Liability Trading Case – v1.1

OVERVIEW

The Liability Trading Case challenges participants to test their critical thinking and analytical skills in an environment where they must evaluate the liquidity risk associated with various tender offers. Throughout the case, participants will encounter multiple tender offers, requiring quick decisions on whether to accept and execute, or reject each offer based on their profitability. Profits can be achieved by exploiting price differentials between market prices and private tender offers. Once a tender is accepted, participants should focus on efficiently closing out their large positions to maximize returns and minimize liquidity and market risks.

KEY OBJECTIVES

DESCRIPTION

Each heat will be 10 minutes long that represents one month of calendar time. Each heat will involve two tradable securities with different volatility and liquidity characteristics.

Tender offers will be generated by computerized traders and distributed at random intervals to random participants. Participants must subsequently evaluate the profitability of these tenders when accepting or bidding on them.

MARKET DYNAMICS

There are numerous independent heats, each with unique market dynamics and parameters. Potential parameter changes include factors such as the spread of tender orders, liquidity, and volatility. The following market dynamics and parameter details that will remain same in each heat will help participants to formulate trading strategies. Details for an example heat with two stocks, ABC and XYZ, are shown below.

	ABC	XYZ
Expected Starting Price	$50.00	$25.00
Commission/Share	$0.02	$0.02
Maximum Order Size	15000	10000
Trading Limit (Gross/Net)	250000/150000	250000/150000
Liquidity	Low	Medium
Volatility	Medium	High

During each heat, participants will periodically receive private tender offers, which are generated by the server and randomly distributed to different participants at various times. Private Tenders are routed to individual participants and are offered to purchase or sell a fixed volume of stocks at a fixed price. The tender price is influenced by the current market price of the stock. Each participant will receive 10 tender offers with varying prices and quantities. No trading commission will be charged on these tender offers. The tender size of the last five offers will be larger than that of the first five, making it more challenging to close their positions.

The prices generated by the RIT for this case follow a random-walk process, using returns drawn from a normal distribution with a mean close to zero. This means that, at any point in the simulation, the probability of the price increasing is equal to the probability of it decreasing. Therefore, participants cannot predict future stock prices without “taking a bet.” As liability traders, participants must not accept tender offers based on speculation or betting on price movements, as these will be flagged as “speculative trades.” Instead, participants should base their decisions on tenders by evaluating the associated liquidity risk.

CALCULATION OF THE PROFIT OR LOSS OF TRADERS

Participants will have time to think about the tender offer before they choose to accept it or decline it, and the time may be different for each security. For example, one may receive a tender offer at time t = 0 and will have until t = 25 to decide whether to accept or decline. Any trades made by a participant during this time without accepting or declining the tender offer will be considered as “front-running” [1] since the participant had the advance knowledge of a pending institutional order.

This case is designed to only reward participants for identifying, accepting, and closing out [2] tender offer positions at a profit, while managing liquidity risk and execution risk. Any other strategy will not be recognized and may incur penalties. In particular, the total profit of each participant [3] will be categorized into two parts: “profits from tender offers” and “profit from speculation”; the latter category includes the profits that are a result of speculative trades and/or front-running trades.

Profits from tender offers are the profits (or losses) gained from efficiently closing out the position from accepted tenders into the market. Profits from speculation are profits (or losses) generated through trades that are not associated with tenders (speculative trades or front-running trades). An “Adjusted P&L” will be calculated based on the following formula:

Adjusted P&L = P/L From Tenders + Min(0,P/L From Speculation)

Participants will be ranked and scored based on their Adjusted P&L.

For example, consider a participant who has made $10,000 from tenders and $50,000 from speculation, the total profit is $60,000 (=$10,000 + $50,000) but the Adjusted P&L will only be $10,000 [=$10,000 + min(0,$50,000)].

In another example, consider a participant who has made $35,000 from tenders and lost $20,000 from speculation (Profit from Speculation = -$20,000); the total profit is $15,000 ($35,000 – $20,000) and it is equal to the Adjusted P&L [$15,000 = $35,000 + min (0, -$20,000)]. Any losses from speculation will be included while profits from speculation will not be included.

The adjusted P&L with the total fines paid is computed and displayed by the RIT application, visible in the “Trader Info” section. Additionally, participants can review speculation fines in their “Transaction Log” within the RIT application.

Footnote:

[1] Front-running is the unethical and illegal practice of trading a security for your own account while taking advantage of the information contained in the pending orders from your institutional clients.

[2] “Closing out” a position means that a participant is executing a trade that is the opposite of the current position in order to eliminate the exposure.

[3] The total profit of each participant is the profit (or loss) that you can observe in the RIT Client at the end of a heat.

TRADING LIMITS AND TRANSACTION COSTS

Each participant will adhere to gross and net trading limits as outlined in the case description, which will be renewed before each heat. The gross trading limit is the sum of the absolute values of long and short positions across all stocks, while the net trading limit accounts for the sum of long and short positions, with short positions offsetting long positions. These trading limits will be strictly enforced, preventing participants from exceeding them.

The maximum order size and commissions outlined in the case description will remain constant for each heat. A transaction fee of 20 cents per share applies. Any shares not covered by the end of the heat will incur a fine of $1.00 per share. Additionally, there is a fine of $0.20 per share for front-running and speculative strategies up to 5,000 shares; for shares beyond this limit, the fine increases to $0.40 per share.

POSITION CLOSE-OUT

Any open position will be closed out at the end of each heat based on the last traded price. Additionally, a penalty of $1 per share will be imposed for neglecting to close a position, encompassing both long and short positions in any security. Computerized market makers will increase the liquidity in the market towards the end of trading to ensure the closing price cannot be manipulated.