Matrix Corporation is a multidivisional company with operations in energy, telecommunications, and shipping. Matrix sponsors a traditional defined benefit pension plan. Plan assets are valued at $5.5 billion, while recent declines in interest rates have caused plan liabilities to balloon to $8.3 billion. Average employee age at Matrix is 57.5, which is considerably higher than the industry average, and the ratio of active to retired lives is 1.1. Joe Elliot, Matrix's CFO, has made the following statement about the current state of the pension plan."Recent declines in interest rates have caused our pension liabilities to grow faster than ever experienced in our long history, but I am sure these low rates are temporary. I have looked at the charts and estimated the probability of higher interest rates at more than 90%. Given the expected improvement in interest rate levels, plan liabilities will again come back into line with our historical position. Our investment policy will therefore be to invest plan assets in aggressive equity securities. This investment exposure will bring our plan to an over- funded status, which will allow us to use pension income to bolster our profitability."
Answer(s): A
i. For the Exam:Elliot as exhibiting "overconfidence." Discussion:Elliot's over reliance on his personal belief chat there is a high probability of interest rate increases ignores historical evidence chat interest rate changes are very difficult if not impossible to predict with that degree of accuracy. Elliot is more than likely overestimating the probability that his analysis will prove correct.ii. For the Exam:The return objectives are excessive, relative to the level of risk that is appropriate for the fund. Discussion:Elliot's plan to solve the underfunded status of the plan by investing in high return securities is ill-advised. It requires the plan to invest in high-risk securities to obtain the high returns. Given the current plan funding status, retired to active lives ratio, and the demographic profile of the workforce, the plan's ability to bear risk is below average-Also, Elliot is considering only the present value of the liabilities when interest races increase, where increasing rates can have a dampening effect on equity return. Hence, the return objectives are excessive relative to the level of risk chat is appropriate for the fund.iii. For the Exam:The investment of plan assets for the stated purpose of bolstering profitability is inappropriate, and may constitute a violation of Elliots fiduciary responsibilities und ERISA.Discussion:ERISA requires that pension plan assets be invested in the sole interest of plan beneficiaries. Failure to do so most likely constitutes a breach of fiduciary duty. Moreover, the financial implications of such an objective suggest an increase in the uncertainty about the future funding status of the plan. For both reasons, Elliot's investment plan is inappropriate.Template for Question 2-B Template for Question 2-C
Somerset Investment Limited is a Singapore-based money management firm that is conducting an appraisal of its investment performance. Cameron Li, CFA, has been charged with conducting the appraisal, and is to report back to upper management with his findings.Li is convinced that trade executions play a substantial role in overall portfolio performance, particularly for funds that have a relatively high level of turnover during the year. As a result, he is seeking methods that will allow him to evaluate the quality of trade executions.He knows that the firm's traders use both market and limit orders, and he is wondering if a framework can be developed to ensure that the best order type is used under the specific circumstances for each trade. When he consults with the firm's head trader, Rick Gleeson, Gleeson tells him that market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty.According to Gleeson, rebalancing and liquidity-motivated trades should use limit orders while value-motivated and information-motivated trades should use market orders.Li knows that bid-ask spreads are a major component of trading costs, and asks Gleeson for some recent trade data that he can use for analysis and presentation to management. He receives the following data relating to a series of buy trades for Sumatra Natural Resources (SNR), with all currency values in Singapore dollars: Trades of Sumatra Natural ResourcesGleeson also tells Li that the portfolio manager had originally made the decision to purchase 5,000 SNR at 10:00 a.m. when the price was $22.36. The closing price for the day was Leeson's last trade at $22.65, at which point the order for the remaining 2,000 shares was cancelled.Which of the following correctly summarizes Gleeson’s comments concerning the differences between market and limit orders?
