Markets exist because of differences of opinion among investors.
- If securities could be valued precisely, there would be many fewer differences of opinion; market prices would fluctuate less frequently, and trading activity would diminish.
- To fundamentally oriented investors, the value of a security to the buyer must be greater than the price paid, and the value to the seller must be less, or no transaction would take place.
The discrepancy between the buyer's and the seller's perceptions of value can result from such factors as
- differences in assumptions regarding the future,
- different intended uses for the asset, and
- differences in the discount rates applied.
Every asset being bought and sold thus has a possible range of values bounded by the value to the buyer and the value to the seller; the actual transaction price will be somewhere in between.
In early 1991, for example, the junk bonds of Tonka Corporation sold at steep discounts to par value, and the stock sold for a few dollars per share. The company was offered for sale by its investment bankers, and Hasbro, Inc., was evidently willing to pay more for Tonka than any other buyer because of economies that could be achieved in combining the two operations. Tonka, in effect, provided appreciably higher cash flows
to Hasbro than it would have generated either as a stand-alone business or to most other buyers. There was a sharp difference of opinion between the financial markets and Hasbro regarding the value of Tonka, a disagreement that was resolved with Hasbro's acquisition of the company.