Intrinsic value

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February 1, 2012 By: , No Comments

Investors try an predict cash flows of a company into the future. They estimate growth rates etc to conduct this. Once they have have their future figures, they then discount these figures back to get the present value ( i.e. today’s value). Therefore, if their calculated figure is higher than the current market price, the share is undervalued by the market and you should buy. If the calculated figure is lower than the current market price, the share is overvalued by the market and you should sell. A perfect example of this was the time of the dot-com, where the intrinsic value for so many companies was below the market value, indicating a sell. As we all know, as time elapsed, these dot-coms crashed.

In the case of a call option, an option has intrinsic value if the strike price is lower than the current value of the underlying market. In the case of a put option, an option has intrinsic value if the strike price is above the current level of the underlying market. The intrinsic value is the difference between the current level of the underlying and the strike price.

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