**Trading Case
B0****6**** **

** **

**Case
Objective**

This
the the same trading case as B05 except now traders can get private information
about future spot rates. As a
result, the objective is to apply efficient market concepts to fixed income
markets.

**Key
Concepts
**

Term
structure of interest rates; informational efficiency/rational expectations;
information and the shape of the term structure of interest rates; unbiased
expectations, liquidity premium

**Case
description (see B05)
**

There are 3 zero-coupon bonds maturing 1-month, 2-month and 3-months from the present time. Future 1-month spot interest rates are large and quite volatile. Each zero-coupon bond pays $100 at the the time of its maturity. Possible spot rates are accurately represented by the following interest rate tree:

That
is, the initial spot rate is 6.5% for 1-month (i.e., *not*
annualized). At the beginning of
month-2 the realized 1-month spot rate can change to 5%, 9% or 11% etc.,
(equally likely). You can
trade any security.

Prices
in this case are determined by the traders, so all trades will take place at
bids and asks that either you or another trader in the system puts in. Finally, borrowing and short sales are permitted.

**Private
Information**

Each month the spot rate of interest can undergo a high (x), middle (y)
and low change (z). You may receive
private information at the beginning of a month in a form (e.g., “Not y”)
that lets you eliminate a spot rate from being feasible. The private information is randomly assigned such that the
market as a whole knows more than any trader’s private information reveals.

Your aim is to make as much money as you can which
depends upon how well you trade relative to the prices discovered by the market.
Each trial you earn
grade cash that is cumulated across trials.
Grade case in any trial equals 0.0001 x your closing balance of market
cash. That is, if you end up with
negative wealth then you lose grade cash and if you make money then you gain
grade cash.

Trading is conducted over a number of independent
trials and a record of your cumulative grade cash is maintained.

© OS Financial Trading System 2001