Lecture 2 - Asset Pricing

Question 1

What are the principles?

Answer 1

1. No Free Lunch
2. Dominance Principle
3. Law of One Price
4. Value Preservation

Question 2

Describe the “No Free Lunch” - principle

Answer 2

» A project with positive cash flows only and at least one strictly positive -There is no such thing as risk-free arbitrage opportunities.

Value(A) > 0

Question 3

Describe the “Dominance Principle” - principle

Answer 3

» If cash flows of A are bigger than those of B, and one of them is at least strictly bigger - if we get the same payoff but to a cheaper price then we go for the cheaper one.

Value(A) > Value (B)

Question 4

Describe the “Law of One Price” - principle

Answer 4

» If cash flows of A are perfectly identical to those of B - there is supposed to be one price on the market.
Value(A) = Value (B)

Question 5

Describe the “Value Preservation” - principle

Answer 5

» If cash flows of B and C sum to those of A

Value(A) = Value(B) + Value(C)