The Law of One Price

prices and economic incentives:
comparing apples and assets
We expect the same thingto sell for the same price. This is the Law of One Price. Why should this be true? Common sense dictates that if you could buy an apple for $0.25 and sell it for $0.50 across the street, then everyone would want to buy apples where they are cheap and sell them where they are priced higher. Yet this price disparity will not last: as people take advantage, prices will adjust until apples of the same quality sell for the same price on both sides of the street. Furthermore, a basket of apples must be priced in light of the total cost of buying the fruit individually. Otherwise, people will make up their own baskets and sell them to take advantage of any mispricing. the arbitrage relationship between individual asset prices and overall portfolio values is explored later in this chapter.
The structure imposed on prices by economic incentives is the same in financial markets as in the apple market. Yet a different approach must be taken to determine what what constitutes the “same thing” in financial markets. For example, securities are the “same” if they produce the sane outcomes, which considers both their expected returns and risk. They should consequently sell for the same prices. Similarly, equivalent combinations of assets providing the same outcomes should sell for the same price. Thus, the criteria for equivalence among financial securities involve the comparability of expected returns and risk. If the same thing sells for different prices, the Law of One Price is violated, and the price disparity will be exploited through arbitrage. Thus, the Law of One Price imposes structure on asset prices through the discipline of the profit motive. Similarly, if stocks with the same risk have different expected returns, the Law of One Expected Return is violated.

Economic Foundations of the Law of One Price
The Law of One Price holds under reasonable assumptions concerning what investors like and dislike and how they behave in light of their preferences and constraints. Specifically, our analysis assumes the following:
More wealth is preferred to less. Wealth enhancement is a more comprehensive criterion than return or profit maximization. Wealth considers not only potential returns and profits but also constraints, such as risk.
Investor choices should reflect the dominance of one investment over another. Given two alternative investments, investors prefer the one that performs at least as well as the other in all envisioned future outcomes and better in at least one potential future outcome.
An investment that generates the same return(outcome) in all envisioned potential future situations is riskless and therefore should earn the risk-free rate. Lack of variability in outcomes implies no risk. Thus, strategies that produce risk-less returns but exceed the risk-free return on a common benchmark, such as the U.S. Treasury bills, must involvemispriced invesments.
Economic incentives ensure that two investments offering equivalent future outcomes should, and ultimately will, have equivalent prices(returns).
The process of a short sale are available to the investor. This assumption is easiest to accept for large, institutional investors or traders who may be considered price-setters on the margin. Even is this assumption seems a bit fragile, market prices generally behave as if it holds wel enough. The nature and significance of short sales are discussed more later in this chapter.

Systematic, persistent deviations from the Law of One Price should not occur in efficient financial markets. Deviations should be relatively rare or so small as not to be worth the transaction costs involved in exploiting them. Indeed, when arbitrage opportunities do appear, those traders with the lowest transaction costs are the ones likely to be the only one who can profitably exploit them. The Law of One Price is largely-but not completely-synonymous with equilibrium, which balances the forces of supply and demand.

This article was in response to an email sent to me asking if there was a law(like supply and demand) that could support value investing. Then here it is for everyone to read. This was taken from the book “understanding arbitrage: an intuitive approach to financial analysis” pages 5 to 7 by randall billingsley. Wishing you all good luck on your life and in your trades and investments. :) for any comments, questions or suggestions please email me at compounder888@gmail.com

week in review

Before i start talking in this article of mine let us remember all the victims who lost their lives in the horrific 9/11 attack six years ago....
okay now lets get down to business, last week was a really bad week for me it was so bad that i decided to go to the barber and had almost all of my hair shaved!!! hehehe problems with business, work and i must admit in the arena of love. But anyway ive recovered and got back on my feet and this week is better for me. :) if its not better then i should make up reasons on why this week will be better for me. :) im just happy because ayala corporation just announced that they are doing a 2.5B stock buyback program!!! this just shows how confident the management is on the value of their company. :) im so happy i was able to get shares of a great company at a fair price. :) patience really does pay off sometimes. :) the week started out with me reading the articles of jack galt and ron nathan aka mr bearbull :) and im glad that somehow we share the same sentiments in some aspects. Mr bearbull and i agree that the us is really due for a recession and he also stated that maybe it might be safer to invest in emerging markets than the us. Ive said many times that i believe that there will be a shift of funds to asia from the us due to the recession. :) i think there will be more panic to follow because of the subprime problem that still lingers the only solution to that is to wait for bargains and just buy with what your comfortable with. :) im also glad that another analyst also likes jollibee which is a stock that i follow and i agree with him the jollibee is one company that will really reflect the boom that we are experiencing. :) just give jollibee some time and im sure the stock price will follow its increase in earnings. :) another topic that is of importance is the fed announcement on sept. 18. most likely the fed will lower interest rates so that they could calm investors and stabilize the economy. :) interest rates usually have a great effect on any economy lower it and assets will usually go up and increase interest rates and you might possibly see a slump in asset prices but the market is irrational and you never know what will happen. :) just expect the unexpected. :) remember....... money is never lost it is only transformed. :) hehehe happy trading to everyone and good luck. Sad to see erap go down but justice must be served. Tsktsk a group of friends and i are planning to put up a restaurant in binan, laguna can anybody here tell me the prospects there???? thanks :) god bless to everybody :)

