Here’s a Schwesser problem for implementation shortfall: Use the following information to calculate the implementation shortfall and its components: • On Wednesday, the stock price closes at $50 a share. • On Thursday morning before market open, the portfolio manager decides to buy Megawidgets and transfers a limit order for 1 ,000 shares at $49 .95. The order expires unfilled. The stock closes at $50.05. • On Friday, the order is revised to a limit of $50.07. The order is partially filled that day as 700 shares are bought at $50.07. The commission is $23. The stock closes at $50.09 and the order is cancelled. The problem is solved as thoe the benchmark price for the paper portfolio is $50.00. When I first did the problem, I used the price of $49.95, because I thought the benchmark price is supposed to be the one that is in place once the decision to make a trade is made. It specifically said he makes the decision to trade at a limit price of $49.95, so I figured that would be the paper portfolio, or benchmark price. Can anyone tell me a surefire way to know which is the correct benchmark price? thanks. *for anyone who’s interested, here is the solution to the problem: To decompose the implementation shortfall, we calculate the following: 8. Explicit costs-the commission as a percentage of the paper portfolio investment is $23 I $50,000 = 0.05%. Realized profit and loss is calculated using the execution price minus the decision price, which is usually measured as the previous day’s closing price. This is divided by the original price and weighted by proportion of the order filled. It is (700 I 1,000) X ($50.07 - $50.05) I $50.00 = 0.03%. Delay costs are calculated using the difference between the closing prices on the day an order was not filled and the previous day closing price. It is weighted by the portion of the order filled. It is (700 I 1 ,000) x ($50.05 - $50.00) I $50.00 = 0.07%. Missed trade opportunity cost is calculated using the difference between the price at which the order is cancelled and the original price. It is weighted by the portion of the order that is not filled. It equals (300 I 1 ,000) x ($50.09 - $50.00) I $50.00 = 0.05%.
The benchmark price is the closing price on the day before you place your order.
The decision price is the closing price on the day before your order is (partially or totally) filled.
$49.95 wasn’t a price Megawidgets traded at, it was the limit order price that the trader was hoping to get - they could just have easily set the limit price at $40.00.
The $50 price is the prevailing price when the decision to trade is made, and accordingly the one to use in calculations.