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COMM 221: Financial Markets > Chapter 3: Arbitrage and Financial Decision Making > Flashcards

Chapter 3: Arbitrage and Financial Decision Making Flashcards

1
Q

What does NPV stand for?

A

Net Present Value

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2
Q

What is the risk-free interest rate denoted as?

A

r_f

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3
Q

What is the discount rate for security s denoted as?

A

r_s

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4
Q

What is the Valuation Principle in finance?

A

The Valuation Principle states that we can use current market prices to determine the value today of the costs and benefits associated with a decision.

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5
Q

What does PV stand for in finance?

A

Present Value

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6
Q

How is Net Present Value (NPV) used in financial decision making?

A

NPV is used to compare the costs and benefits of a project in terms of today’s dollars, indicating the net amount by which the decision will increase wealth.

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7
Q

What does the Law of One Price state?

A

Equivalent investment opportunities trading simultaneously in competitive markets must have the same price.

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8
Q

What is the primary responsibility of a financial manager?

A

To make decisions on behalf of the firm’s investors that increase the firm’s value.

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9
Q

How do marketing skills contribute to financial decision making?

A

Marketing skills help determine the increase in revenues resulting from an advertising campaign.

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10
Q

How do economics skills contribute to financial decision making?

A

Economics skills help determine the increase in demand from lowering the price of a product.

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11
Q

How do organizational behavior skills contribute to financial decision making?

A

Organizational behavior skills help determine the productivity impact of a change in management structure.

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12
Q

How do strategy skills contribute to financial decision making?

A

Strategy skills help determine a competitor’s response to a price increase.

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13
Q

How do operations skills contribute to financial decision making?

A

Operations skills help determine production costs after the modernization of a manufacturing plant.

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14
Q

What should a financial manager do after analyzing the costs and benefits associated with a decision?

A

Compare the costs and benefits and determine the best decision to maximize the value of the firm.

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15
Q

What is the first step in decision making in finance?

A

Identifying the costs and benefits of a decision.

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16
Q

How do we quantify the costs and benefits of a financial decision?

A

By evaluating them in the same terms—cash today.

17
Q

How do you compare the value of different assets in decision making?

A

Convert their values to a common measure, like cash today, using current market prices.

18
Q

What is the purpose of quantifying costs and benefits in cash today?

A

To ensure a fair comparison and make informed financial decisions.

19
Q

What is the net value of a decision if the benefit is $17,000 and the cost is $14,000?

A

$3,000

20
Q

Why are current market prices used to determine cash values in financial evaluations?

A

They provide an objective measure of value, unaffected by individual preferences.

21
Q

What principle does the example of using current market prices to evaluate a trade illustrate?

A

In competitive markets, the price determines the cash value of goods.

22
Q

How should you decide between different assets in a financial decision?

A

Choose the option with the highest market value, regardless of personal preferences.

23
Q

What is the Valuation Principle in finance?

A

The value of an asset is determined by its competitive market price.

24
Q

How should decisions be evaluated according to the Valuation Principle?

A

By comparing the market value of benefits to the market value of costs.

25
Q

How do you apply the Valuation Principle to decide whether to take an opportunity?

A

Calculate the net value by subtracting the total cost from the total market value of the assets. If the net value is positive, the opportunity is worth taking.

26
Q

What are the notations used for Net Present Value, Risk-free interest rate, Present Value, and Discount rate for security s?

A

NPV: Net Present Value
rf: Risk-free interest rate
PV: Present Value
rs: Discount rate for security s

27
Q

What is arbitrage in financial decision making?

A

Arbitrage involves taking advantage of situations where the prices of publicly available investment opportunities do not conform to their true values, allowing investors to exploit these discrepancies for profit.

28
Q

What is the Time Value of Money (TVM)?

A

The Time Value of Money concept states that a dollar today is worth more than a dollar in the future due to its potential earning capacity. This principle is essential in finance for evaluating investment opportunities.

29
Q

How is the interest rate like an exchange rate across time?

A

The interest rate allows us to convert money from the present to the future and vice versa. It acts as the price of money today in terms of money in the future.

30
Q
A

COMM 221: Financial Markets (8 decks)

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