What Is Fair Value Pricing?

Malcolm Tatum

Fair value pricing is a process that is used to arrive at a fair value or fair price for an asset. The idea is to identify and assign a price that is considered to be in line with what is happening in the market place, allowing the investor to make decisions regarding purchases and sales of assets that have the potential to generate some sort of returns, or at least minimize losses. Considered to be a viable means of finding the balance between market price and fair value, the process of fair value pricing has both proponents and detractors in the investment world.

Businessman with a briefcase
Businessman with a briefcase

One of the benefits that proponents attribute to fair value pricing is the ability to take advantage of current market conditions to buy low then schedule a sale of those same assets for a time when those assets will carry a higher market value. For example, if a mutual fund falls sharply but there is reason to believe that the fund will level off and bounce back by the next trading day, an investor may set up a trade in which shares of the fund are purchased at the currently low price. The broker is then instructed to sell as soon as the shares reach a certain level, effectively generating a profit for the investor.

While fair value pricing does pave the way for some investors to generate pricing based on events that impact the performance of assets for a short period of time, this approach also has the effect of creating losses for others who are trading in the market place. This means that if an investor sells his or her investment in a mutual fund due to the sudden drop in value, that sale price must be at least as much as the original investment in order to avoid a loss. Often, this is not the case and the investor must assume a loss in order to prevent being adversely affected by any additional erosion in the market price. If that asset does bounce back on the following trading day, that investor could have weathered the storm and possibly come out ahead by choosing to hold rather than to sell. In this instance, the fair value pricing involved resulted in a loss for one party and a gain for another.

Detractors tend to view the use of fair value pricing in putting together trades as an issue of ethics, with one party taking advantage of the other due to circumstances that are likely to be short-term. Proponents note that sellers ultimately make the decision of whether to hold onto an asset in hopes that the value of the asset will recover, or to sell before a greater loss is incurred. From that perspective, the buyer is simply identifying what is available in the marketplace, determining if the acquisition of an asset is likely to be beneficial, then initiating the purchase at the price required by the seller, with that price either being equal to the current market price or a fair value price that the seller has identified and chosen as the sale price for the asset.

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