Insider trading Flashcards

Question

In the US, the SEC has the power to bring a civil | suit against

Answer 1

insiders on behalf of investors. • And if you can show you were trading around the time the insider trading happened, you can become party to the suit.

Answer 2

(1) has been released, (2) has likely reached the people that typically trade in the relevant security, and (3) enough time has elapsed

Answer 3

directors and employees of a firm. Typically these trades always need to be disclosed, and insiders are not allowed to trade based on ”material non-public information”. In particular they are not allowed to buy and sell their own shares within a 6 month period.

Answer 4

abnormal returns by copying the | trades of insiders.

Answer 5

more money due to the market reaction to their disclosed trades, than due to the inside information itself.

Answer 6

barred from trading in any relevant securities. • Even if a broker or market maker becomes aware of a piece of insider information, they are legally barred from trading that security • Problem: Large activist shareholders can accidentally become insiders and then lose some of their leverage over the firm, as they are no longer allowed to sell off their position within six months of acquiring their stocks.

Answer 7

to ’procure’ anybody else (friends, family) to do your trading for you. • Applies whether you are benefiting from the information or not: Even if you buy after receiving ’bad’ insider information, you are still in violation. • You are also barred from tipping: • You are not allowed to directly or indirectly communicate the information to any other person if you know or should know that the other person could or would be likely to trade on this information

Answer 8

• A separation between separate departments of a firm such that information cannot flow from one side to the other • Typical example: investment banking and brokerage arms of the same bank • Initially Chinese Walls were voluntary, but later the SEC made it mandatory in 1988. • In the wake of the Enron scandal, Sarbanes-Oxley made the separation even more stringent (e.g. banning sell-side bonuses)

Answer 9

Banned "any manipulative or deceptive device or contrivance used or employed in connection with the purchase or sale of registered or unregistered securities" • Specifically banned "short-swing profits", i.e. making a profit by buying and selling within 6 months. • But wasn’t very specific about what’s an insider, what is a • manipulative or deceptive device, etc. • All additional regulation came from jurisprudence and SEC rule making. • But quite limited in scope (mostly only directors), had to prove intent and actual fraud. This was followed by the disclose or abstain rule

Answer 10

• Imposing treble damages and increasing the maximum fine. • In 1988 a maximum jail time of 10 years and a fine of $1 million was established

Answer 11

• Limits especially selective disclosure to large | shareholders, chosen analysts.

Answer 12

• Illegal to trade on material non-public information, or to communicate it with others. • Issuers of financial instruments have to reveal relevant material information as soon as possible (unless against ’legitimate interests’.) • Also have to immediately publish changes to previous disclosures. • Firms can’t disclose information to selective parties. • Unless for professional purposes to persons owing a duty of confidence to the company

Answer 13

• Primary insiders are all directors, lawyers, accountants, etc. that are presumed to have knowledge of the relevant material non-public information. The actual knowledge of insider information doesn’t need to be proven. • Secondary insiders applies to anyone else that somehow learned insider information and traded afterwards. In this case the AFM needs to prove that you did in fact acquire such information.

Answer 14

When the trade occurs due to pre-existing derivative obligations, share buyback programs, at expiry date of employee option schemes, dividends in the form of shares, major shareholders during a takeover, departments shielded by Chinese Walls.

Answer 15

lists of people who are presumed to have insider information. People on this list have report any trading to the AFM within 4 days

Answer 16

-> single trading period, value is realized at the end of period Expected value: µ = p𝑉𝐻 + (1 − p) 𝑉L q = insiders 1-q = liquidity traders, they only know the probability p of V=VH - > traders only buy/sell a single stock - > zero profit MMs - > MMs also only know p, VH and VL: no inside info - > MMs quote ask price pa and bid pb

Answer 17

every single stock on the market that their clients may want to buy, but they don’t want to hold too much of any stock either (just adds risk), so inventory management is very important to the MM. • MM balances the inventory after the trading period: When they buy a stock today, sell a stock tomorrow. When they sell a stock today, buy a stock tomorrow.

Answer 18

if V = VH and MM sold the stock for pa< VH, MM needs to buy the stock the next day for VH and thus make loss of - (VH - pa) if V= VL and MM sold for pa>VL, they make profit of (pa-VL) On average MM makes profit of 𝑃𝑎 − 𝜇*n sales assuming no insiders

Answer 19

If V = 𝑉𝐿 and the MM bought the stock for 𝑃𝑏 > 𝑉𝐿 , MM makes a loss −(𝑷𝒃 − 𝑽𝑳) • And if V = 𝑉𝐻 and the MM bought the stock for 𝑃𝑏 < 𝑉𝐻 , the MM makes a profit 𝑽H − 𝑷𝒃 • So on average MM makes a profit of µ − 𝑃𝑏 on buys. Assuming there are no insiders

Answer 20

Insiders already know what the price will be tomorrow, so they only buy when V = 𝑉𝐻 and they only sell when V = 𝑉𝐿. • For any 𝑃𝑎 < 𝑉𝐻 the MM will face a loss −(𝑉𝐻− 𝑃𝑎) from each insider buyer • For any 𝑃𝑏 < 𝑉𝐿 the MM will face a loss −(𝑃𝑏 − 𝑉𝐿) from each insider seller

Answer 21

• For any 𝑃a> µ the market maker will make an expected profit of 𝑃a − µ from uninformed buyers • For any 𝑃b < µ the market maker will make an expected profit µ − 𝑃𝑏 from uninformed sellers

Answer 22

Zero profit condition for MM mandates that 𝑃𝑎 and 𝑃𝑏 are set such that the gains from the uninformed traders cancel out the losses on the informed traders

Answer 23

Pa = 𝜇 + 𝑞(𝑉𝐻 − 𝜇) Pb = 𝜇 + 𝑞(𝑉L − 𝜇)

Answer 24

𝑆 = 𝑃𝑎 − 𝑃𝑏 = 𝑞(𝑉𝐻 − 𝑉𝐿)

Answer 25

• Value spread: the bigger the value spread the bigger the bid-ask spread - >The more uncertainty the bigger the potential losses of the MM to the insiders, and so the larger the bid-ask spread. • Number of insiders q: the more insiders the bigger the spread: -> Increasing the spread both lessens the losses from the insiders and increases the gains from the liquidity clients -> For q = 1 bid-ask spread widens all the way to the value spread

Answer 26

• When there are a lot of buy orders: Update (increase) the subjective probability 𝑝 that the value is 𝑉𝐻! • When there are lots of sell order: Update (decrease) the subjective probability 𝑝 that the value is 𝑉𝐻

Answer 27

• The bigger the bid-ask spread • But also the bigger the ’jumps’ towards the true value • i.e. the quicker the market converges to the true equilibrium price

Answer 28

if information acquisition is costly, insider profits could aid in ensuring that sufficient research takes place. • Suppose traders could acquire information at a cost c • The expected profit from being an insider equal 𝜋 = 𝑝(𝑉𝐻 − 𝑃𝑎) + (1 − 𝑝)(𝑃𝑏 − 𝑉𝐿) • So invest in information if 𝑐 ≤ 𝜋

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Insider trading Flashcards

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