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Unformatted text preview: ke advantage of this arbitrage by buying the bond, and so,
due to the excess demand, its price would quickly rise. Similarly, if the price were above $952.38,
everyone would sell the bond, invest the proceeds at 5%, and in one year would have more than
the $1000 needed to pay the buyer of the security. The selling, and resulting excess supply, would
cause the price of the bond to drop until this arbitrage was no longer possible—when it reaches
$952.38. This powerful application of the Law of One Price shows that the price you pay for a security’s cash flows cannot be different from their present value. 03_ch03_berk.indd
03_ch03_berk.indd 82 12/15/11 8:08 PM Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making 83 Transactions Costs
In our examples up to this point, we have ignored the
costs of buying and selling goods or securities. In most
markets, there are additional costs that you will incur
when trading assets, called transactions costs. As
discussed in Chapter 1, wh...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.
- Spring '07