Opportunity Cost, Bond Yields, and Zero NPV in Liquid Markets

Summary

The document asks whether a liquid, well-functioning market should make a project’s net present value zero. It compares valuing a conventional bond’s cash flows using yield to maturity with valuing an identical project’s cash flows using an opportunity cost or cost of capital. The questioner reasons that investors would pursue any project yielding more than comparable market investments, bidding its return down toward the market rate.

This is a conceptual question rather than a worked analysis: it gives no data, calculations, or empirical evidence. Its key distinction is that a project’s appropriate discount rate should reflect the market return for investments with comparable risk, while a bond’s yield to maturity is tied to its price and promised cash flows. The proposed equilibrium intuition is suggestive, but the document does not establish that every project in a liquid market must have zero NPV. Its conclusion depends on assumptions about risk comparability, available investment opportunities, and whether the project’s cash flows and price are correctly specified.

Key ideas

• The document distinguishes a bond’s yield to maturity from a project’s opportunity cost of capital.
• It proposes that competition may push unusually high project returns toward comparable market returns.
• The relevant discount rate should reflect the risk of the investment being valued.
• The document poses, but does not resolve, whether market liquidity implies zero NPV for every project.

Tags

# Should the NPV be equal to zero in liquid markets?


# Should the NPV be equal to zero in liquid markets?












My question is actually very simple. I would like to motivate it by bringing the following example:

suppose we have a (conventional) bond which generates $CF_1;CF_2;...;CF_n$ cash flow (for simplicity assume that $CF_1=...=CF_{n-1}$). In order to evaluate this cash flow, we say that we discount using yield to maturity (YTM), and the resulting present value (PV) is the price of a bond. I would like to underline that we call the discount rate as YTM.

Now, if some investment project different from bond (i.e. real investments) generates the identical cash flow as the bond disscused above: $CF_1;CF_2;...;CF_n$, then in order to evaluate this cash flow we again discount it, but now we replace YTM with "opportunity cost", "cost of capital", etc. As I know opportunity cost and YTM are not identical. Opportunity cost is the rate derived from the market which has the same risk level as our investment.

My question: In a liquid and well funtioning market, I think that opportunity cost and yield (or YTM for bond case) should be equal. Why? Beacuse, if my investment project's yield is higher than it is in the market, then everyone will invest in this project, therefore decreasing its return to the market return which is the same opportunity cost (sort of equilibrium rate). This implies that in the liquid markets any prjects' NPV should be equal to 0. Am I right? If no, why? Thanks!!

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.