Week 4 - Information and Price

Question 1

What is meant by:
“Trading is a zero-sum game”

Answer 1

Means that the total gain of a winner exactly equals the losses of the loser

Question 2

What are the trading returns?

Answer 2

Positive for winners:
Have a comparative advantage

Negative for losers:
Must receive other benefits from trade

Question 3

What are the three broad categories of traders?

Answer 3

1. Utilitarian Traders
2. Profit Motivated Traders
3. Futile Traders/Noise Traders

Question 4

Describe a Utilitarian trader and their preferred market conditions

Answer 4

Defined:
Traders that trade for benefits other than profit

Preferred Conditions:
1. Liquid markets
2. Low transaction costs

Question 5

Why do Utilitarian traders trade?

Answer 5

For reasons other than profit:

1. Investment/divestment
2. Risk-Sharing
3. Asset Exchange
4. Hedging
5. Gambling
6. Tax purposes

Question 6

Describe Futile Traders / Noise Traders

Answer 6

Traders that attempt to make money but fail

Trade on information they believe to be “special”

Large quantities of noise traders can distort prices

Question 7

Define profit motivated traders

Where do their earnings come from?

Answer 7

Traders that trade purely for profit

Profit primarily comes from utilitarian trader’s willingness to pay
+
futile/noise traders

Question 8

What are the two subcategories of Profit motivated traders?

Answer 8

1. Liquidity supplier
2. Speculators

Question 9

What are the two subcategories of Speculator traders?

Answer 9

1. Informed Traders
2. Parasitic Traders

Question 10

What are the two categories of parasitic traders?

Answer 10

1. Order anticipators
2. Market manipulators

Question 11

What are the three different types of informed traders?

Answer 11

1. Value Traders
2. News Traders
3. Information-oriented technical traders

Question 12

What are the three different types of “order anticipators”?

Answer 12

1. Front Runners
2. Quote matchers
3. Sentiment-orientated technical traders

Question 13

Describe parasitic traders

Answer 13

Parasitic traders:
- Act on information about other traders
- create information to fool others

Question 14

Describe speculator traders

Answer 14

Speculator Traders:
Informed traders that expect conditional returns:
R_f + R_prem + R_info

• rational reasoning behind decisions

Question 15

What are the two type of liquidity suppliers?

Answer 15

1. Dealers
2. Arbitragers

Question 16

Describe this type of trader: Dealer

Answer 16

Dealers are a form of liquidity supplier

Profit = bid-ask spread

Question 17

Describe this type of trader: Arbitrager

Answer 17

Dealers are a form of liquidity supplier

• buy + sell the same asset across different markets
• uphold the law of one price

Question 18

What is the difference between speculators and gamblers?

Answer 18

Speculators are informed traders who collect, analyse and produce information to predict price changes

Gamblers are uniformed traders that guess

Question 19

Describe a Sentiment-oriented technical trader

Answer 19

type of parasitic order-anticipator trader

Traders that predict trades that uninformed traders will decide to make

Question 20

Describe a front runner

Answer 20

Type of parasitic order-anticipator trader

Know or infer future trades and demand liquidity before demand increases

buys before and sells after deamnd increases

Question 21

Describe a quote matcher

Answer 21

Type of parasitic order-anticipator trader

Exploit option values of standing limit orders

Question 22

Describe a value trader

Answer 22

type of informed trader

Estimate fundamental value using economic models

Question 23

Describe a news trader

Answer 23

Type of informed trader

Estimate changes in fundamental value from news

Question 24

Describe an information-oriented technical trader

Answer 24

Type of informed trader

Try to forecast prices from past prices and other market data

Question 25

Describe informed traders and their trading strategy

Answer 25

Informed traders are rational decision-makers that trade on fundamental value of an asset

trade when market price deviates from fundamental value

Attempt to make profit with minimal price impact to hide intentions

If information is public = trade aggressively
Private info = trade slowly

Question 26

How can you tell the difference between private and public information?

Can you act of each type?

Answer 26

1. Considers timing
   private = unscheduled
2. Significance of the information

Both can be traded on
*private cannot if you have a fiduciary duty

Question 27

What is the effects of informed traders?

Answer 27

Increase market efficiency by moving prices towards fundamental value

Question 28

Who do informed traders make money from?

Answer 28

Uninformed traders

Question 29

Define an efficient market

Answer 29

A market where prices reflect all available information

Question 30

What are the three forms of market efficiency

Answer 30

1. Weak form
2. Semi-strong
3. Strong form

Question 31

What factor do traditional market efficiency definitions fail to identify?

Answer 31

The cost of acquiring and acting on information

Question 32

What is the market microstructure definition of efficiency?

Answer 32

A market where traders cannot profit from acquiring and acting on information

Mc=Mb