## **Learning Outcomes**

This article explains implementation shortfall and arrival price in the context of trade implementation and performance evaluation, including:

- defining implementation shortfall and contrasting the paper portfolio return with the realized return after trading frictions;
- decomposing implementation shortfall into delay, execution, explicit, and opportunity cost components and interpreting each quantitatively;
- explaining the role of arrival price as the primary benchmark for measuring trading costs and execution quality;
- calculating implementation shortfall in dollar and per-share terms for fully executed and partially filled orders using exam-style data;
- distinguishing explicit and implicit trading costs and relating them to market impact, slippage, and unexecuted shares;
- applying implementation shortfall and arrival price to evaluate trade strategies, broker performance, and portfolio implementation decisions;
- linking these measures to portfolio performance attribution, trade process review, and common CFA Level 3 exam question formats;
- highlighting typical pitfalls in interpreting implementation shortfall calculations and benchmark choices that frequently appear in CFA Level 3 examinations.

## **CFA Level 3 Syllabus**

For the CFA Level 3 exam, you are expected to understand the practical steps of trade implementation and be able to apply them in portfolio and trading contexts, with a focus on the following syllabus points:

- Define implementation shortfall and break down its cost components.
- Explain the use and significance of arrival price as a pre-trade and post-trade benchmark.
- Calculate implementation shortfall given trade data and market information.
- Recognize the sources of explicit and implicit trading costs.
- Analyze how implementation shortfall and arrival price are used for trade evaluation and manager oversight.

These syllabus points are essential for your revision and will be tested in both constructed response (essay) and item set questions.

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. What is implementation shortfall, and what key costs does it attempt to capture?
2. Given a trade where the decision price (arrival price) is \$50, the execution price is \$51, and you trade 1,200 shares, what is the per-share implementation shortfall?
3. How does using the arrival price as a benchmark help in evaluating the performance of trade execution?
4. Name two common sources of implicit trading costs measured by implementation shortfall.

## **Introduction**

Effective trade implementation is essential for achieving the target portfolio performance. Two central concepts, implementation shortfall and arrival price, provide a framework for measuring and analyzing total transaction costs relative to portfolio decisions. Understanding these measures allows you to identify sources of slippage, evaluate execution quality, and improve the investment process. This article provides concise, exam-focused coverage of these CFA Level 3 curriculum requirements.

> **Key Term: implementation shortfall**
> The total difference between the theoretical return of a 'paper' portfolio and the actual return achieved after trades are executed. It quantifies the impact of explicit and implicit trading costs, including delays, market impact, commissions, taxes, and unexecuted portions.
>
> **Key Term: arrival price**
> The market price of the security at the time the investment decision is made. Arrival price, also called decision price, serves as the baseline for measuring trading costs and assessing execution performance.

## THE CONCEPT OF IMPLEMENTATION SHORTFALL

Implementation shortfall measures the total cost of executing a trade, quantified as the gap between the hypothetical 'paper' return based on decision price and the actual realized return, after accounting for all transaction-related frictions.

Implementation shortfall includes:

- **Explicit costs:** Commissions, fees, and taxes.
- **Implicit costs:** Price impact (market impact), delay costs (slippage from time between decision and execution), and opportunity costs (missed profits/losses due to incomplete fills).

By focusing on decision price (arrival price) as the benchmark, implementation shortfall aggregates all sources of trade slippage in a comprehensive manner.

## ARRIVAL PRICE AS TRADE BENCHMARK

The arrival price, sometimes known as the decision price, is the price of the security at the exact moment the trade decision is made. It is used as the reference point to calculate the true cost or slippage associated with each trade, regardless of the execution methodology.

Using arrival price as a benchmark enables you to:

- Evaluate trade execution relative to market conditions at decision time.
- Assess trade management (timing, urgency) and manager skill.
- Ensure costs are measured from the investor’s actual investment decision standpoint, not from an arbitrary market close or average.

