Understand which factors influencing Premium & Discount | Motilal Oswal

Factors influencing Premium & Discount in Stock Market

The Net Asset Value (NAV) is usually used in mutual fund for describing the value of funds of assets and less the value of liabilities. It is also referred to as net book value or book value and the term may also be used in many places with different meanings. Net asset value is mostly used in mutual fund to signify total value of the portfolio of the fund, less its liabilities.

The net asset value per share for mutual funds investment is daily calculated in the closing market price reflecting the value change. In the case of stocks, the NAV is the value of the assets over the liabilities divided by the number of stocks issued.

One would think that the NAV is the price at which a stock should be trading in the stock market. However, it barely ever happens in reality. In reality many factors impact the final price of the stock, making it available in premium or in discount of its Net Asset Value. When people refer to stocks being traded in premium or in discount, this is the context they use it in.

At the risk of sounding repetitive, futures trading is not for everyone. The futures market holds a lot of opportunities however, before embarking into it make sure you get an expert broker to guide you through the entire process.

Understanding Spot Prices & Futures Prices:

Commodity spot prices and futures prices are different quotes presented for different types of contracts. The spot price is the current price of a spot price contract, at which a particular commodity could be bought or sold at a specified place for immediate delivery and payment on a spot date. Conversely, a commodity's futures price is quoted for a financial transaction that will occur on a future date and is the settlement price of the futures contract.

What is the difference?

The main differences between commodity spot and futures prices are the delivery dates and prices.

A commodity's spot price is the price at which the commodity could be traded at any given time in the marketplace. In contrast, a commodity's futures price is the price of the commodity in relation to its current spot price, time until delivery, risk-free interest rate and storage costs at a future date.

Calculate commodity futures prices by adding storage costs to the spot price of a particular commodity. Multiply the resulting value by Euler's number raised to the risk-free interest rate multiplied by the time to maturity. Generally, futures prices and spot prices are different because the market is always forward-looking. The difference in a commodity's spot price and future price is due to the cost of carry and interest rates.

Factors influencing premium and discount in the stock market:

Market Sentiment of Stock Market–
The sentiment prevalent in the market is one of the most intangible and difficult to measure factors that often drive a stock price to the bottom or to the top. A single piece of relevant news can disproportionately affect the fortunes of a stock in the market because in a mob, individuals tend to follow the crowd and hence overreact. This can lead to a premium when the news is somewhat good but the sentiment it generates is extraordinary. It can lead to a discount when the news is somewhat bad but the sentiment it generates is debilitating.

Inflation in Share Market–
During highly inflationary times, stocks tend to get disproportionately discounted as the disposable income generally in the economy lowers and the pricing for investments suffers. Conversely, during deflationary times, stocks tend to get disproportionate amounts of premium because investments are seen as attractive and hence demanded more.

Economic strength of the industry –
Companies belonging to the same industry or sector generally tend to rise or fall together. This is because several factors such as regulation, substitute industries, etc. don’t just affect a single company but the entire sector.

Substitutes of Stock Market -
Availability of viable substitutes, in other markets such as commodities, debt, real estate, bullion, etc. also impacts whether stocks in a market in general will sell at a premium or in discount. Like in any other situation, availability of good alternatives will discount the stocks and lack of them will add the sheen of premium to them.

Demographics in Stock Market –
In an economy, the larger the proportion of people belonging to the middle age category, in their peak earning period, the higher the likelihood of shares being traded at a premium. If however there are a larger proportion of people in the younger or older age groups, the stocks will be discounted. It is significant to understand here that for an economy, the middle aged are important for the immediate future and the young are important for the long term.

Trends in Stock Markets–
There are phases due to international cues or big stories when say, there is an ecommerce boom, and suddenly those stocks will be at a premium. Trends are fickle and unreliable. It needs a very good understanding of behavioural economics to benefit from them.

Liquidity in Stock Market –
Liquidity is one of those invisible factors that can easily be ignored by the retail investor who isn’t paying attention. Among the many macroeconomic cues that give an insight into the market, liquidity is perhaps most important. With lack of substitutes to invest in and low spend on consumption, sometimes the economy is left with heavy surplus cash at one end and funds-hungry companies on the other. In such a situation there is an influx of cash in the stock market leading to the stocks being traded on discount.

Now with the knowledge that the implications of the premium and discounted stock prices can have on your portfolio, you can now tread carefully while investing in mutual funds.

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