Trading Case BE1
Case Outline
In this case, some traders receive insider
information about the earnings of companies.
It is unethical and sometimes illegal to use insider information, even though
it may help you make money. When you
receive the information, you have the option of declining it; if you decline
the information, you will not be able to see it. If you do not decline the information, you
will see the information. The information
is always correct.
Key Concepts
Ethics, social norms, insider trading, and market
efficiency.
Case
Description
The case has 3 stocks: ABC, CRA, and BPH. You will start with an initial position in the
stocks. You can trade (i.e., buy or sell) the stocks for one trading period. At the end of the trading period, the actual
earnings will be announced. Based on
these earnings, the companies will be valued as described below. Your portfolio value at these values will
then determine your performance. The interest rate on cash is 0%. You can borrow and short sell the stocks.
Case Data
The value of a company will be a multiple of
earnings. Based on past information, the
multiples at which these companies trade, or the “P/E” ratios of the companies,
is given below. For each company,
analysts have produced a range of earning, where for simplicity we have reduced
the possible earnings over the trading period to six equally likely earnings
per share. The earnings of the companies
are independent of each other.
Company |
Multiple |
Earnings |
|||||
ABC |
15 |
0.7 |
0.72 |
0.75 |
0.78 |
0.8 |
0.81 |
CRA |
20 |
0.5 |
0.575 |
0.65 |
0.725 |
0.85 |
1 |
BPH |
30 |
0.4 |
0.5 |
0.6 |
0.7 |
0.8 |
1.2 |
So the possible
end of period value of each company can be one of six possibilities, each
determined independently:
Company |
Values |
|||||
ABC |
10.5 |
10.8 |
11.25 |
11.7 |
12 |
12.15 |
CRA |
10 |
11.5 |
13 |
14.5 |
17 |
20 |
BPH |
12 |
15 |
18 |
21 |
24 |
36 |
Example
Suppose
that at the end of the trading period, the realized earnings per share of ABC
are 0.72, of CRA are 0.85 and those of BHP are 0.4. Then the value of ABC will be 11.25, that of
CRA will be 17, and the value of BPH will be 12.
Information
At
the beginning of the trading period, you may receive information about the
earnings. The information will always be
correct. When you receive information,
you can decline it. If you do not
decline the information, you will be shown the information. The information is always correct.
Trading Objective
Your
aim is to maximize your portfolio value.