Lecture 6

Question 1

Efficiency comes in two forms:

Answer 1

Pareto efficiency
&
Informational efficiency

Question 2

What is Pareto efficiency?

Answer 2

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

Question 3

What is Informational efficiency?

Answer 3

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

Question 4

Fairness can be thought of a claim to certain entitlements:

Answer 4

• Freedom from coercion
• Freedom from misrepresentation
• Equal information
• Equal processing power
• Freedom from impulse
• Efficient prices
• Equal bargaining power

Question 5

List some (4) financial regulations:

Answer 5

1. Insider trading regulations
2. Mandatory disclosure regulations
3. Margin regulations
4. Trading interruption regulations

Question 6

What is inside information definition?

Answer 6

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

Question 7

Does inside information include information obtained from someone who obtained it from management?

Answer 7

Yes; Managers must control the dissemination of material managerial information.

Question 8

What is insider trading?

Answer 8

Illegal insider trading traditionally defined as “execution of transactions on the basis of material non-public information”.
•In the US, reference to “violation of a relationship of trust and confidence”.

Question 9

Does Australia have the violation of fiduciary duties in definition?

Answer 9

No

Question 10

Registered insiders are allowed to do what with non-public information?

Answer 10

are forbidden from trading on material non-public information

Question 11

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

Answer 11

• the disclose-or-abstain theory.

* the misappropriation theory

Question 12

What section in the Corporations Act defines inside information?

Answer 12

1042A Corp Act 2001

Question 13

How does the 1042A Corp Act 2001 define inside information?

Answer 13

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

Question 14

What ASX Listing Rule require an entity to report to ASX any material information?

Answer 14

Rule 3.1

Question 15

Why have insider trading rules?

Answer 15

1. The public demands fairness
2. To protect dealers and limit order traders from inside traders.
3. To remove unwanted distortions in the managerial labour markets.

Question 16

What are likely effects of insider trading rules in regards to adverse selection components?

Answer 16

1. see reduction in the adverse selection spread components.

Question 17

What are likely effects of insider trading rules in regards to capital?

Answer 17

More capital will be saved by uniformed traders when
•liquidity is cheap,
•markets are widely believed to be fair.

Question 18

What are likely effects of insider trading rules in regards to price efficiency?

Answer 18

Prices may be less efficient in the short run.

Question 19

Arguments for permitting insider trading, who is the most famous economist that argues for insider trading?

Answer 19

Milton Friedman

Question 20

What are the do some arguments to permit insider trading?

Answer 20

1. Insider trading rules cost too much to enforce

2. Insider trading may increase liquidity by quickly eliminating information asymmetries.

Question 21

Problems with insider trading for Corporations if managers can trade on inside information …?

Answer 21

• Will they share information with the public, the board and other competing insiders, they could selectively disclose or hide it for themselves.
• Effects on management decisions that impacts on information asymmetries, will they try and make decisions that will increase information asymmetries.
• Effects on shareholder values decrease as people front run the company.

Question 22

Can insiders trade legally and what are the requirements?

Answer 22

Registered insiders usually own shares in their own companies.
•They may trade in these shares provided they inform the regulators about their trades and do not trade on material non-public information.

Question 23

When are insider traders most likely to occur?

Answer 23

Non routine trades, or trades by babies.

Question 24

What is market manipulation and what price level does it want to create/maintain?

Answer 24

is an 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 25

Types of manipulation: | There are three broad categories:

Answer 25

* Action-based manipulation * Information-based manipulation * Trade-based manipulation

Question 26

Action-based manipulation:

Answer 26

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

Question 27

Information-based manipulation:

Answer 27

Manipulation based on releasing false information or spreading false rumors.

Question 28

Trade-based manipulation:

Answer 28

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 29

What are 3 examples of Trade-based manipulation:

Answer 29

* Spoofing: sending out orders and then cancelling them very quickly (high frequency trading so they are never executed) * Corners and pools: they pool together their money and if they think there will be a demand in gold they will buy out all the contracts and then sell them to the people who need them at a high price. * Wash trades: involve buying a selling of a security to create a impression of where the shares should be- create and maintain a artificial price

Question 30

Trade-based manipulation can be technically defined as a market-manipulation trading strategy that:

Answer 30

takes a dynamic trading position in financial securities that moves prices and satisfies three conditions: •trader’s wealth after liquidation of the position is expected to be greater than the amount of wealth required to initiate the position, •the trade is not an arbitrage opportunity that would also be available to small investors, •the strategy is independent of information, and the trader uses the strategy because he feels the strategy itself creates the expectation of profit.

Question 31

What kind of manipulative trading is the hardest to eradicate?

Answer 31

Trade-based manipulation

Question 32

Manipulation is possible only when market structure does what?

Answer 32

Departs from perfect markets

Question 33

How can we limit manipulative opportunities?

Answer 33

Improve market efficiency