Question

several years ago, chelsea was given a painting by a famous artist. she planned to keep it as an investment, hoping its value would increase so that she could sell it and make a profit. several years later, chelsea had costly emergency surgery, and she did not have enough money in her savings to pay for the procedure. fortunately, the painting had substantially increased in value, and she decided to sell it. she found a reputable art dealer who told her that market conditions would make it difficult to sell the painting for its full value in the next six months. chelsea needed the money immediately, so the art dealer offered to buy the painting at a deep discount. how would you describe the financial risk that chelsea faces?

Answer 1

Chelsea faces financial risk in the form of a liquidity discount, which is when an asset must be sold quickly for less than its market value. Art and collectibles, while providing utilitarian and financial returns, can be illiquid and may not always yield high returns over time.

Step-by-step explanation:

The financial risk faced by Chelsea involves selling a valuable painting for significantly less than its market value. Such an action is necessitated by Chelsea's immediate need for funds to cover emergency surgery costs. The art dealer has offered to purchase the painting at a deep discount, indicating that Chelsea faces the risk of liquidity discount—a reduction in price due to the need for her to sell the asset quickly. This scenario is common in the art market, where market conditions can complicate the sale of artworks.

Collectibles like paintings are considered tangible assets that typically provide both utilitarian and financial returns. Chelsea's painting, initially kept for investment, could have been enjoyed as art while also potentially increasing in value. However, the fact that Chelsea needs to sell the painting quickly—due to an urgent financial need—complicates her ability to realize the full value of this investment.

Art investments are known to have fluctuating values and may not consistently offer high returns over time. When an owner like Chelsea sells at a time not optimal for the market, they likely must accept a liquidity discount. While collectible investments can see price increases, they are illiquid compared to other assets and hence are harder to sell rapidly without losing value.