finance Finance refers to monetary resources and to the study and Academic discipline, discipline of money, currency, assets and Liability (financial accounting), liabilities. As a subject of study, is a field of Business administration, Business Admin ...

, the intrinsic value of an

asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

or security is its ''value'' as calculated with regard to an inherent, objective measure. A distinction, is re the asset's ''price'', which is determined ''relative'' to other similar assets. The intrinsic approach to valuation may be somewhat simplified, in that it ignores elements other than the measure in question.

Options

For an option, the intrinsic value is the

absolute value In mathematics, the absolute value or modulus of a real number x, is the non-negative value without regard to its sign. Namely, , x, =x if x is a positive number, and , x, =-x if x is negative (in which case negating x makes -x positive), ...

of the difference between the current

price A price is the (usually not negative) quantity of payment or compensation expected, required, or given by one party to another in return for goods or services. In some situations, especially when the product is a service rather than a ph ...

(''S'') of the

underlying In finance, a derivative is a contract between a buyer and a seller. The derivative can take various forms, depending on the transaction, but every derivative has the following four elements: # an item (the "underlier") that can or must be bou ...

and the strike price (''K'') of the option, to the extent that this is in favor of the option holder. Thus, the option is said to have intrinsic value if the option is in-the-money; when

out-of-the-money In finance, moneyness is the relative position of the current price (or future price) of an underlying Financial asset, asset (e.g., a stock) with respect to the strike price of a derivative (finance), derivative, most commonly a call option or a ...

, its intrinsic value is ''zero''. For an option, then, 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. Formulaically: :

IV_= 0

IV_=\left \vert S-K \right \vert = \left \vert K-S \right \vert

For example, if the strike price for a call option is

USD The United States dollar (symbol: $; currency code: USD) is the official currency of the United States and several other countries. The Coinage Act of 1792 introduced the U.S. dollar at par with the Spanish silver dollar, divided it int ...

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: as alluded to, it is based on the current

market value Market value or OMV (open market valuation) is the price at which an asset would trade in a competitive auction setting. Market value is often used interchangeably with ''open market value'', ''fair value'' or '' fair market value'', although t ...

of the underlying instrument, but ignores the possibility of future fluctuations. Further, 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 (finance), option is the premium a rational investor would pay over its ''current'' exercise value (intrinsic value (finance), intrinsic value), based on the pro ...

. For example, while an

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 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 analysts 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, Liability (financial accounting), liabilities, and earnings); health; Competition, competitors and Ma ...

—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. As a type of active management, it stands in contradiction to ...

—to estimate the intrinsic value of a company. Here the "intrinsic" characteristic is the

cash flow Cash flow, in general, refers to payments made into or out of a business, project, or financial product. It can also refer more specifically to a real or virtual movement of money. *Cash flow, in its narrow sense, is a payment (in a currency), es ...

to be produced by 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 (PDV), 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 ha ...

of all expected ''future'' net cash flows to the company; i.e. it is calculated via discounted cash flow valuation. (See also

owner earnings Owner earnings is a valuation method detailed by Warren Buffett in Berkshire Hathaway's annual report in 1986. He stated that the value of a company is simply the total of the net cash flows (owner earnings) expected to occur over the life of the ...

and earnout.) Importantly, the required return used here to discount these cash flows, must include a

risk premium A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky Rate of retur ...

appropriate to the company in question. An alternative approach is to view intrinsic value as linked to the business' ''current'' operations. Here, under an asset-based valuation the business is seen as worth, at least, the sum of the

fair market value The fair market value of property is the price at which it would change hands between a willing and informed buyer and seller. The term is used throughout the Internal Revenue Code, as well as in bankruptcy laws, in many state laws, and by several ...

of its assets (i.e. as opposed to their accounting-based book value, or break-up value). Relevant here are the

fixed asset Fixed assets (also known as long-lived assets or property, plant and equipment; PP&E) is a term used in accounting for assets and property that may not easily be converted into cash. They are contrasted with current assets, such as cash, bank ac ...

working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...

and (initial) "opex" required so as to replicate or recreate the ongoing business. Note though, that under this approach

intangible asset An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, exclusive franchises, Goodwill (accounting), goodwill, trademarks, and trade names, reputation, Research and development, R&D, Procedural knowledge, ...

s (including "goodwill") are ignored, and the valuation may (will) then be understated. The valuation, then, will also often include See for example
"Intangible Asset Valuation"
CBV Institute (estimated) costs for any R&D and

marketing Marketing is the act of acquiring, satisfying and retaining customers. It is one of the primary components of Business administration, business management and commerce. Marketing is usually conducted by the seller, typically a retailer or ma ...

required in this replication. See also Replacement value and Tobin's q.

Real estate

In valuing real estate, a similar approach may be used. The "intrinsic value" of real estate is therefore defined as the net

of all future net

s 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.

References

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