Lecture 4 Flashcards
3 types of traders:
- (profit motivated)
; trade to make a profit - (utilitarian); trade for other reasons
3.(futile); trade to make profits but fail
Utilitarian traders why trade?
- Risk Sharing
- Asset Exchanges
- Risk Exchanging (Hedging)
- Gambling
- Tax Reasons
What is Risk Sharing?
•Large projects are often too risky to be financed by individuals (contrast this to the previous section).
–divide up projects among many owners to distribute risks
–pieces (shares and bonds) are marketed.
What is Asset Exchanges?
Traders use many markets to exchange one type of asset (usually money) for another that has some specific use.
What is Risk Exchanging (Hedging)?
Hedgers use the financial markets to reduce their exposure to financial risk.
–When two risks offset each other, one is said to be a hedge for the other.
–A hedged position has less risk than the separate components
What do utilitarian traders look for in market structure?
- Liquid markets
& - Low transaction costs
What are and Why do Speculators trade?
- Speculators are informed traders who expect a conditional return
- Speculators collect, analyse and produce information that is then used to predict future price changes.
Important difference between gamblers and speculators…
Speculators differ by the information they use to forecast future price changes:
Dealers are what kind of traders and how do they profit?
Dealers are profit-motivated traders who profit by supplying liquidity to other traders who wants to trade.
The liquidity service they sell – immediacy- is valuable to impatient traders.
Dealers often are known as?
specialists or market-makers in stock exchanges and options exchanges.
Why do Futiles trade?
- Noise traders
- Trade on what they falsely believe to be special information or misinterpret useful information
- If they trade in large numbers and if their trading behaviour is correlated, they may distort prices from fundamental value
What is the fundamental value of a security?
the expected NPV of all future benefits and costs associated with holding the security.
When do Informed traders trade?
when price differs from their estimates of fundamental underlying value.
•Undervalued
•Overvalued to profit when the price reverts to their estimate of the fundamental value.
what motivates informed traders?
Profit motivates informed traders and NOT a desire to make prices more informative.
How do informed traders trade?
traders try to minimise their price impact to maximise their profits.
•Trade aggressively to utilise the informational advantage before it becomes public knowledge.
•Trade slowly if they know the information will not become public knowledge
