Lecture 2 (Chapter 3) Flashcards
How do we decide if it’s a good investment? What is the issue with this?
Tumregel: Invest if Revenue/Benefits > Costs
Benefits and costs can occur at different times, have different risks and be in different currencies.
How can we compare revenues and costs when either revenues or costs will occur in the future? När kan detta användas?
We use a simple valuation principle: “If a good can be sold and purchased as the same price, the price determines the cash value of the good”. The costs and benefits should be decided using market prices.
The above is correct when we’re in a competitive market.
How can SEK 1 today be worth more in a year than SEK 1 that year?
Since we can put that 1 SEK in a bank account with risk-free return.
How do we denote (betecknas) risk-free rate and what does it mean?
risk-free rate = rf = the rate we get on a investment without any risk
It can also be called the discount rate for a risk-free investment
How can we change money?
We can convert money today to future money by depositing it in the bank.
We can exchange future money with money today by borrowing from the bank.
What is the discount factor?
1/ 1+rf
The value today of SEK 1 in 1 years time
What is NPV, how to calculate it and why?
NPV = Net present value. The difference between present value of revenues and present value of cots.
To calculate the value of an investment. We have to express both revenue and costs in present values, otherwise it’s like comparing apples and bananas.
NPV = PV(Benefit/Revenues) - PV (Costs)
Calculate
PV(cost)
PV(revenue)
FV (cost)
FV(revenue)
PV(Cost) = Kostnad
PV(Revenue) = Intäkt / 1+rf
FV (Cost) = Kostnad * 1+rf
FV(Revenue) = Intäkt
Decision rules of NPV:
- General rule: Maximize NPV
- If the investments are mutually exklusive, always chose the one with highest NPV
- If not mutually exklusive, invest if NPV > 0
Equivalence of FV och PV
(Likvärdighet)
NFV = NPV * (1+rf)
FV = PV * (1+rf)
Arbitrage?
Arbitrage opportunity?
Do they exist in finans?
Utnyttjandet av obalans i två eller flera marknader där obalansen består av skillnader i marknadspris.
When you buy and sell equivalent goods in different markets to take advantage of the price difference.
An investment that is giving positive payoff with a probability 1 and has 0 costs. A situation where it’s possible to make profit without taking any risks or making any investments. Always positive NPV.
Yes they do and they are very desirable, investors will quickly exploit them and therefore they will not exist for long.
What can we call the absence of arbitrage opportunity?
Law of one price. If there is no opportunities then the all prices will be equal. If price would differ then it would be imbalance and investors would take the opportunities to exploit this. Often happens in normal markets.
What is no arbitrage price and how is it determined?
No arbitrage price means that the prices are in equilibrium. It is determined by:
P(Security) = PV (Cashflow security)
What is a portfolio of securities? How to value a portfolio?
A portfolio of securities is a collection of securities. For example if you have 200 shares in H&M and 300 in Apple.
To set a value we can think that portfolio C consists of asset A & B. The portfolio C has the same cash flow as A & B together. Because of this, the law of one price implies.
Price (C) = Price (A+B) = Price (A) + Price (B)
How do we want NPV?
It should always be positive. As long as it is positive it increases the value of the firm.
