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Essay sample on Transactions Cost Analysis

Transactions Cost Analysis

Transactions cost analysis is a method of measuring the effectiveness of the portfolio transactions of a company. Abbreviated as TCA, this method is essentially a rating of the spread between two possible prices. The difference that exists between those prices is known as slippage. The first possible price is the price of a specific transaction if it were executed at the prevailing price at the time that the portfolio manager made the decision to make purchases or sales. The second one refers to the actual price of the transaction, including taxes, commissions among other costs.

Transactions Cost Analysis is basically the study of trade prices with the aim of determining whether the trades were arranged at favorable prices. Prices can be termed as favorable if the purchases are made at low prices and sales made at higher prices. It is always ideal that investment managers, exchanges and brokers carryout analyses of transactions in order to determine whether their trading procedures are yielding the best possible results. TCA can also be applied by investors in determining whether their managers are trading in the most effective way. The results obtained from conducting these analyses are usually used in fine tuning trading processes to enhance their effectiveness.

It is always important to note that increased slippage can amount to the direct reduction of investor confidence, thereby hurting relative performance versus the performance of investment managers that are competing. Besides, this can also lead to low returns on equities. In case an entire stock is sold at once, the resulting sale price will be generally locally depressed relative to the decision price of the portfolio manager.

The reason for the above results is because of the trade-offs between time and price, as well as with stocks that possess the best market liquidity. Alternatively, if the distribution of the order is done over time in the market, there is likely an opportunity cost that the market price decline over a given time frame. The overall opportunity is summed up by the timing delays between compliance officials, portfolio manager, businessmen and the actual delivery of the order to the market.

Just like other tools of analysis, the Transactions Cost analysis has its setbacks. The main setback is determining whether a trade price is high or low given the conditions of the market at the time that the processing of the order was done. Due to this, trade prices are usually compared for benchmarking of prices like the volume-weighted average trade price of the day or the midpoint of the bid at the time of the first creation of the order. Making purchases with high prices relative to these benchmarks are considered to be costly trades just like sales at prices below the benchmark prices.

Transactions cost analysis can at times consider the opportunity costs that are associated with incomplete trades. Failure to trade can have very negative impacts to the portfolio performance if the trade emerged profitable were it completed.

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