ABSTRACT
Some of the basic concepts of finance are widely understood in broad terms; however this chapter will introduce them from a novel perspective of prices being treated relative to a reference asset. We first show the difference between an asset and the price of an asset. The price of an asset is always expressed in terms of another reference asset. The reference asset is also called a numeraire. The numeraire asset should never become worthless so that the price with respect to this asset is well defined. The relationship between prices of an asset expressed with respect to two different reference assets is known as a change of numeraire. The concept of price appears in different markets under different names, so it may not be obvious that it is just a particular instance of a more general concept. For instance, an exchange rate is in fact a price representing a pairwise relationship of two currencies. An even less obvious example of a price is a forward London Interbank Offer Rate (LIBOR). By adopting a precise definition of price, we are able to treat various markets (equities, foreign exchange, fixed income) in one single unified framework, which simplifies our analysis.
