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Unformatted text preview: most preferred pattern of cash flows. Concept
Check 9. What is the NPV decision rule? How is it related to the Valuation Principle?
10. Why doesn’t the NPV decision rule depend on the investor’s preferences? 3.6 The Law of One Price
Up to this point, we have emphasized the importance of using competitive market prices
to compute the NPV. But is there always only one such price? What if the same good
trades for different prices in different markets? Consider gold. Gold trades in many different markets, with the largest markets in New York and London. Gold can trade easily
in many markets because investors are not literally transacting in the gold bars themselves (which are quite heavy!), but are trading ownership rights to gold that is stored
securely elsewhere.3 To value an ounce of gold, we could look up the competitive price
in either of these markets. But suppose gold is trading for $1200 per ounce in New York
and $1300 per ounce in London. Which price should we use?
In fact, situations such as this one, where...
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- Spring '07