CFA CFA Level 3 Implementation Shortfall Costs — what is the benchmark price?

# Implementation Shortfall Costs — what is the benchmark price?

• Author
Posts
• 27

I am quite confused about what price is supposed to be used as the benchmark price for implementation shortfall calculations — is it the closing price of the stock on the day before the order was first instructed, or is it the price at which the order is instructed?

For example (I just made up this example):
Stock X had closing price of \$20 at close on Monday (or maybe start of the day on Tuesday). On Tuesday, the manager instructed a limit order purchase of 100 shares at a price of \$20.01 or lessâ€¦..

So in this case which is the benchmark price — \$20 or \$20.01?

• 7

Thanks all.

• vincentt
Participant
• CFA Level 3
5

@MockTurtleâ€Œ I might not be correct but based on what I know decision price is the closing price of the day you make your decision.

Stock price closes @ \$20.

Day 1: you place a limit order 100k shares @ 19.90
Price never falls below \$20 and close at \$21.00

filled 50k shares at \$21.50
share prices went up and closed at \$24

you cancelled the order.

benchmark price -> \$20
decision price -> \$21
execution price -> \$21.50
cancellation price -> \$24

• MM12
Participant
• CFA Level 3
4

Hey guys, I don’t agree entirely. In this case, I definitely agree that it should be \$20 in this case, but the price taken in general is the ‘decision price’ which is the price at the moment the decision was made. So if the PM decided to buy the security in the middle of the day, the previous closing price is not relevant anymore.

Quote from page 24 of book 6 of the CFA Curriculum:

“Implementation shortfall is defined as the difference between the money return on a notional or paper portfolio in which positions are established at the prevailing price when the decision to trade is made (known as the decision price, the arrival price, or the strike price) and the actual portfolioâ€™s return.”
(Institute 24)

Institute, CFA. CFA Institute Level III 2014 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards. John Wiley & Sons P&T, 2013-07-12. VitalBook file.

• vincentt
Participant
• CFA Level 3
4

@mm12 i understand that the decision price is the closing price when you first decided to place an order. But I thought @MockTurtleâ€Œ is asking about the Benchmark Price?

• vincentt
Participant
• CFA Level 3
3

It’s definitely the closing price of the day before the decision. \$20.00.

• 3

@vincentt, @mm12, @Alta12â€Œ, @RaviVoodaâ€Œ: I should clarify my question. When we have to calculate the implementation shortfall as the dollar amount difference between the gain/loss on the paper portfolio and the actual portfolio, then it is clear that the paper portfolio initial value is calculated at the decision price (the price in the original trade instruction).
But in the exercises, sometimes you have to calculate the four components of the implementation shortfall, all in the form of basis points. In this case, the denominator seems to be the number of shares in the original order times the ‘benchmark’ price. My question is — what is this benchmark price? Is it the same as the decision price or not? There is a solved example in the CFAI books, but there they explicitly mention what they are taking as the benchmark price without saying anything about what it should be in general.

• vincentt
Participant
• CFA Level 3
3

benchmark price is \$20.

Decision price will be the closing price of the day you place your order. That’s how i understood it.

• 2

@vincentt that is right. @mockturtle there is a good example in the text book (in white text i.e. not blue/grey box – can be easily missed). The EOC question on this did not address the full calculation.

• 2

I know @Alta12, that was the example I was referring to (with the 1000 shares) — there they explicitly say what they are taking as the benchmark price.

• 1

Agree.

• 1

@vincenttâ€Œ Thanks for confirming the benchmark price. But the decision price will be the price in the instruction, no? In my made-up example, it would be \$20.01.