Question

Suppose that every time a fund manager trades bond, transaction costs such as commissions and bid-ask spreads amount to 1.5% of the value of the trade. If the portfolio turnover rate is 40%, by how much is that the total return of the portfolio reduced by trading costs?

A.1.2%

B.0.6%

C.1.8%

D.None of the above

Answer 1

The portfolio turnover rate is 40% this indicates that on average, 40% of the portfolio is sold and replaced with other securities each year.

transaction costs = 1.5 %

The fund manager does transaction one time for selling bonds another time for buying bonds so that sold bonds could be replaced.

Total Trading Cost = 2 * 1.5% = 3%

Total return of the portfolio reduced by trading costs =  total trading cost × turnover rate

= 3% * 40% = 0.03 * 0.40 = 0.012 = 1.2%

Ans. A 1.2%