When an investor buys a stock or bond, does the price he is willing to pay...

When an investor buys a stock or bond, does the price he is willing to pay depend on whether he intends to resell his investment in 2 years or in 30 years?

Why or why not?

Solutions

Expert Solution

ANSWER

YES, the price an investor would be willing to pay would totally depend upon the "tenure" he is going to hold his Investment for.

EXPLANATION/JUSTIFICATION

Whenever we purchase any product from the market , we first look at the benefits that we will get out of such product in the future and then decide its worth . If the price of such product is higher than its worth than we do not buy such product and vice-versa.
Similarly above Concept applies in Stock Market as well. When an Investor wants to Invest into any Stock or Bond, he would first look at the future benefits that he will get from such stock in the form of Dividends and Redeemable Value/Resale value of such Bond/Stock at the time of exiting from such Investment.
Accordingly he will be willing to pay only the actual worth of such Investment which will be the Present Value of all the Future Incomes that he would receive and the Resale Value at the time of Selling such Investment.
So now if he would be holding an Investment for a shorter period of time (lets say 2 years) than the Future Incomes (ie. Dividends or Coupons) will get reduced to such period of 2 years only which will reduce the Fair Value of such Investment WHEREAS if the holding tenure is greater (lets say 30years) then it would Increases the Worth of such Investment as on today by the amount of such additional income discounted value.
Hence in such a case (ie. when he is holding for 30 years) he might be willing to pay more than in otherwise case
Also when the Holding Period of an Investment is higher, Risk Factor attached to such Investment also gets increased which again impacts the price that an Investor would pay for such Investment as such risk would reduce the amount.
Such Risks can be Default Risk , Market Risk , Interest Rate Risks etc.
Hence we can conclude that the "holding period" of an Investment is an important factor that will impact the price that an investor would pay for such investment.

jeff jeffy answered 1 year ago

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