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Finance GlossaryFair Value
Fair Value
Definition of Fair Value
The fair value of a stock, product, or service is the price at which the buyer and seller willingly agree on without being on the losing end of the deal. Think of fair value as a win-win situation for both parties, assuming that all conditions are normal.
Say Mr. Apple is offered to buy shares of Mr. Orange’s company at Rs. 1000 per share. Mr. Apple evaluates the business and figures out that he can sell the same shares for Rs. 1200, even though Mr. Orange is content to sell the shares at Rs. 200 lower. Both parties agree on the deal at Rs. 1000 because both view it as a good deal.
The formula for the fair value of a stock or index is:
Fair Value = Cash * { 1 + r (X / 360)} - D
Where,
Cash = Latest stock or index value
r = interest rate on purchase
x = number of days to contract expiry
Dividend = Dividends
The definition of fair value is slightly different in the futures market. In the futures market, the fair value is reached when the supply meets the demand, which simply means that the spot price is equal to the futures contractprice.
However, due to inherent volatility of the markets, the price of a futures contract is known to fluctuate around the fair value of a stock or index. Thus, in the fair value in the context of futures is what the price of the contract should be, given the value of the stock or index, dividends, and others.
Say Mr. Apple is offered to buy shares of Mr. Orange’s company at Rs. 1000 per share. Mr. Apple evaluates the business and figures out that he can sell the same shares for Rs. 1200, even though Mr. Orange is content to sell the shares at Rs. 200 lower. Both parties agree on the deal at Rs. 1000 because both view it as a good deal.
The formula for the fair value of a stock or index is:
Fair Value = Cash * { 1 + r (X / 360)} - D
Where,
Cash = Latest stock or index value
r = interest rate on purchase
x = number of days to contract expiry
Dividend = Dividends
The definition of fair value is slightly different in the futures market. In the futures market, the fair value is reached when the supply meets the demand, which simply means that the spot price is equal to the futures contractprice.
However, due to inherent volatility of the markets, the price of a futures contract is known to fluctuate around the fair value of a stock or index. Thus, in the fair value in the context of futures is what the price of the contract should be, given the value of the stock or index, dividends, and others.
Related Terms
Liabilities
Liabilities are debt that a company owes to individuals or financial institutions in the form of bonds, debentures, salary, tax, and others.Liabilities play an important role in the balance sheet of a company as it signals competence to existing and prospective stakeholders.
Reverse Stock Split
A reverse stock split is a corporate action that involves a company reducing the number of outstanding shares it has, while the stock price increases proportionately. For instance, if there is a 1:5 reverse split, five shares are combined into one. A reverse stock split does not change the value of a company. However, it is often used to meet the requirements of listing on an exchange or improve the perception in the market.
Commodity
A commodity refers to physical goods and raw materials like aluminium, cotton, copper, sugar, steel, zinc, and others. Commodities are an essential part of the day-to-day life of individuals, companies, and industries.
But they can’t be traded like stocks in India. Instead, a commodity trader will enter into either of these three contracts to secure commodities or benefit from its price fluctuations:
But they can’t be traded like stocks in India. Instead, a commodity trader will enter into either of these three contracts to secure commodities or benefit from its price fluctuations:
- Futures contracts
- Options contracts
-
Cash contracts
These derivative contracts are traded on commodity exchanges in India like:
- Indian Commodity Exchange (ICEX)
- Multi Commodity Exchange of India (MCX)
- National Commodity & Derivatives Exchange Limited (NCDEX)
- National Multi Commodity Exchange of India (NMCX)
Delivery Trading
Delivery trading refers to buying a stock or ETF and holding it for more than one day. In such a scenario, the buyer take delivery of the asset instead of squaring off their position in the same trading session. Delivery trading is applicable for short term and long term trades and can last overnight to a decade or more.
Gold Futures
Gold futures are commodity derivatives that derive their value from gold bullion. A trader who buys a gold futures contract acquires the right and obligation to buy gold at a later date and price that’s pre-agreed. Gold futures in India are eligible for physical delivery once the terms of the contract are successfully fulfilled.
Net Worth
Net Worth represents the overall financial value of an individual or company after subtracting total liabilities from total assets. It shows the true financial position at a given point in time and is commonly used to assess financial strength and stability.
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