New rules will set out exactly how banks must adjust valuations of their fair valued financial instruments. Ragveer Brar, who leads the Bank of England's valuation and controls team, gives his expert view on what this means.
Mercer Capital's Value Focus: FinTech Industry | Second Quarter 2015Mercer Capital
Mercer Capital’s quarterly newsletter, FinTech Watch, provides an overview of the FinTech industry, including public market performance, valuation multiples for public FinTech companies, and articles of interest from around the web. This newsletter focuses on FinTech segments, including payment processors, technology, and solutions companies, examining general economic and industry trends as well as a summary of M&A and venture capital activity.
Mandatory Centralised Clearing - Creating a liquidity crisis?John Wilson
Co-presentation with Nicole Grootveld [Cardano] on the liquidity issues presented by the introduction of mandatory clearing for OTC derivatives. Includes commentary on the buy-side and some potential solutions to the issues created.
This document summarizes and discusses value investing approaches and strategies. It begins by outlining the history of value investing pioneered by Benjamin Graham and further developed by Warren Buffett. It then describes four common approaches to value investing: passive, contrarian, activist, and minimalist. The document also analyzes the academic research supporting the higher returns achieved by value stocks over the past decades. Overall, the document provides a comprehensive overview of the evolution and foundations of value investing.
Study on "Regulatory impact on banks' and insurers' investments"Manu Mathys
The financial sector is operating in a rapidly changing environment with new regulations coming up and with a growing dependency on macro-economic developments. In this context, banks and insurers are both confronted with the, Basel III and Solvency II regulations that will soon be effective. To get a better insight in the consequences and opportunities of these new regulations for their investment behavior, Ageas asked Vlerick to make a detailed study.
Vlerick Business School and Ageas and its Belgian operational company AG Insurance, promoters of the Vlerick Chair “Centre for Financial Services”, strongly belief that the exchange between the business community and the academic world is beneficial for both parties by increasing the mutual understanding of each other’s strategies, challenges, opportunities and needs.
CVA Capital Charge under Basel III standardized approachGRATeam
The document provides an explanation of the standardized approach for calculating capital charges for credit valuation adjustments (CVA) risk under Basel III. It first discusses how counterparty credit risk has become a major concern following the 2008 financial crisis. It then defines CVA risk and explains how the Basel Committee on Banking Supervision responded by introducing a new CVA capital charge to better capture this risk. The document focuses on explaining the standardized approach for determining the CVA capital requirement, including looking at where the standardized formula comes from and what it is intended to measure.
Mercer Capital | A Layperson's Guide to the Option Pricing ModelMercer Capital
Mercer Capital's whitepaper on the option pricing model, often used to value ownership interests in early-stage companies. Developed in response to the need to reliably estimate the value of different economic rights in complex capital structures, the OPM models the various capital structure components as a series of call options on underlying total equity value. Through a detailed example, Travis W. Harms explains key concepts including breakpoints and tranches in a straightforward and non-technical way, taking the mystery out of OPM terms such as “breakpoint” and “tranche”. Relative to the probability-weighted expected return method, the principal strengths of the OPM include the small number of required assumptions and auditability. The PWERM, in contrast, offers greater flexibility and transparency. Harms closes with some thought on reconciling OPM results with the market participant perspective.
STRESS TESTING IN BANKING SECTOR FRAMEWORKDinabandhu Bag
This document summarizes a study analyzing default correlation in retail banking portfolios in India. It discusses:
1) Literature on default correlation and factor modeling approaches to estimate correlation. Previous studies found correlation varies over time and across industries/ratings.
2) Analysis of a test portfolio with 4 retail segments showing migration of exposures between segments over 14 months. Segments showed varying default rate trends over time.
3) The study builds a multi-factor linear model to test if external economic factors significantly impact default correlations between segments over time.
Mercer Capital's Value Focus: FinTech Industry | Second Quarter 2015Mercer Capital
Mercer Capital’s quarterly newsletter, FinTech Watch, provides an overview of the FinTech industry, including public market performance, valuation multiples for public FinTech companies, and articles of interest from around the web. This newsletter focuses on FinTech segments, including payment processors, technology, and solutions companies, examining general economic and industry trends as well as a summary of M&A and venture capital activity.
