Transaction costs
The costs of trading — commissions, bid-ask spreads and market impact. Prices need only be efficient to within them, since a mispricing too small to trade profitably will not be corrected.
Where you will meet it
Transaction costs appears in 17 learning outcomes on the CFA syllabus. A few of them:
- Explain how big data and data science are used in investment management
“The limitation to hold on to is that a statistically real pattern in a very large dataset is not the same thing as a tradable signal: transaction costs, the capacity of the strategy, and the speed with which a known pattern is competed away all sit between the two.”
- Explain where the capital asset pricing model falls short
“The model rests on assumptions that do not hold: a single period, homogeneous expectations, unlimited borrowing and lending at the risk-free rate, no taxes or transaction costs, and a market portfolio containing every asset.”
- Set out what derivatives offer users and the risks they carry
“Derivatives allow risk to be transferred to whoever is best placed to bear it, at far lower transaction cost than trading the underlying, and they let exposure be taken where the cash market is impractical.”
- Set out where active management's fundamental law is useful in practice and where it falls short
“The law also ignores transaction costs and treats the transfer coefficient as fixed.”
See also
Practise it
Practise transaction costs until it is automatic: questions that explain every wrong option.
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