Kinematics
To clarify, I think there are some additional conditions: your thumb and index finger are aligned with the bottom of the bill, and you cannot move your hand.
When your friend drops the bill, you must have pinched your thumb and index finger together at or before the time the top of the bill falls to their height. In other words, your reaction time must be less than or equal to the time it takes the bill to fall 16 cm.
We know that objects at or near Earth's surface experience an acceleration of ~9.8 meters per second every second toward the Earth's center of mass. Since the bill remains close to Earth's surface throughout its fall, we may assume acceleration is a constant -9.8 m/s2 as long as we define the upward direction to be positive. Therefore, we may define a function that relates the acceleration of this bill to the elapsed time, a(t) = -9.8. From this, we can antidifferentiate a(t) to find a family of functions that relate the velocity of the bill to time, v(t) = -9.8t + vi, where vi is the initial velocity of the bill. Since it is at rest before being dropped, vi = 0, and v(t) = -9.8t. Antidifferentiate v(t) to find a family of functions that relate the position of the top of the bill to time, p(t) = -4.9t2 + hi, where hi is the initial height of the top of the bill. If you let your hand be the reference point, then the hi = .16 m, and p(t) = -4.9t2 + .16. We want to know the elapsed time when the top of the bill has reached your hand, so we set p(t) = 0.
-4.9t2 + .16 = 0
t = \sqrt{}(.16/4.9) ≈ .18 seconds, so with a reaction time of .2 seconds, the bill will fall through your fingers before you can react, and your friend will win the bet.