Business, Legal & Accounting Glossary
The amount at which an asset or liability could be exchanged in an arm’s-length transaction between a willing buyer and a willing seller.
Fair value is a market price that both the buyer and the seller, neither under duress, will accept for the good or service they’re transacting.
Fair value is the price at which supply and demand meet. Fair value not only assumes that neither the buyer nor the seller are in any way forced to make the transaction; fair value also assumes that both the buyer and the seller have reasonable knowledge of relevant facts. Fair value reflects the price at which a seller is willing to part with his item in exchange for money and a buyer is willing to part with her money in exchange for the item. Fair value does not necessarily reflect an item’s intrinsic worth (e.g. the value of the materials used to make the item). An item’s fair value is based on a comparable market analysis (in other words, an item’s fair value is determined by the price at which similar items were recently sold for).
Fair value also refers to a relationship between stocks and stock futures. Alternatively, in the realm of value investing, fair value is a synonym for intrinsic value.
Fair value deals with the difference between the cost of owning all the stocks in an index such as the Dow Jones Industrial Average (DJIA) or S&P 500 and owning futures in the index. Owning all the stocks would cost a lot of money, that likely would have to be borrowed (for a price), but also would bring you dividends from the individual companies paying dividends. Owning futures would likely cost less, but earn you no dividends. Determining the ‘fair value’ relationship takes these factors into account.
Traders can profit if they know the difference between ‘fair value’, spot price, and the price of futures. Calculations of fair value are also used by some to predict whether the market will open up or down the next day.
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This glossary post was last updated: 5th August, 2021 | 6 Views.