Wednesday, June 3, 2009

approaches to security valuation

It is reasonable enough to say that market prices of"comparable investments"should be used to determine the value of a security.But when are two investments truly comparable?
An obvious case arises when investments provide identical payments in every possible contingency.If an investment,s outcome is affected by relatively few events,it may be possible to purchase a set of other investments,each of which pays off in only one of the relevant contingencies.A properly selected mix of such investments may thus be completely comparable to the one to be valued.
A much more common approach to valuation is less detailed but more useful. Two alternatives are considered comparable if they offer similar expected returns and contribute equally to portfolio risk.Central to this view is the need to assess the probabilities of various contingencies.

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