## COMPONENTS OF IMPLEMENTATION SHORTFALL

Implementation shortfall is generally divided into:

1. **Delay cost:** The price movement between decision (arrival) price and order release time.
2. **Execution cost:** Difference between order release price and actual execution price(s).
3. **Explicit cost:** Direct costs such as commissions and fees.
4. **Opportunity cost:** The cost of unfilled or partially filled orders, often measured by the price movement from decision to end-of-day (or end-of-period) price on unexecuted shares.

Recognizing and quantifying these pieces helps managers identify the main sources of trade cost and adjust their trading process accordingly.

### **Worked Example 1.1**

A manager decides at 10:00am to buy 2,000 shares of XYZ at current market price of \$100. The order is entered at 10:10am with market now \$100.40, and executed in full at an average price of \$100.80. Commission is \$0.05/share.

**Q: What is the total implementation shortfall per share?**

> **Answer:**
>
> - Delay cost: \$100.40 - \$100.00 = \$0.40
> - Execution cost: \$100.80 - \$100.40 = \$0.40
> - Explicit cost: \$0.05
> - Total cost per share: \$0.40 + \$0.40 + \$0.05 = **\$0.85**

### **Worked Example 1.2**

A portfolio manager submits a buy order for 5,000 shares, but only 3,000 are executed at \$49.70. The decision price (arrival price) was \$49.50, closing price is \$50.10, and commission is \$0.04/share.

**Q: Calculate the implementation shortfall in dollars and per share, including opportunity cost.**

> **Answer:**
>
> - Cost on executed shares: (3,000 × (\$49.70 - \$49.50)) + (3,000 × \$0.04) = \$600 + \$120 = \$720
> - Cost on missed (unexecuted) shares: 2,000 × (\$50.10 - \$49.50) = \$1,200
> - Total shortfall: \$720 + \$1,200 = **\$1,920**
> - Per share (for all 5,000): \$1,920 ÷ 5,000 = **\$0.384**

### **Exam Warning**

> Many candidates mistakenly use closing price or VWAP as the cost benchmark in CFA exam questions on implementation shortfall. Always use the arrival price specified in the question to measure the full cost of trading as required by the CFA curriculum.

## PRACTICAL USE IN TRADE ANALYSIS

Implementation shortfall and arrival price benchmarks are central to portfolio performance evaluation, trade cost analysis, and trade process review. They allow asset owners, managers, and their supervisors to:

- Assess and compare execution quality across brokers and platforms.
- Identify inefficiencies such as poor timing, excessive delay, or high market impact.
- Justify trade urgency or passive approaches by showing actual costs.
- Monitor opportunity cost due to unfilled trades or slow execution.

These tools support manager oversight, broker selection, and effective revision of trading strategies to lower overall cost.

### **Revision Tip**

> Use implementation shortfall to diagnose if most trading cost comes from market impact or missed opportunity, and adjust your urgency and order routing accordingly for future trades.

## **Summary**

- Implementation shortfall measures the true total cost of executing an order versus the original decision (arrival) price, including all explicit and implicit costs.
- Arrival price is the correct benchmark for trade cost measurement and CFA exam calculation, grounding cost analysis in the actual investment decision.
- Implementation shortfall breaks down costs into delay, execution, explicit, and opportunity cost, enabling detailed analysis and corrective action.
- These concepts are tested not only in trading calculation questions but also in portfolio attribution and trading process evaluation.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Define and break down implementation shortfall and arrival price, and explain their relevance for the CFA Level 3 curriculum.
- Identify explicit and implicit trading costs and explain how they affect total trade performance.
- Calculate implementation shortfall per share and in total dollars for executed and missed trades.
- Use the arrival price as the correct benchmark for evaluating and comparing trade execution.
- Structure trade reviews and performance attribution using implementation shortfall to lower costs and improve future execution quality.

## **Key Terms and Concepts**

- implementation shortfall
- arrival price

Trade implementation - Implementation shortfall and arrival price