1. Trading, monitoring, balancing and performance attribution

2. Market and limit orders
Market Microstructures refers to the structure and processes of a market that may affect the pricing of securities in relation to intrinsic value and the ability of managers to execute trade.
A market order is an order to execute the trade immediately at the best possible price. If the order cannot be filled by one trade, it is filled at the next best possible prices. Emphasis is on the speed of execution, however, it has price uncertainty .
A limit order is an order to trade at the limit price or better. It has execution uncertainty.

3. Effective spread
The bid price is the price a dealer will pay for a security, and the bid quantity is the amount a dealer will buy of a security.
The ask/offer price is the price at which a dealer will sell a security and the ask quantity is the amount a dealer will sell of a security.
The ask price – bid price is (bid-ask spread) provides the dealer’s compensation.
The best bid price (the highest bid price from the traders perspective) is referred to as inside bid or market bid.
The best ask price (lowest ask, traders perspective) - inside ask/market ask.

4. Best ask and best bid – inside/market quote
Best ask price – best bid price = inside bid-ask spread/market bid-ask spread
Average of the inside bid and ask is the mid-quote
Effective spread is an actual transaction price versus the mid-quote of the market bid and ask prices. It is then doubled. If the effective spread is less than the market bid-ask spread, it indicates a good trade execution or a liquid security.

5. $0.04

7. Answer Average quote spread = $0.07
Average effective spread = $ (or $ 0.133)
The average effective spread was higher than the average of quoted price, reflecting the high cost of liquidity in the last trade.

8. Market structures Securities market serves several purposes:
Liquidity – minimal cost and timely trading
Transparency – correct and up-to-date trade and market information
Assurity of completion – trouble free trade settlement (trade is completed and ownership is transferred without problems)

9. There are three main categories of securities market;
Quote driven - investors trade with dealers
Order driven markets – investors trade with each without the need of an intermediaries.
Brokered markets – investors use brokers to locate counterparty to a trade.
Hybrid markets – combination of the other three markets

10. Execution costs
Explicit costs of trade are directly observable and include commissions, taxes
Implicit costs – harder to measure and include bid-ask spread, market or price impact costs, opportunity costs, and delay costs (i.e. slippage costs)

11. Volume-weighted average price
Implicit costs are measured using some benchmark, such as mid-quote
Alternatively, VWAP can be used. VWAP is a weighted average of execution prices during a day, where the weight applied is the proportion of the days trading volume.
For example; assume the only trades for a security during the day are
At 10am 100 shares trade at $12.11
At 1 pm 300 shares at $12.00
At 2 pm 600 shares trade at $11.75
Determine the VWAP $11.86

12. Implementation shortfall
It measures transaction costs as the difference in performance of a hypothetical portfolio in which the trade is fully executed with no cost and the performance of the actual portfolio.
It can be calculated either as
an amount $ and for a per share amount, it is divided by the number of shares in the initial order
Percentage or Basis point (total amount is divided by the market value of the initial order)

13. Total IS can be subdivided into component costs
The total IS is based on an initial trade decision and subsequent execution price.
Key terms include;
Decision price (DP) – the market price of the security when the order is initiated. Previous closing day price is often used as the DP
Execution price (EP) – the price(s) at which the order is executed.
Revised Benchmark price (BP*) – this is the market price of the security if the order is not completed in a timely manner as defined by the user.
Cancelation price (CP) – the market price of the security if the order is not fully executed and the remaining portion of the order is canceled.

14. Total IS can be computed as the difference in the value of the hypothetical portfolio if the trade was fully executed at the DP (with no costs) and the value of the actual portfolio.
Missed trade (opportunity costs, unrealized profit or loss) – the difference in the initial DP and CP applied to the number of shares in the order not filled.
Explicit costs (commissions or fees) -

15. Delay (slippage) – difference in initial DP and revised benchmark price (BP*) if the order is not filled on a timely manner, applied to the number of shares subsequently filled.
Market impact (price impact or realized profit/loss) – difference in EP and the initial DP (or BP* if there is delay) and the number of shares filled at the EP

16. example
Determine the Total IS and its components;

17. Total IS = $84
Missed trade = $18
$0.018
0.09%/9 bp
Explicit costs = $18
Delay costs = $40
$0.04
0.20%/20 bp
Price impact = $8
$0.008
0.04%/4 bp