2) TIME VALUE OF MONEY: A dollar today is worth more than a dollar tomorrow
3) Rf interest rate= interest rate at which the money can be lent or borrowed without risk and the discount rate for a free risk investment
4) (1+rf)= interest rate factor for risk-free cash flows
5) NPV= PV (benefits) – PV (costs) of investment or project and has to be positive
6) Regardless of our preferences for cash today vs cash tomorrow we should always maximize NPV first: we can then borrow or lend to shift cash flows through time and find our most preferred pattern of cash flows (vedi grafico pag 58)
7) ARBITRAGE OPPORTUNITY: the possibility to make a profit without taking any risk or making any investment.
8) ARBITRAGE: the practice of buying and selling equivalent goods in different competitive markets to take advantage of the price. A normal market is a market with no arbitrage opportunities.
9) LAW OF ONE PRICE: If equivalent investment opportunities trade at the same moment in different competitive markets, then they must trade for the same price in both markets.
10) When a security is undervalued there is an arbitrage opportunity: I must buy the security now and borrow money at the rf rate so that: rf rate = 0.05; face value = 1000; PV = 1000/1.05 = 952 ( it trades at 940 so if I borrow 952 and I buy the sec I have in cash 952 – 940 = 12; tomorrow I use the 1000 par value to refund the loan but I had an earning.
11) When a security is overvalued I have another arbitrage opportunity: I sell the security and lend money at the rf rate so: rf rate = 0.05; face value = 1000; Trades at 960; PV = 952 so I make 8 today and lose 1000 tomorrow from the security but get 1000 tomorrow from the refund of my... [continues]
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