180 Securities Trading: Principles and Procedures Answer to Problem 11.2 The market considers the following possibilities (the full table is given, but only the numbers in bold are actually needed): End-of-day value Trader type Trader … Probability 100 Uninformed Buys ?. ?×?. ?× ? ? = ?. ?? Sells same Informed Buys 0 Sells 0.8×0.1 = 0.08 110 Uninformed Buys ?. ?×?. ?× ? ? = ?. ?? Sells same Informed Buys ?. ?×?. ? = ?. ?? Sells 0 The probability of a buy order from the first incoming trader is ?(???) = 0.36 + 0 + 0.09 + 0.02 = 0.47 The probability of a buy order and a low end-of-day value is ?(???, 100) = 0.36 The probability of a low end-of-day value given a buy order is ?(100|???) = ?(???, 100) ?(???) = 0.36 0.47 = 0.766 The expected end-of-day value given a buy order is 0.766×100 + 0.234×110 = 102.34 . This is the break-even ask price. Answer to Problem 11.3 The new probabilities are: End-of-day value Trader type Trader … Probability 100 Uninformed Buys ?. ?×?. ?×?. ? = ?. ??? Sells 0.8×0.9×0.7 = 0.504 Informed Buys 0 Sells 0.8×0.1 = 0.08 110 Uninformed Buys ?. ?×?. ?×?. ? = ?. ??? Sells 0.2×0.9×0.7 = 0.126 Informed Buys ?. ?×?. ? = ?. ?? Sells 0 Then: ?(???) = 0.216 + 0 + 0.054 + 0.02 = 0.290 ?(???, 100) = 0.216 ?(100|???) = ?(???, 100) ?(???) = 0.216 0.290 = 0.745 The expected end-of-day value given a buy order is 0.745×100 + 0.265×110 = 102.55 . This is the break-even ask price. (A buy order is more informative than in the last case because it is more surprising.)
Answers to Problems and Exercises 181 Answer to Problem 11.4 The evidence could well be correct: Orders move security prices due to the markets’ beliefs in the likelihood of insider trading – not the actuality. All orders move prices in the same way because the market can’t tell who is informed and who isn’t. The con- struction the defense pu ts on this claim, however, is false. Just because the market couldn’t tell, at the time of his trades, whether or not Clarence had information, it doesn’t rule out the possi- bility that he actually did. Answers for Chapter 12. Insider trading Answer to Problem 12.1 Managers might actually have an incentive to delay, so they can make their trades. Answer to Problem 12.2 b. Found innocent; he had no fiduciary responsibility to the target com- panies. Note: it might have been argued that he had misappropriated information from his em- ployer (the printing company), as in the O’Hagan case. But this argument was not originally pre- sented to the jury. Answer to Problem 12.3 d. Answer to Problem 12.4 b. Answer to Problem 12.5 b, c. Answer to Problem 12.6 By strict disclose or abstain, Mike can’t trade (he has material non -pub- lic information); it doesn’t matter that it’s not about his company. He has no fiduciary duty to SSL, but he does have a fiduciary duty to ICE. ICE produced the information that he’s planning to trade on the basis of; the information properly belongs to ICE shareholders. In using the info to trade, he is misappropriating the info from the shareholders. Answers for Chapter 13. Conditional and complex orders Answer to Problem 13.1 a. The trade at $42 is followed by trades at $40, $41 and $39.
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