Why the EOCsolution for B and C only tell the strategy to match closing price and VWAP?
Q9 A client of a broker evaluates the broker’s performance by measuring transaction costs with a specified price benchmark. The broker has discretion over the timing of his trades for the client. Discuss what the broker could do to make his performance look good to the client (even though the broker’s execution decisions may not be in the best interests of the client) if the price benchmark used by the client for evaluation is the:
A. opening price.
B. closing price.
C. volume-weighted average price (VWAP).
Solution
A. If the order is received late in the day, the broker would act based on how the prices have changed during the day. If the order is a sell order and prices have increased since the opening, the broker would immediately fill the order so that the sale price is greater than the benchmark price. If prices have fallen during the day, the broker would wait until the next day to avoid recording a low-priced sale on a day when the market opened higher. The broker would do the opposite if the order is a buy order. If prices have increased since the opening, the broker would wait until the next day to avoid recording a high-priced buy on a day when the market opened lower. If the prices have fallen during the day, the broker would immediately fill the order so that the purchase price is lower than the benchmark price.
B. The broker would execute the order just before closing so that the transaction price is the same as the closing price.
C. The broker would split the order and spread its execution throughout the day so that the transaction price is close to the market VWAP.
Q9 A client of a broker evaluates the broker’s performance by measuring transaction costs with a specified price benchmark. The broker has discretion over the timing of his trades for the client. Discuss what the broker could do to make his performance look good to the client (even though the broker’s execution decisions may not be in the best interests of the client) if the price benchmark used by the client for evaluation is the:
A. opening price.
B. closing price.
C. volume-weighted average price (VWAP).
Solution
A. If the order is received late in the day, the broker would act based on how the prices have changed during the day. If the order is a sell order and prices have increased since the opening, the broker would immediately fill the order so that the sale price is greater than the benchmark price. If prices have fallen during the day, the broker would wait until the next day to avoid recording a low-priced sale on a day when the market opened higher. The broker would do the opposite if the order is a buy order. If prices have increased since the opening, the broker would wait until the next day to avoid recording a high-priced buy on a day when the market opened lower. If the prices have fallen during the day, the broker would immediately fill the order so that the purchase price is lower than the benchmark price.
B. The broker would execute the order just before closing so that the transaction price is the same as the closing price.
C. The broker would split the order and spread its execution throughout the day so that the transaction price is close to the market VWAP.