1. Suppose the New York stock exchange were to impose a fee of $.0025 per share
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Question
1. Suppose the New York stock exchange were to impose a fee of $.0025 per share in addition to all existing fees and costs on all transactions carried out on the exchange.
a. What effect, if any, would this tend to have on the price and expected returns of securities trading on the exchange?
Explain your reasoning.
b. Suppose Fastrac Inc. now trades for 24 1/8 bid, 24 1/4 asked, while SloMo Enterprises trades at 25 3/4 bid 27 asked.
Which of these two securities would find its returns most affected by the additional cost? Why?
c. What, if any, differences might you expect to observe between investors holding Fastrac Inc. and those holding SlowMo Enterprises? Explain
Explanation / Answer
a)
In order to have similar returns on the stock post introduction of these additional transaction costs, the prices on the buy side should decrease and on the sell side should increase. Thus the bid ask spread would increase.
The expected returns on the exchange should decrease because of the introduction of the transaction cost which is an overhead.
b)
Since SloMo enterprises have a wider bid ask spread thus indicating less liquidity, so an introduction of transaction costs would imply further divergence in bid and ask prices. And the stock of SloMo enterprises is expected to get impacted by the introduction of transaction costs more.
c)
Since Slo Mo enterprises have higher bid ask spread signifying less liquidity, it implies that investors are mostly buy and hold type and as a result the liquidity is less.
On the other hand, for Fastrac Inc., the higher liquidity implies that the share is frequently traded and investors are mostly short term investors who are more prone to trading.
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