Financial Decision Making and the Law of One Price Flashcards
Competitive market
a market in which a good can be bought and sold at the same price
Valuation principle
the value of an asset to a firm is determined by its competitive market price
Time value of money
the difference in value between money today and money in the future
Risk free interest rate
rate at which money can be borrowed or lent without risk for a certain period of time
Discount rate
interest rate used to determine the present value of future cash flows
Present value
the value of a cost or benefit in terms of cash today
Future value
the value of a cost or benefit in terms of dollars in the future
Net present value
the difference between the PV of benefits and the PV of cost for an investment. It expresses the value of an investment decision as an amount of cash received today
NPV decision rule
when making an investment decision, take the alternative w/ the highest NPV. Choosing this alternative is equivalent to receiving its NPV in cash today
Arbitrage
the practice of buying and selling goods in different markets to take advantage of price difference
Arbitrage opportunity
any situation where it is possible to make a profit without taking any risk or making any investment
Normal market
competitive market w/ no arbitrage opportunities
Law of One Price
if equal investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in all markets
Financial security
an investment opportunity that trades in a financial market
Bond
security sold by governments and corporations to raise $ from investors today in exchange for the promised future payment.
