7.1 Relationship between Asset's Value and Its Price Definition: An asset's fundamental value is the price well informed investors must pay to purchase it in a free and competitive market THE COURSE OF FINANCE 2017 SPRING SJTU 6
7.1 Relationship between Asset’s Value and Its Price Definition: An asset’s fundamental value is the price well informed investors must pay to purchase it in a free and competitive market THE COURSE OF FINANCE 2017 SPRING SJTU 6
Relationship between Asset Value and Price There can exist temporary differences between the market price of an asset and its fundamental value(Reasons:incomplete competitive market and asymmetric information) Security analysts make their living by discovering these aberrations Many well-informed professionals are looking for these aberrations.A reasonable initial assumption is that aberrations are small THE COURSE OF FINANCE 2017 SPRING SJTU
Relationship between Asset Value and Price There can exist temporary differences between the market price of an asset and its fundamental value(Reasons: incomplete competitive market and asymmetric information) Security analysts make their living by discovering these aberrations Many well-informed professionals are looking for these aberrations. A reasonable initial assumption is that aberrations are small THE COURSE OF FINANCE 2017 SPRING SJTU 7
7.2 Value Maximization and Financial Decisions Financial decisions can be made rationally purely on the basis of value maximization,and without regard to risk preferences and expectations Markets for financial assets provide the information needed to choose between some alternatives Example:You win a contest,and the prize is a choice between a ticket to the opera and a ticket to the ball game.The opera ticket has a price of $100 and the ticket to the ball game has a price of $25.Assuming you prefer ball games to opera,which ticket should you choose? THE COURSE OF FINANCE 2017 SPRING SJTU
7.2 Value Maximization and Financial Decisions Financial decisions can be made rationally purely on the basis of value maximization, and without regard to risk preferences and expectations Markets for financial assets provide the information needed to choose between some alternatives Example: You win a contest, and the prize is a choice between a ticket to the opera and a ticket to the ball game. The opera ticket has a price of $100 and the ticket to the ball game has a price of $25. Assuming you prefer ball games to opera, which ticket should you choose? THE COURSE OF FINANCE 2017 SPRING SJTU 8
Value maximization and financial decisions 1. The markets for financial assets provide the information needed to value the alternatives 2. The financial decision can rationally be made purely on the basis of value maximization,regardless of the stranger's risk preferences or expectations about the future. Ex.The management should choose investment to maximize current shareholders'wealth. THE COURSE OF FINANCE 2017 SPRING SJTU
Value maximization and financial decisions 1. The markets for financial assets provide the information needed to value the alternatives 2. The financial decision can rationally be made purely on the basis of value maximization, regardless of the stranger’s risk preferences or expectations about the future. Ex. The management should choose investment to maximize current shareholders’ wealth. THE COURSE OF FINANCE 2017 SPRING SJTU 9
7.3 The Law of One Price and Arbitrage Law of One Price: In a competitive market,if two assets are equivalent,they will tend to have the same price Ex.In the super market,water with similar ingredients are sold at the similar price THE COURSE OF FINANCE 2017 SPRING SJTU 10
7.3 The Law of One Price and Arbitrage Law of One Price: In a competitive market, if two assets are equivalent, they will tend to have the same price Ex. In the super market, water with similar ingredients are sold at the similar price THE COURSE OF FINANCE 2017 SPRING SJTU 10