Both statements made by the fund manager are accurate. The first statement correctly identifies the need to amortize transaction costs in order to compare them with the annual rate of gain from alpha and the annual rate of loss from active risk. This is because transaction costs are incurred at the point of rebalancing a portfolio, while alpha and active risk are expected over the next year. Therefore, to make a fair comparison, transaction costs must be allocated over the one-year period, with the rate of amortization depending on the anticipated holding period. The second statement is also correct in stating that the annualized transaction cost is calculated by dividing the round trip cost by the holding period in years. This is a standard method of calculating annualized transaction costs, allowing for a consistent comparison across different holding periods.

Choice A is incorrect. The first statement made by the fund manager is indeed accurate. Transaction costs are typically amortized over the anticipated holding period, which means they are spread out over that time frame rather than being accounted for all at once. This allows for a more accurate comparison of transaction costs to the annual rate of gain from alpha and the annual rate of loss from active risk.

Choice B is incorrect. The second statement made by the fund manager is also correct. The annualized transaction cost can be calculated by dividing the round trip cost (i.e., the total cost of buying and then selling an asset) by the holding period in years. This provides a yearly estimate of transaction costs, which can be compared to other yearly rates such as those from alpha or active risk.

Choice D is incorrect. As explained above, both statements made by the fund manager are accurate, so this choice cannot be correct.

Things to Remember

• Transaction costs are incurred at the point of rebalancing a portfolio, while alpha and active risk are expected over a future period.
• Amortizing transaction costs involves spreading them out over the anticipated holding period for a fair comparison.
• Round trip cost is the total cost of buying and then selling an asset.
• Annualized transaction cost is calculated by dividing the round trip cost by the holding period.