Fair value deals with the difference between the cost of owning all the stocks in an index such as the Dow Jones Industrial Average (DJIA) or S&P 500 and owning futures in the index. Owning all the stocks would cost a lot of money, that likely would have to be borrowed (for a price), but also would bring you dividends from the individual companies paying dividends. Owning futures would likely cost less, but earn you no dividends. Determining the 'fair value' relationship takes these factors into account.
Traders can profit if they know the difference between 'fair value', spot price, and the price of futures. Calculations of fair value are also used by some to predict whether the market will open up or down the next day.
Related Fool Articles
Recent Mentions on Fool.com
- The Difference Between a Restricted Stock Unit and a Restricted Stock Award
- Netflix, Amazon Prime, or Hulu: Which Offers the Best Deal?
- Emerson Electric: Worth Buying As a Dividend Aristocrat?
- Is Qualcomm Inc. Bottoming Out?
- This Just In: Upgrades and Downgrades
- Here Is How the New Groupon Inc CEO Plans to Turn the Business Around