Suppose that every time a fund manager trades stock, transaction costs such as commissions and bid–ask spreads amount to 2.7% of the value of the trade. If the portfolio turnover rate is 50%, by how much is the total return of the portfolio reduced by trading costs? (Round your answer to 1 decimal place.)

Suppose that every time a fund manager trades stock, transaction costs such as commissions and bid–ask spreads amount to 2.7% of the value of the trade. If the portfolio turnover rate is 50%, by how much is the total return of the portfolio reduced by trading costs? (Round your answer to 1 decimal place.)

Fall in returns

%

Explanation:

The turnover rate is 50%. This means that, on average, 50% of the portfolio is sold and replaced with other securities each year. Trading costs on the sell orders are 2.7%; the buy orders to replace those securities entail another 2.7% in trading costs. Total trading costs will reduce portfolio returns by: 2 × 0.027 × 0.5 = 0.027 or 2.7%