easy · Market Microstructure
A value trader estimates the fundamental value of a stock at $48.00. The stock is currently quoted at $44.00 bid / $44.10 ask. Expected round-trip transaction costs are $0.30.
If the trader requires a margin of safety (risk premium) of $1.50 due to estimation uncertainty, should they trade?
- No; transaction costs exceed the mispricing gap
- Yes, buy; mispricing ($3.90) exceeds threshold ($1.80)
- Yes, sell; the trader misjudged valuation direction
- No; mispricing fails to clear the required safety threshold here
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