Portfolio Management - ETF Question 14

CFA Level II Portfolio Management
#1

Hello, Can anyone correct my understanding as to why the answer should not be choice C for this instead of A as shown in the curriculum. Shouldn’t the bid-ask spread be twice once each for buy and sell? Here is what’s in curriculum:

14 Consider an ETF with the following trading costs and management fees:
●● Annual management fee of 0.40%
●● Round-trip
trading commissions of 0.55%
●● Bid–offer spread of 0.20% on purchase and sale
Excluding compound effects, the expected total holding-period
cost for investing
in the ETF over a nine-month
holding period is closest to:
A 1.05%.
B 1.15%.
C 1.25%.

Solution(from curriculum):
14 A is correct. The expected total holding-period
cost for investing in the ETF
over a nine-month
holding period is calculated as follows:
Total holding-period
cost = Annual management fee + Round-trip
trading commissions + Bid–offer spread on
purchase/sale.
Total holding-period
cost = (9/12) × (0.40%) + 0.55% + 0.20% =
1.05%.

#2

Entry at the ask price (higher of the two prices when going long) and exit at the bid (lower of the two prices when selling)

The difference in these prices assuming no price movements in the ETF assets is 20bps. You’d only pay this once. This is the market makers slice of the action.

You may be confusing this bid/ask spread with the trading costs but you’re told that the round trip (total cost or commission paid) is 55bps. Commission paid is a separate cost from spread.

#3

Thanks for the response! Makes total sense now. I am laughing as to how I was so convinced before that bid-ask spread will be paid twice. Here is little snippet from excel exercise I had to do, if this helps anyone who might get into the same thinking trap like i did:

image

1 Like