Mandatory Centralised Clearing - Creating a liquidity crisis?John Wilson
Co-presentation with Nicole Grootveld [Cardano] on the liquidity issues presented by the introduction of mandatory clearing for OTC derivatives. Includes commentary on the buy-side and some potential solutions to the issues created.
This document summarizes and discusses value investing approaches and strategies. It begins by outlining the history of value investing pioneered by Benjamin Graham and further developed by Warren Buffett. It then describes four common approaches to value investing: passive, contrarian, activist, and minimalist. The document also analyzes the academic research supporting the higher returns achieved by value stocks over the past decades. Overall, the document provides a comprehensive overview of the evolution and foundations of value investing.
Study on "Regulatory impact on banks' and insurers' investments"Manu Mathys
The financial sector is operating in a rapidly changing environment with new regulations coming up and with a growing dependency on macro-economic developments. In this context, banks and insurers are both confronted with the, Basel III and Solvency II regulations that will soon be effective. To get a better insight in the consequences and opportunities of these new regulations for their investment behavior, Ageas asked Vlerick to make a detailed study.
Vlerick Business School and Ageas and its Belgian operational company AG Insurance, promoters of the Vlerick Chair “Centre for Financial Services”, strongly belief that the exchange between the business community and the academic world is beneficial for both parties by increasing the mutual understanding of each other’s strategies, challenges, opportunities and needs.
CVA Capital Charge under Basel III standardized approachGRATeam
The document provides an explanation of the standardized approach for calculating capital charges for credit valuation adjustments (CVA) risk under Basel III. It first discusses how counterparty credit risk has become a major concern following the 2008 financial crisis. It then defines CVA risk and explains how the Basel Committee on Banking Supervision responded by introducing a new CVA capital charge to better capture this risk. The document focuses on explaining the standardized approach for determining the CVA capital requirement, including looking at where the standardized formula comes from and what it is intended to measure.
Mercer Capital | A Layperson's Guide to the Option Pricing ModelMercer Capital
Mercer Capital's whitepaper on the option pricing model, often used to value ownership interests in early-stage companies. Developed in response to the need to reliably estimate the value of different economic rights in complex capital structures, the OPM models the various capital structure components as a series of call options on underlying total equity value. Through a detailed example, Travis W. Harms explains key concepts including breakpoints and tranches in a straightforward and non-technical way, taking the mystery out of OPM terms such as “breakpoint” and “tranche”. Relative to the probability-weighted expected return method, the principal strengths of the OPM include the small number of required assumptions and auditability. The PWERM, in contrast, offers greater flexibility and transparency. Harms closes with some thought on reconciling OPM results with the market participant perspective.
STRESS TESTING IN BANKING SECTOR FRAMEWORKDinabandhu Bag
This document summarizes a study analyzing default correlation in retail banking portfolios in India. It discusses:
1) Literature on default correlation and factor modeling approaches to estimate correlation. Previous studies found correlation varies over time and across industries/ratings.
2) Analysis of a test portfolio with 4 retail segments showing migration of exposures between segments over 14 months. Segments showed varying default rate trends over time.
3) The study builds a multi-factor linear model to test if external economic factors significantly impact default correlations between segments over time.
Mercer Capital | Best Practices: Fair Value ManagementMercer Capital
Topics include: Best Practices for Valuing Illiquid Portfolio Assets, Fair Value Measurement, Valuation Methods, Valuing Fund Interests, Mezzanine Loans, GIPS Valuation Hierarchy, International Private Equity and Venture Capital Valuation Guidelines (December 2012), CFA Institute Global Investment Performance Standards (2010)
Understand the Value of Your InsurTech CompanyMercer Capital
Valuing an InsurTech company can be complicated and difficult, but carries important significance for employees, investors, and stakeholders for the company. While all InsurTech companies have differences, including what niche (distribution, claims, benefits, etc.) they operate in or what stage of development the company is in, understanding the value of the business is critically important.
