Free CFA Level III: Portfolio Management Trade Strategy & Execution Practice Questions

A is correct. Alpha decay is the reduction in the expected alpha of a trade as time passes. Once a manager identifies a trading opportunity, the information advantage erodes as other market participants also discover and trade on the same or similar information. The longer the delay between the investment decision and trade execution, the less alpha remains to capture. This creates urgency to execute quickly, which must be balanced against market impact costs.
B is incorrect because alpha typically decreases, not increases, over time as information is priced in.
C is incorrect because transaction costs generally increase with trade size (due to market impact), not decrease.

A is correct. This is the fundamental trade execution dilemma. A \$50M sell order representing 2.5x ADV is a large order that cannot be executed instantly without significant market impact (pushing the price down). However, spreading the order over multiple days creates opportunity cost: the stock price may decline due to the same information the manager is acting on, or the market may move against the position. The optimal strategy balances these two costs.
Choice B is incorrect because commissions and custodian fees, while costs, are not the primary strategic tradeoff for a large institutional order.
Choice C is incorrect because regulatory and tax considerations, while important for compliance, are not the central trade strategy tradeoff for execution.

B is correct. Implementation shortfall per the Perold framework measures the difference between the return of the paper portfolio (trading at the decision price, 42.00) and the return of the actual portfolio. All IS components are expressed relative to the decision price. Step 1 — Delay cost (slippage before order arrival): $\frac{42.80 - 42.00}{42.00} = \frac{0.80}{42.00} \approx 190$ bps. Step 2 — Market impact (slippage during execution): $\frac{43.10 - 42.80}{42.00} = \frac{0.30}{42.00} \approx 71$ bps. Step 3 — Commissions: $\frac{0.03}{42.00} \approx 7$ bps. Total IS: $190 + 71 + 7 = 268$ bps.
A is incorrect because it arrives at 262 bps, which reflects a rounding or arithmetic error — the exact components sum to 268 bps when expressed over the 42.00 decision price.
C is incorrect because it includes an "opportunity cost" component for the price movement after execution (43.50 − 43.10). In the standard IS framework, once the order is fully executed, there is no further IS attribution — the unrealized gain from 43.10 to 43.50 belongs to the actual portfolio and does not represent an execution shortfall.