Law of One Price

Law of One Price

1. 1. State the NPV decision rule for a single project:

   Take the project if its IRR exceeds the historical average return on stocksTake the project if PV(benefits) exceeds PV(costs); equivalently if NPV > 0Take the project if its payback period is under three yearsTake the project only if it has positive expected accounting profit

2. 2. The Law of One Price says:

   Every asset must have the same priceTwo assets that produce identical cash flows in all states must have identical pricesStocks and bonds must be equally pricedMarkets must always be efficient

3. 3. A one-year risk-free bond paying $100 trades at $95.24 (yielding ~5%). A one-year credit-default-swap that pays $100 in case of default trades at $4 today (you receive the $4 premium upfront). What is the no-arbitrage price for a one-year corporate bond that pays $100 if the firm survives and $0 if it defaults? Answer in dollars to two decimals.

   $

4. 4. EUR/USD = 1.10, USD/JPY = 110. What should EUR/JPY be (approximately) to avoid triangular arbitrage?

   100110121200