Fair value is a term that in the investment field refers to the agreed sale price . This, provided that the participants act in freedom and are informed about the details of the transaction.
In other words, in the financial world, the fair value of an operation is that agreed between two parties, without coercion.
We can cite several examples of this type of value. One of them is the price paid by an investor in the stock market for the purchase of the shares of a company.
It should be noted that the financial market is characterized by immediately reflecting changes in demand, that is, in the mood of investors. Therefore, the market price is a good indicator of fair value.
Application in accounting
On the other hand, for accounting , the fair value is that with which the assets and liabilities of the company must be recorded.
For example, imagine that a firm purchases a new machine for its factory. This asset will lose utility over time ( depreciation ). Therefore, in each period its value will be reduced in the accounting books.
That is, if one year the valuation of the machine was 18,000 euros, for the following period it can drop to 14,400 euros, due to its wear. Thus, it approaches the fair value.
Derivatives and futures
Going back to the stock market, the fair value of a financial derivative is mainly determined by its underlying asset .
For example, imagine that an investor has a gold purchase option , which gives him the right to purchase the gold metal within a specified period.
So if the price of gold goes up, so will the price of the derivative. Thus, the investor could sell his option at a higher price than what he paid to buy the instrument.