Final answer:
The statement that the fair value of a trading security is the market price for selling the investment is true. Fair value accounts for potential capital gains and dividends, and fluctuates with changes in market interest rates.
Step-by-step explanation:
The statement that the fair value of a trading security is the price that would be used if the company were to sell the investment on the market is true. Fair value is a financial concept that reflects the price at which an asset would be bought or sold in a current transaction between willing market participants. When it comes to trading securities, fair value is particularly significant, as it allows companies to provide a snapshot of the real value of their financial instruments.
In the context of present discounted value, both stocks and bonds are valued based on anticipated future cash flows discounted back to their present value. This incorporates both potential capital gains and expected income streams like dividends for stocks, or coupon payments for bonds.
Therefore, fair value can fluctuate based on the current market's assessment of these future benefits. When interest rates fall, the fair value of bonds tends to increase as these securities become more attractive due to their higher locked-in rates compared to the now lower market rates. Conversely, bonds will decrease in value when market interest rates rise.
Understanding fair value is crucial for investors as it helps them to determine whether an investment is potentially profitable based on future benefits. Differences in expectations about these benefits lead to the dynamic nature of financial markets where one party is willing to buy what another is looking to sell.