1. Consider our "simple model of bid-ask spreads". Suppose that a dealer trades against an order which might come from an informed trader or a liquidity trader. The security's true value is either $60 or $50. The true value is $60 with 70% probability and $50 with 30% probability. The order is from an informed trader with 20% probability and from a liquidity trader with 80% probability. An informed trader observes the true value of $60 or $50 perfectly and places a buy order if the value is high or a sell order if the value is low. A liquidity traders buys or sells with equal probabilities. a. What are the bid and ask prices at which the dealer breaks even? Calculate the bid-ask spread. b. The dealer knows that at the end of the month the probability the order is from a liquidity trader is even greater than 80% as workers invest part of their paychecks for retirement and as retirees sell investments to pay monthly expenses. Recalculate the breakeven bid and ask prices and the bid-ask spread) if the order is from an informed trader with 10% probability and from a liquidity trader with 90% probability. C. Compare the bid-ask spread in part (a) to the bid-ask spread in part (b). 1. Consider our "simple model of bid-ask spreads". Suppose that a dealer trades against an order which might come from an informed trader or a liquidity trader. The security's true value is either $60 or $50. The true value is $60 with 70% probability and $50 with 30% probability. The order is from an informed trader with 20% probability and from a liquidity trader with 80% probability. An informed trader observes the true value of $60 or $50 perfectly and places a buy order if the value is high or a sell order if the value is low. A liquidity traders buys or sells with equal probabilities. a. What are the bid and ask prices at which the dealer breaks even? Calculate the bid-ask spread. b. The dealer knows that at the end of the month the probability the order is from a liquidity trader is even greater than 80% as workers invest part of their paychecks for retirement and as retirees sell investments to pay monthly expenses. Recalculate the breakeven bid and ask prices and the bid-ask spread) if the order is from an informed trader with 10% probability and from a liquidity trader with 90% probability. C. Compare the bid-ask spread in part (a) to the bid-ask spread in part (b)