You are a dealer in shares of Kangaroo Trading Corp. (KTC), a mining exploration company based in Western Australia. Information asymmetry often exists for stocks in this industry.

Based on prior experience, you estimate that the probability of trading with a well-informed trader is 12%. As this stock is relatively illiquid, you estimate that it may deviate from its true value by up to 40% at any point in time. The share is currently trading at a price of $1.44 and your transaction costs per share are $0.05.

a) Given the presence of information asymmetry, evaluate whether you would be able to remain a dealer if you set the bid-ask spread at $0.15.

b) Next week, KTC will make an announcement regarding the latest annual earnings report. An informed trader has found out that the announcement will show that earnings will be 5% higher than expected. Describe the trading strategy you would you expect this informed trader to use.

c) Carefully explain what you would expect to happen to the price of KTC, and the spreads you offer if the next three trades all involved you selling (i.e. the counterparty buying) KTC shares.