Final answer:
Fair value is used to value trading and AFS securities to reflect current market conditions and provide an accurate valuation based on market expectations of future benefits including capital gains and dividends. Changes in interest rates after issuance affect bond valuations, indicating the market's efforts to reach equilibrium.
Step-by-step explanation:
We use fair value to value both trading securities and Available-for-Sale (AFS) securities because it reflects the current market conditions and provides a more accurate assessment of the securities' actual worth at a specific point in time. Fair value is determined based on the present value of future benefits, including potential capital gains from the sale of the security and expected dividends.
For bonds, fair value is influenced by changes in interest rates after issuance. If interest rates decrease, a bond's fair value may increase, as the bond's higher locked-in rate becomes more attractive compared to new bonds. Conversely, if interest rates rise, the bond's fair value may decrease. These valuations help investors make decisions based on their economic knowledge and expectations about the future, whether they are buying, holding, or selling securities.
Markets aim to reach an equilibrium where securities are priced fairly based on all available information, allowing investors to make informed decisions based on potential risks and returns. Hence, fair value accounting plays a critical role in ensuring market efficiency and transparency.