HE2001 - Asset Markets

• Assets are goods that provide a flow of services over time. For instance, a flow of consumption services like housing services
• Financial assets are assets that provide a flow of money over time
• Rate of return in year t is the income earned by the assets in year 1 as a fraction of its value in year t
• If there is no uncertainty, then all assets have the same rate of return because if both assets were identical, then no one would buy the asset with the lower rate of return.
• The time at which an asset should be sold is determined by the rate of return (interest rate)
• An asset should be sold when V'(t)/V(t)
• Implicit rental rate is that rate at which you could rent a similar house
• h = (T + A)/P in which A is the expected appreciation of house over a year, T is the rental return, P is the initial cost of house and h is the total rate of return on initial investment
• Arbitrage is the trading for profit in commodities which are not used for consumption such as buying and selling stocks, bonds or stamps
• An equilibrium condition is when there is no opportunities for arbitrage
• The rate of return from holding an asset is (1 + R)p0 = p1, where p0 is the price today of an asset and p1 is the expected price tomorrow
• It is not best to sell when the asset interest rate (R) > bank interest rate (r)
• When interest rate paid by banks rises, the market price of bonds fall
• rb indicates the before-tax rate of return of a taxable asset; re indicates the rate of return of a tax exempt asset and t is the tax rate

  
• The no arbitrage rule assumes that the asset services provided by the two assets are identical, except for the purely monetary difference.
• If one asset is easier to sell than the other, then we can say that the asset is more liquid than the another.
• This total rate of return is composed of the consumption rate of return, T/P, and the investment rate of return, A/P.