The questions asks to calculate Implementaion Shortfall (below).
Why in the answer do they put the decision price in the denominator and not the benchmark price?!?
Raffo is analyzing several equities to add to the portfolio. She finds a cement company, CTAC, that she believes is trading at an attractive valuation. In establishing the CTAC position, the sequence of events is as follows:
On Monday, CTAC shares close at GBP 12.24.
On Tuesday afternoon, Raffo directs Reynolds to buy 15,000 shares of CTAC. The decision price is GBP 12.45. He purchases 6,000 shares at GBP 12.51. Trading fees total an additional GBP 0.01 per share purchased. CTAC’s closing price on Tuesday is GBP 12.50.
On Wednesday, Reynolds decides to cancel the buy order for the remaining 9,000 shares and records a cancellation price of GBP 12.90. D.
Calculate the component of the implementation shortfall (in basis points) that is attributable to realized profit/loss. Show your calculations.
These questions are difficult because the price to use is ambigous. I just looked at EOC #11 for further color and they compute the realize p/l as Price Paid - Decision price (close from previous day)/ benchmark from original bm (2 days ago)
I think this component in the syllabus was poorly written. I’ve watched a few videos and still dont comprehend which bm price they expect us to use until i read the answers.
The key to this is determining when the original decision to trade was. THAT will be your denominator. THAT is your BM price, which like in this case, can be equal to your decision price when calculating Realized Gain/Loss. In this question, the 12.24 price is irrelevant because the original decision to trade was made AFTER the market open and the price had risen from the open price before the decision to trade took place. If the original decision to trade was made before market open on Tuesday, then 12.24 would have been the decision/benchmark price.
Now, let’s say the original decision to trade was prior to market open on Tuesday, so the Benchmark/Decision price is the previous close of 12.24, but no shares execute on Tuesday and the stock closes at 12.50. If the trader decided to carry the order into Wednesday, and some or all of the ordered shares execute at 12.60, you will have a different decision price and benchmark price. For purposes of calculating the Realized Gain/Loss, it would be 12.60 - 12.50 (new decision price) / 12.24 (original benchmark decision price).
This is my understanding and I hope it’s right because if not I give up on IS. Also, sorry for the caps. I wasn’t shouting I promise.