Question

1)

In general, what determines the market price of any financial asset? What determines its intrinsic value? How are the two related in the absence of mispricing?

2) Assuming a constant real return, why are investors worse off when the inflation rate is high

3)

Why do we measure the risk of an asset by the standard deviation of its returns?

4)

Why do we consider only portfolios on the efficient frontier when trying to find the optimal risky portfolio?

5)

What is the separation property and why does it apply?

Answer 1

You have asked multiple questions in the same post. I will address the first one. Please post the balance questions separately one by one.

Q - 1

In general, what determines the market price of any financial asset? What determines its intrinsic value? How are the two related in the absence of mispricing?

In general, the market price of an asset is determined by the underlying future cash flows the asset can generate.

Intrinsic valuation of an asset as the present value of all the future cash flows that it can generate.

As a buyer of a financial asset, I will not be willing to pay a price today that is more than the present value of all the future cash flows the stock can generate.

Hence, P_buy = Buying price ≤ PV (all the future cash flows)

As a seller, I will not be willing to sell it at a price lower than the present value of all the future cash flows it can generate. Hence, P_sell ≥ PV (all the future cash flows)

Since, there is an absence of mispricing and transactions do happen on the financial assets, this implies

at some point P_buy and P_sell converges and that convergence happens only when:

P_buy = P_sell = PV (all the future cash flows) = Intrinsic value of the asset

Hence, in the absence of mispricing, the market price of an asset = PV (all the future cash flows it can generate) = Intrinsic value of the financial asset.