find the opposite side of a trade</li>
<li>Supply market information</li>
<li>Provide discretion and security</li>
<li>Provide other supporting investment services</li>
<li>Support the market mechanism</li>
</ul>
</section>
<section>
<h2>Market Quality</h2>
<ul>
<li>Characteristics of a liquid market</li>
<ul>
<li>Relatively low bid-ask spreads</li>
<li>Deep</li>
<li>Resilient</li>
</ul>
<li>Contribution factors</li>
<ul>
<li>Many buyers and sellers</li>
<li>Diversity of opinion, information, and investment needs</li>
<li>Convenience</li>
<li>Market integrity (pre- and post-trade transparency)</li>
</ul>
</ul>
<aside class="notes">
Depth refers to the number of shares available for purchase or sale at the quoted bid and ask prices. Resilient markets are those in which discrepancies between the market price and intrinsic value tend to be small and quickly corrected.
</aside>
</section>
</section>
<section>
<h2>Transaction Cost Components</h2>
<ul>
<li>Explicit costs</li>
<li>Implicit costs</li>
<ul>
<li>Bid-ask spread</li>
<li>Market impact</li>
<li>Missed trade opportunity costs</li>
<li>Delay costs</li>
</ul>
<li>Volume-weighted average price (VWAP)</li>
<li>Implementation shortfall</li>
<li>Econometric cost models (pretrade analysis)</li>
</ul>
<aside class="notes">
Explicit costs are the direct costs of trading, such as broker commissions, taxes, and exchange fees. Implicit costs are indirect trading costs. Implementation shortfall is the difference between the money return on a notional portfolio in which positions are established at the prevailing price when the decision to trade is known and the actual portfolio's return (explicit costs, realized profit/loss, delay costs, missed trade opportunities)
</aside>
</section>
<section>
<h2>VWAP vs. Implementation Shortfall</h2>
<img src="images/39/comparison-of-vwap-and-implementation-shortfall.png" alt="comparison of VWAP and Implementation Shortfall" />
</section>
<section>
<h2>Types of Traders</h2>
<img src="images/39/summary-of-trader-types.png" alt="summary of trading motivations, time horizons, and time vs. price preferences" />
<aside class="notes">
There is a trade-off between the urgency of a trade and its certainty of execution.
</aside>
</section>
<section>
<h2>Trading Objectives</h2>
<img src="images/39/objectives-in-trading.png" alt="objectives in trading" />
</section>
<section>
<h2>Algorithmic Trading</h2>
<img src="images/39/algorithmic-trading-classification.png" alt="algorithmic trading classification" />
<aside class="notes">
Simple logical participation strategies allow institutional investors to participate in overall market volumes without being overly visible. Implementation shortfall strategies solve for the optimal trading strategy that minimizes trading costs as measured by the implementation shortfall method. Opportunistic strategies involve passive trading combined with the opportunistic seizing of liquidity.
</aside>
</section>
<section>
<h1>THE END</h1>
<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
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