December 15, 2015

Thoughts on pricing & fair valuation

The fair value of any financial security is driven by 3 critical factors:

1. What are you going to get from it? Coupon for fixed income, interest for currencies, dividend/earnings for equities.
2. When are you going to get it? Coupon - half-yearly/annually, interest - monthly, dividend/earnings - annually but not certain to be received
3. What is your desired rate of return from the investment? Yield for fixed income, Cost of equity for equities.

A rational investor would evaluate & determine each of the above 3 factors before deciding to invest. And then there are many who gamble in the name of investments.

Also adds another aspect to pricing - how would you price commodities that do not really 'earn' anything except possible capital gains. That strategy is defined by many as the "Bigger Fool Theory" - you will necessarily need someone to buy it from you at a much higher price than what you bought at!