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In
finance Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
, the intrinsic value of an asset usually refers to a
value Value or values may refer to: Ethics and social * Value (ethics) wherein said concept may be construed as treating actions themselves as abstract objects, associating value to them ** Values (Western philosophy) expands the notion of value beyo ...
calculated on simplified assumptions. For example, the intrinsic value of an option is based on the current market value of the underlying instrument, but ignores the possibility of future fluctuations and the
time value of money The time value of money is the widely accepted conjecture that there is greater benefit to receiving a sum of money now rather than an identical sum later. It may be seen as an implication of the later-developed concept of time preference. The ...
.


Options

An option is said to have intrinsic value if the option is
in-the-money In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...
. When out-of-the-money, its intrinsic value is ''zero''. For an option, the intrinsic value is the same as the "immediate value" or the "current value" of the contract, which is the profit that could be gained by exercising the option immediately. The intrinsic value for an in-the-money option is calculated as the absolute value of the difference between the current
price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the ...
(''S'') of the
underlying In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be use ...
and the
strike price In finance, the strike price (or exercise price) of an option is a fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. The strike price may be set ...
(''K'') of the option. :IV_= 0 :IV_=\left \vert S-K \right \vert = \left \vert K-S \right \vert For example, if the
strike price In finance, the strike price (or exercise price) of an option is a fixed price at which the owner of the option can buy (in the case of a call), or sell (in the case of a put), the underlying security or commodity. The strike price may be set ...
for a call option is
USD The United States dollar (symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the official ...
1.00 and the price of the underlying is US$1.20, then the option has an intrinsic value of US$0.20. This is because that call option allows the owner to buy the underlying stock at a price of 1.00, which they could then sell at its current market value of 1.20. Since this gives them a profit of 0.20, that is the current ("intrinsic") value of the option. The market price of an option is generally different from this intrinsic value, due to uncertainty. Options are valid for a duration of time, so inventors may buy or sell options contracts on their belief in the likelihood that the value of the stock will change before the option's expiration date. This is called the
option time value In finance, the time value (TV) (''extrinsic'' or ''instrumental'' value) of an option is the premium a rational investor would pay over its ''current'' exercise value ( intrinsic value), based on the probability it will increase in value before ex ...
. For example, while an out-of-the-money option has an immediate/intrinsic value of zero, since exercising the option would not be profitable at the current time, the option could still be sold at nonzero price to an investor who speculates that the option might become
in-the-money In finance, moneyness is the relative position of the current price (or future price) of an underlying asset (e.g., a stock) with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a thr ...
before it expires, due to a change in the value in the underlying stock. This describes what happened in one GameStop options trade that became famous: a trader spent $53,000 buying a large number of call options that were extremely cheap, since they were so far out-of-the-money that other traders thought it was very unlikely that they would ever hold intrinsic value. However, these options had an expiration date far in the future, and two years later the underlying GameStop shares spiked in value, putting the options in-the-money, which the trader was able to exercise for $48 million.


Equity

In valuing equity,
securities analyst A financial analyst is a professional, undertaking financial analysis for external or internal clients as a core feature of the job. The role may specifically be titled securities analyst, research analyst, equity analyst, investment analyst, o ...
s may use
fundamental analysis Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements (usually to analyze the business's assets, liabilities, and earnings); health; and competitors and markets. It also considers the overall sta ...
—as opposed to
technical analysis In finance, technical analysis is an analysis methodology for analysing and forecasting the direction of prices through the study of past market data, primarily price and volume. Behavioral economics and quantitative analysis use many of the sam ...
—to estimate the intrinsic value of a company. Here the "intrinsic" characteristic considered is the expected cash flow production of the company in question. Intrinsic value is therefore defined to be the
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of all expected future net cash flows to the company; i.e. it is calculated via discounted cash flow valuation. An alternative, though related approach, is to view intrinsic value as the value of a business' ongoing operations, as opposed to its accounting based
book value In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. T ...
, or break-up value.
Warren Buffett Warren Edward Buffett ( ; born August 30, 1930) is an American business magnate, investor, and philanthropist. He is currently the chairman and CEO of Berkshire Hathaway. He is one of the most successful investors in the world and has a net ...
is known for his ability to calculate the intrinsic value of a business, and then buy that business when its price is at a discount to its intrinsic value.


Real estate

In valuing
real estate Real estate is property consisting of land and the buildings on it, along with its natural resources such as crops, minerals or water; immovable property of this nature; an interest vested in this (also) an item of real property, (more general ...
, a similar approach may be used. The "intrinsic value" of real estate is therefore defined as the net
present value In economics and finance, present value (PV), also known as present discounted value, is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money has inte ...
of all future net cash flows which are foregone by buying a piece of real estate instead of renting it in perpetuity. These cash flows would include rent, inflation, maintenance and property taxes. This calculation can be done using the
Gordon model In finance and investing, the dividend discount model (DDM) is a method of valuing the price of a company's stock based on the fact that its stock is worth the sum of all of its future dividend payments, discounted back to their present value. In ...
.


See also

* Terminal value *
Net realizable value Net realizable value (NRV) is a measure of a fixed or current asset's worth when held in inventory, in the field of accounting. NRV is part of the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IF ...
*
Option time value In finance, the time value (TV) (''extrinsic'' or ''instrumental'' value) of an option is the premium a rational investor would pay over its ''current'' exercise value ( intrinsic value), based on the probability it will increase in value before ex ...
*
Option (finance) In finance, an option is a contract which conveys to its owner, the ''holder'', the right, but not the obligation, to buy or sell a specific quantity of an underlying asset or instrument at a specified strike price on or before a specified d ...
* Expected value


References

{{DEFAULTSORT:Intrinsic Value (Finance) Derivatives (finance)