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!!

  • $\begingroup$ This question is opinion based rather than factual.. My 2 cents: "real investments" are not particularly liquid or easy to find. They must have a positive NPV to reward the entrepreneur who finds them and develops them. If drilling an oil well in Texas has the same expected return as investing in Exxon stock, nobody will drill new oil wells, which is problematic... $\endgroup$
    – Alex C
    Nov 11, 2019 at 18:01
  • $\begingroup$ My point is: a bond's YTM is greater than opportunity cost, i.e.$YTM>r_m$, then if we discount CFs of bond using ooportunity cost, then $NPV>0$. Thereafter, investors will be happy to invest in this bond, which yields to price increase, and therefore to $YTM$ decrease. I think,market will eventually force to the case $YTM=r_m$. I assume that this condition holds in liquid markets. $\endgroup$
    – sane
    Nov 12, 2019 at 10:13


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