Definitions Flashcards
Time Value of Money
Difference in value between money today and money in the future
Interest Rate
Price of money
Exchange rate across time
Risk-free interest rate rf, discount rate d
Present Value
Today’s value of a future cash flow
Net Present Value
Difference of PV of benefits and PV of costs
Difference of PV of cash inflows and PV of cash outflows
Arbitrage
Taking advantage of price differences arising from buying and selling equivalent goods in different markets
Arbitrage Opportunity
Situation in which it is possible to make a profit without taking any risk
Normal markets
Competitive market in which there are no arbitrage opportunities
Law of One Price
If equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in both markets
Criteria for perfect markets
Homogenous products
Market prices will be built based on supply and demand
Demand participants are price takers
Criteria for efficient financial markets
Constant liquidity
Information symmetry
Transaction cost free environment
Economic rational behaviour
NPV rules
Take any investment opportunity which produces a positive NPV
Out of several investments with a positive NPV go for the one with the highest
Payback rule
The shorter the payback period of the investment the better
Internal Rate of Return Rule
Take any investment opportunity where IRR exceeds the opportunity cost of capital
Out of several investments with higher IRRs than opportunity cost of capital go for the one with the highest
Book Value
Net worth of the firm according to the balance sheet
Liquidation Value
Net proceeds that would be realized by selling the firm’s assets and paying off its creditors
