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.