Question

Now that you're taking a finance class, I was hoping you could settle a disagreement that your father and I are having. We are considering buying stock in General Electric (GE). We agree on what the dividends will be in the near future and how risky the company is, but I liked to hold stock in our portfolio for just a couple of years and your dad likes to hold for 10 years or more. Based on what you've been learning about valuing financial assets, do you think we should be able to agree on a fair price for the stock given how we can't agree on how long to hold the stock? That is, should our intended holding period affect what we should be willing to pay? I hope to hear from you soon! Also, when are you coming to see us? It has been too long!

Need help Answering this question.

Answer 1

In this question. The writer and father agree on the price of the stock, the near future and the riskiness of the stock, however both couldnt arrive at a common holding period. The writer wants to hold for just a couple of years and father wants to hold for atleast 10 years or more. And whether the holding period decide the price to be paid for the stock.

Now since dividend is paid by the company, in this case its General Electric (GE), which is decided by the management of the company. The rate of dividend is based on the profitability of the company and also on the dividend policy of the company. Here the investors (both writer and father) has no option than to agree on the dividends which is paid by the company. Now about mutually agreeing on the riskiness of the stock. Again the risk associated with the stock is dependant on the balance sheet, macro factors, profitability, liquidity, solvency position of the company. In short, the macro and micro factors of the company, Financial position and financial performance of the company decides the riskiness of the share. Here again being an investor, if they study the company, they will find the common outcome, in this case, both agree on the risk profile of the company.

Where they disagree, is based on the number of years, theyc ould hold the stock. The writer wants to hold for just a couple of years, whereas father wants to hold for ten or more years.

Here the investor is at discretion, whether he wants to hold it for one year or ten years or the number of years as per his investment horizon. when an investor invests in a stock, it may have certain expectations from the investment, also the purpose of investment may also differ individually. Each investor may have his or her own risk apetite, income flow, and other financial needs. If writer wants to invest for just a couple of years, it may be because the writer may achieve the desired investment goal in two years, he may not have to hold the investment for more days. Where as if father wants to remain invested for ten years or more, it may be because father may have a investment objective, which may be fulfilled in ten years. Now if he wants to achieve his investment goal by holding the stock for ten years, its his wish.

If I am willing to pay x amount for a stock, it may be because it satisfies my investment needs. If father wants to invest in for ten years, it may be because father may have the willingness to pay for the stock, which depends on the urgency to invest in the stock. The price willing to pay may differ with the investment objective, because if the price is arrived at by discounting the cash flows expected in the investment period, it will vary with the number of years the stock is held by the investor.