Question

You specialize in analyzing pharmaceutical companies. Tomorrow, the FDA is going to make an announcement about the approval of a pending drug that a certain company produces. You think that the stock of the company has an expected alpha of 0.8% tomorrow. The company’s current BID is $50 and its current ASK is $50.2. Ignore commissions for this problem. If you decided to enter a 200 share position for one day then exit your position, what is the best estimate of round-trip transactions cost you will pay? $0 $20 $40 $60

Answer 1

Answer:

$ 40

Explanation:

Given :

Bid price = $ 50

Ask price = $ 50.2

Ideal price = $\frac{\text{bid price + ask price}}{2}$

                 $=\frac{50+50.2}{2}$

                = $ 50.1

This is the ideal price of the stock that is based on the mid point price.

The transactional cost for the buy is  = Ask price - ideal price

                                                             = 50.2 - 50.1

                                                             = $ 0.1

Thus we have to give $ 0.1 as the transactional cost if we want tot buy the stock immediately, so that we buy it more than the ideal price.

Therefore, the transactional cost for the sales is = ideal cost - bid cost

                                                                                 = $ 50.1 - $ 50

                                                                                 = $ 0.1

Thus we have to pay $ 0.1  as the transactional cost if we want to sell the stock now, so as to sell it cheaper than the ideal price.

We known the quantity = 200

So the round up transactional cost = $\text{quantity}\times \text{transactional cost(buy)+transactional cost(sale)}$

= 200 x (0.1 +0.1)

= $ 40