Finance Notes

The ''True'' Principles of Finance

P1: There Is No Such Thing as a Free Lunch

P2: Other Things Equal, Individuals :

Prefer more money to less (non-satiation)

Prefer money now to later (impatience)

Prefer to avoid risk (risk aversion)

P3: All Agents Act To Further Their Own Self-Interest

P4: Financial Market Prices Shift to Equalize Supply and Demand

P5: Financial Markets Are Highly Competitive

P6: Risk-Sharing and Frictions Are Central to Financial Innovation

Two objectives of finance:

1- Valuation of assets (real/financial, tangible/intangible)

2- Management of assets (acquiring/selling)

Two challenges of finance: time & risk (money has a time value-> int rate is exchange rate across time, time implies uncertainty)

Int rate (1+r) and discount facor 1/ (1+r)

PV and FV tell us the same thing, what is the values of our investment, but expressed as values at different points in time.

NPV(investiment)= PV(Benefits)-PV(Costs)

–Accept those projects with positive NPV because accepting them is equivalent to receiving their NPV in

cash today. –Reject those projects with negative NPV because accepting them would reduce the wealth of investors.

Arbitrage is the practice of buying and selling equivalent goods in different markets to take advantage of a price difference. An Arbitrage Opportunity arises when its possible to make a profit without taking any additional risk. We assume arbitrage opportunities may exist, but only for a short time. You can make money for a (short) while but not forever.

If markets are efficient (rational), prices reflect the value of an assets and you cannot make (easy) money on the market. If there are opportunities out there someone will pick them up. Why do people collect info to make money? Why do people participate in the stock market at all? ->Irrational people make the market efficient.

Law of One Price:

If equivalent investment opportunities trade simultaneously in different competitive markets, then they...