Answer(s): B
Gleeson is correct concerning the nature of uncertainty. Market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty. However, he is incorrect concerning when rhese order types should be used. In most cases, information-motivated and liquidity-motivated trades should use market orders to ensure that execution takes place, while value-motivated and rebalancing trades should use limit orders because price is typically more important than the speed of execution. (Study Session 16, LOS 45.a)
Somerset Investment Limited is a Singapore-based money management firm that is conducting an appraisal of its investment performance. Cameron Li, CFA, has been charged with conducting the appraisal, and is to report back to upper management with his findings.Li is convinced that trade executions play a substantial role in overall portfolio performance, particularly for funds that have a relatively high level of turnover during the year. As a result, he is seeking methods that will allow him to evaluate the quality of trade executions.He knows that the firm's traders use both market and limit orders, and he is wondering if a framework can be developed to ensure that the best order type is used under the specific circumstances for each trade. When he consults with the firm's head trader, Rick Gleeson, Gleeson tells him that market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty.According to Gleeson, rebalancing and liquidity-motivated trades should use limit orders while value-motivated and information-motivated trades should use market orders.Li knows that bid-ask spreads are a major component of trading costs, and asks Gleeson for some recent trade data that he can use for analysis and presentation to management. He receives the following data relating to a series of buy trades for Sumatra Natural Resources (SNR), with all currency values in Singapore dollars:Trades of Sumatra Natural ResourcesGleeson also tells Li that the portfolio manager had originally made the decision to purchase 5,000 SNR at 10:00 a.m. when the price was $22.36. The closing price for the day was Leeson's last trade at $22.65, at which point the order for the remaining 2,000 shares was cancelled.Concerning the Sumatra Natural Resources price and execution data, the average effective spread and weighted average effective spread are closest to.Average effective spread Weighted average effective spread
Answer(s): C
The quoted spread for the first trade = 22.36 - 22.18 = 0.18. The quoted spreads for the remaining three trades are 0.20, 0.19, and 0.26, so the average quoted spread * (0.18 + 0.20 + 0.19 + 0.26) / 4 = 0.2075.The mid-quote for the first trade = (22.36 + 22.18) / 2 - 22.27, and the effective spread = (22.33 - 22.27) x 2 = 0.12. The effective spreads for the remaining three trades are 0.20, 0.17, and 0.30, so the average effective spread = (0.12 + 0.20 + 0.17 + 0.30) / 4 = 0.1975.The weighted average effective spread = (900 / 3,000) x 0.12 + (600 / 3,000) x 0.20 + (700 / 3,000) x 0.17 +(800 / 3,000) x 0.30 - 0.1957. (Srudy Session 16, LOS 45.b)
Somerset Investment Limited is a Singapore-based money management firm that is conducting an appraisal of its investment performance. Cameron Li, CFA, has been charged with conducting the appraisal, and is to report back to upper management with his findings.Li is convinced that trade executions play a substantial role in overall portfolio performance, particularly for funds that have a relatively high level of turnover during the year. As a result, he is seeking methods that will allow him to evaluate the quality of trade executions.He knows that the firm's traders use both market and limit orders, and he is wondering if a framework can be developed to ensure that the best order type is used under the specific circumstances for each trade. When he consults with the firm's head trader, Rick Gleeson, Gleeson tells him that market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty.According to Gleeson, rebalancing and liquidity-motivated trades should use limit orders while value-motivated and information-motivated trades should use market orders.Li knows that bid-ask spreads are a major component of trading costs, and asks Gleeson for some recent trade data that he can use for analysis and presentation to management. He receives the following data relating to a series of buy trades for Sumatra Natural Resources (SNR), with all currency values in Singapore dollars:Trades of Sumatra Natural ResourcesGleeson also tells Li that the portfolio manager had originally made the decision to purchase 5,000 SNR at 10:00 a.m. when the price was $22.36. The closing price for the day was Leeson's last trade at $22.65, at which point the order for the remaining 2,000 shares was cancelled.Assume that the four trades in Sumatra Natural Resources are the only trades in the security for the day. Determine which of the following statements concerning the volume weighted average price (VWAP) is most correct.
The VWAP for the day = (900 / 3,000) x 22.33 + (600 / 3,000) x 22.43 * (700 / 3,000) x 22.47 + (800 / 3,000) x 22.65 = 22.468, and rhe trader's goal would be to have an average cost that is less than the VWAP if they are buying. (Srudy Session 16, LOS 45-f
Somerset Investment Limited is a Singapore-based money management firm that is conducting an appraisal of its investment performance. Cameron Li, CFA, has been charged with conducting the appraisal, and is to report back to upper management with his findings.Li is convinced that trade executions play a substantial role in overall portfolio performance, particularly for funds that have a relatively high level of turnover during the year. As a result, he is seeking methods that will allow him to evaluate the quality of trade executions.He knows that the firm's traders use both market and limit orders, and he is wondering if a framework can be developed to ensure that the best order type is used under the specific circumstances for each trade. When he consults with the firm's head trader, Rick Gleeson, Gleeson tells him that market orders have price uncertainty but no execution uncertainty, while limit orders eliminate price uncertainty but have execution uncertainty. According to Gleeson, rebalancing and liquidity-motivated trades should use limit orders while value-motivated and information-motivated trades should use market orders.Li knows that bid-ask spreads are a major component of trading costs, and asks Gleeson for some recent trade data that he can use for analysis and presentation to management. He receives the following data relating to a series of buy trades for Sumatra Natural Resources (SNR), with all currency values in Singapore dollars:Trades of Sumatra Natural ResourcesGleeson also tells Li that the portfolio manager had originally made the decision to purchase 5,000 SNR at 10:00 a.m. when the price was $22.36. The closing price for the day was Leeson's last trade at $22.65, at which point the order for the remaining 2,000 shares was cancelled.Calculate the implementation shortfall assuming total commissions paid by Glceson when he purchased the 3,000 SNR were $210.
The benchmark price is 22.36, and the benchmark quantity is 5,000, so the benchmark investment = 22.36 x 5,000 = $111,800. The terminal benchmark value = 22.65 x 5,000 - $113,250, and the benchmark gain = 113,250 - 111,800 = $1,450.The actual portfolio cost = (900 x 22.33) + (600 x 22.43) +(700 x 22.47) + (800 x 22.65) = 67,404 + 210 =$67,614. The actual portfolio terminal value = 22.65 x 3,000 = $67,950, and the actual gain = 67,950 - 67,614 =$336.The implementation shortfall = (1,400 - 336) / 111,800 = 0.0096 or 0.996%. (Study Session 16, LOS 45.g)
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