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A fundamental question on finance
Posted: March 6th, 2011, 8:45 pm
by kindlyMe
Dear all, I am new in finance domain and would like to ask one fundamental question:Suppose I have 2 instruments and the difference of the payoff at time T is a "definite figure" like say 'K1 - K2'. Then is it true that the difference of their values at present time will be the discounted value of "K1 - K2", (discounted with some risk free rate)?Is it obvious all time? Is there any fundamental financial axiom (like perhaps, 'law of one price' or something similar) behind above conclusion?Thanks,
A fundamental question on finance
Posted: March 6th, 2011, 10:52 pm
by Alan
As a general rule, yes, but there are many exceptions. Google put-call parity violations for classic examples of why itdoesn't always work.
A fundamental question on finance
Posted: March 7th, 2011, 4:18 pm
by list
QuoteOriginally posted by: kindlyMeDear all, I am new in finance domain and would like to ask one fundamental question:Suppose I have 2 instruments and the difference of the payoff at time T is a "definite figure" like say 'K1 - K2'. Then is it true that the difference of their values at present time will be the discounted value of "K1 - K2", (discounted with some risk free rate)?Is it obvious all time? Is there any fundamental financial axiom (like perhaps, 'law of one price' or something similar) behind above conclusion?Thanks,If you have a "definite figure" like say 'K1 - K2' paid at T and B( 0 , T ) is discount factor the price at 0 is B( 0 , T ) [ K1 - K2 ]. Any other answer should be checked whether the price or a method of pricing are interpreted correctly. It was before derivatives market came to the existence and one can suppose that the answer still remains correct after derivatives market came up.
A fundamental question on finance
Posted: March 7th, 2011, 5:06 pm
by Paul
An interesting exercise is to look at the theoretical Black-Scholes value of contracts with payoff S^a. And ln(S).P