6 - Trading gone awry

Question 1

Pareto efficiency

Answer 1

exists when no other feasible allocation of resources and technology can improve one person’s situation without harming that of another

Question 2

Informational efficiency

Answer 2

achieved when all investors hold objective beliefs and information in common, so that competitive prices accurately reflect that information

Question 3

Fairness can be thought of a claim to certain entitlements:

Answer 3

• efficient prices
• equal bargaining power
• equal information

Question 4

Inside information

Answer 4

material information obtained from management that is not widely available to the public

Question 5

Managers must control the dissemination of material managerial information

Answer 5

must be either widely publicized or kept secret

Question 6

Illegal insider trading:

Answer 6

execution of transactions on the basis of material non-public information

• US: violation of a relationship of trust and confidence

Question 7

Registered insiders are forbidden from trading on material non-public information based on:

Answer 7

• the disclose or abstain theory

- the misappropriation theory

Question 8

inside information australia:

Answer 8

information that is not generally available, which is likely to have an effect on the value of a financial product

Question 9

Why have insider trading rules?

Answer 9

• public demands fairness
  
  • other traders have a right to equal information
• to protect dealers and limit order traders from inside traders
• to remove unwanted distortions in managerial labour markets

Question 10

What are likely effects of insider trading rules?

Answer 10

• effectively enforced insider trading rules see reduction in the adverse selection spread components
• more capital will be saved by uninformed traders when liquidity is cheap, and markets are widely believed to be fair
• prices may be less efficient in the short run

Question 11

Arguments for permitting insider trading:

Answer 11

• insider trading rules cost too much to enforce

- insider trading may increase liquidity by quickly eliminating information asymmetries

Question 12

Corporate problems with insider trading

Answer 12

• Hides information from public
• Increases information asymmetry
• Front running corporate trading

Question 13

Market manipulation

Answer 13

act or transaction that is intended to or likely to have the effect of creating or maintaining an artificial price level in a security

Question 14

Action-based manipulation

Answer 14

manipulation based on actions that change the actual or perceived value of the assets

Question 15

Information-based manipulation

Answer 15

manipulation based on releasing false information or spreading false rumors

Question 16

Trade-based manipulation

Answer 16

manipulation based on buying and selling of securities without observable actions to alter the value of the firm or releasing information to change the price

Question 17

Market manipulation trading

Answer 17

satisfies 3 conditions:

1) trader’s wealth after liquidation of the position is expected to be greater than the amount of wealth required to initiate the position
2) trade is not an arbitrage opportunity that would be available to small investors
3) strategy is independent of information

Question 18

Action-based and information based manipulation are effectively outlawed

Answer 18

but trade based manipulation is harder to eradicate

Question 19

Manipulation is possible only when market structure departs from perfect markets

Answer 19

e.g less information asymmetry