explosive 1st year

I can still remember it so clearly, its like it was just yesterday i had the guts to start my own blog about finance, investing, business and everything else because i was inspired by some of the blogs that i read on the internet. Its been a year since i started chiefstocks with the mission to popularize value investing and help others do better at the stock market. :) i hope i have achieved this even in just a small way. :) value investing is here to make investing easier and makes sure that when you build your portfolio there is very little margin for error. Ive mentioned this lots of times in this blog investing is about making as little mistakes as possible. :) according to warren buffett the most important thing investing is not even about making money but not losing money. In other words, capital preservation because what is the point of earning money if you also lose it. :) i have learned a lot from the market, from other investors, from spyfrat, from ericgo, from raffy boy and from my idol warren buffett and though i might not be good in writing but i really do try my best to impart to all of you the things that i learn. :) a lot has happened over the past year, it started with the computer in our home, then after awhile i was able to buy a laptop of my own, then i became single, then the market “crashed” with the shanghai bubble, then i went on a vacation, then the market had a strong rally and reached 3,800 and a few weeks lost almost 25% the cause of the drop was the us subprime market concerns, then the fed lowers the interests rates and the us market stabilizes which also calms our market here so from the bottom of the drop the market has recovered almost 10% from its low with all that has happened im still here and fighting. Phew! What a year it has been and im looking forward to another with all of you. I still believe that the bull market is not yet over for the problem is in the us and not here. :) i expect the market to rally back to its previous levels and even go higher from there. Our market just needs some time. :) id just like to make a rundown of some of the things that i have mentioned for the last year. :) always remember that the market is irrational and it also has a short memory. One day it gains 5% and the next day it losses 8% it really doesnt matter for we can take advantage of the market volatility to our advantage. :) buy low and sell high. :) there are two things that will happen in the market: it will go up and it will go down. :) the up and down of the market is caused by market sentiments but always remember that behind all those stocks that are trading in the market are company valuations. :) this is where money is to be made if you are just patient enough to wait long enough for the inconsistencies that do occur every once in awhile. Like a few weeks ago i was forced to sell my shares in unionbank to make way for ayala corp because it was selling at bargain levels. :) i had to do this for i only limit my portfolio to up to 20 stocks. Now a comment on our market, after two weeks of heavy selling or maybe you could even call it panic and it was definitely a panic for why sell when our market is healthy. The market drop was a chance to get stocks of great companies at lower prices. After the fed in the us lowered the interest rates it calmed the us market and that sentiment was also embraced here and caused the market to rise a bit. After this week's trading im lead to believe that technically the market is going to make a rally but it is going to be a weak one. I know that some agree and some dont agree to some of the things that i say but as ive said that it is only my opinion and time is the best judge if im right or wrong. :) i hope that your portfolio is doing well in this very volatile market of ours. :) good luck on all your trades and God bless. :)

go eric go!

here is a peek on what is inside eric go's portfolio who also has an inclination to value investing and at the same time also trades stocks for the short term. :)

i have a set of stocks which are considered permanent and another set of stocks which are for trading and capital gains. (basically value for holding and speculatives for quick trading margin)rules for investing are as follows:speculatives are always up for sale. Whether to take profits or in some times to cut loss. Value stocks are permanent and will not be sold unless fundamentals start to erode. Cash dividends are reinvested and majority of capital gains(if any) are reinvested as well into the value portfolio. There will only be 7 stocks in the value portfolio which i have set as the maximum. In the event another stock would be a candidate for the value portfolio, one of the current positions must be sold before another will be added. % is based on the closing prices as of july 6, 2007. for the value stocks there are 7 and for the speculatives there are 4.

%for the whole are the following: chib – 6.45%; bdo – 2.53%; mvc – 4.15%; smdc – 5.75%; ans – 16.83%; reg – 10.76%; ephi – 4.22%; apc – 5.35%; geo – 27.23%; mac – 12.44%; pcp – 4.22%

for value:chib – 12.72%; bdo – 4.99%; mvc – 8.19%; smdc – 11.35%; ans – 33.18%; reg – 21.22%; ephi – 8.32%

specualtives are:apc – 10.86%; geo – 55.29%; mac – 25.26%; pcp - 8.57%