What is the Law of one price?
The law of one price is if two items are perfect substitutes on all dimensions then they should be the same price
What is the
difference between the value of the firm and the sum of the values of all
outstanding obligations and all outstanding stocks?
They are the same thing. If you own all the obligations you own all the stocks
2.44 What is a perfect market? What were the assumptions made in this chapter
that were not part of the perfect market scenario?
Perfect market has No taxes, no transaction costs, no differences in opinion, and many investors and firms. This means there is no change in price
rate.
2.46 Your stock costs $100 today, pays $5 in dividends at the end of the period,
and then sells for $98. What is your rate of return?
($98 + $5)-$100/100%
= 3%.
2.48 Assume an interest rate of 10% per year. How much would you lose over 5
years if you had to give up interest on the interest
—
that is, if you received 50%
instead of compounded interest?
1.10^5
–
(100% + 50%) = 11.1%
2.50 Over 20 years, would you prefer 10% per annum, with interest compounding,
or 15% per annum but without interest compounding? (That is, you receive the
interest, but it is
put into an account that earns no interest, which is what we call
simple interest.)
Over 20 years, you would receive a rate of return of 1.1^20
–
1
≈
573%. The
uncompounded rate earns 15% · 20 = 300%. You would prefer the compounded lower interest rate.
2.52 A project returned +50%, then
–
40%. Thus, its arithmetic average rate of
return was (50% + [
–
40%])/2 = +5%. Is your rate of return positive or negative?
The rate of return is (1 + 50%) · (1–40%)
–1 =
–
10%.. You would lose money.
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