This document summarizes a staff memo from Norges Bank that proposes a method for assessing credit risk on bank lending to corporations based on bankruptcy prediction modeling. The method estimates bankruptcy models for different industries using real-time economic indicators, credit ratings, and financial accounts data. It then assigns a risk weight to each firm's debt equal to its bankruptcy probability to estimate the share of debt that may end up in bankruptcy accounts. Comparing estimated risk-weighted debt to actual debt in bankruptcy accounts and bank losses historically shows good correspondence, indicating the model fits well.
The document summarizes SEC comments on fair value measurements for financial reporting. It provides examples of comments on topics such as:
1) Purchase price allocations where little value was assigned to intangible assets other than goodwill.
2) Goodwill impairment testing when indicators of impairment exist but no impairment was recorded.
3) Use of market prices for common stock versus other valuation methods to determine fair value.
4) Identification and valuation of embedded derivatives in contracts.
The SEC encourages companies to consult valuation specialists if they lack expertise to properly measure fair values.
Factors Affecting Investment Decisions in the Stock ExchangeAyman Sadiq
The document discusses factors affecting investment decisions in the stock exchange. It begins with definitions and an introduction to the topic. The broad objective is to identify factors influencing investment decisions. Specific objectives are to determine the impact of company profile, financial performance, market conditions, financial facilities, types of information, and regulatory bodies. Hypotheses are presented related to each objective. The methodology section outlines data collection through surveys and analysis using t-tests and factor analysis. Key findings indicate company reputation, size, and past financial performance most influence decisions, while market factors and financial services have less impact. Insider information and analyst recommendations also hold sway.
This document summarizes a research paper that develops a model of how "growth options" in a firm's technology can generate value above and beyond the present value of current cash flows. The model shows how variation in a technological frontier can lead to fluctuations in firm value unrelated to current performance. Simulations of the model produce results consistent with empirical findings, such as small coefficients on Tobin's Q and larger coefficients on cash flow in investment regressions. The model also demonstrates how growth options can cause excess volatility in firm valuation relative to cash flows.
The UK Value Premium - An Assessment of Possible Explanations - AbstractEdoardo Marangon
The document is a master's thesis that investigates the value premium in the UK stock market between 1982-2014. It finds that a value premium does exist, with strategies based on low price-to-book and low price-to-earnings ratios being the most profitable. A risk-based explanation from standard finance theory is not sufficient to explain the anomaly. Behavioral finance offers a more plausible alternative by incorporating the psychology of individual investors.
Understanding greek government bond spreadsIlias Lekkos
The aim of our research is to enhance our understanding on the fundamental behavior of the Greek Government Bond Spreads both before and after the Greek economic crisis. We do that by trying to address the following issues:
Which are the fundamental drivers of GGB spreads?
Is this set of driving factors constant or it varies relative to the situation in the Greek bond market and the size of the spreads?
Even for factors that are significant across the spreads distribution do they maintain a constant influence (constant betas) on the spreads or this varies as well?
Are Greek Government Bonds fairly valued given the levels of their fundamentals?
Are the risks around their fair value always symmetric or can we identify periods of positive (i.e. increased probability for narrower spreads) and negative (i.e. increased probability for wider spreads) risks?
Can we use the enhanced flexibility of the model for risk management purposes? That is, can we produce more accurate Value-at-Risk analysis for GGB spreads?
Finally, can we employ our model to explore the behavior of GGB spreads under various macroeconomic scenarios?
This paper presents a model to value cash holdings for all-equity financed firms with growth opportunities. The model considers the tradeoff between agency costs of free cash flow and costs of external financing. It derives the optimal dynamic cash retention policy and shows that firms optimally retain only a fraction of cash flows. The model implies that high cash flow volatility decreases the value of cash and that optimal cash retention can delay investment timing. Empirical tests on US firm data from 1980-2010 confirm these implications, finding a negative relationship between cash value and volatility in the context of growth options.
This document proposes adjustments to fair value accounting to reduce procyclicality. It suggests using a historical moving average over four quarters to calculate asset values for capital requirements, rather than quarterly mark-to-market valuations. This would dampen the impact of short-term market volatility on capital while still providing transparency through footnote disclosures. It aims to balance microprudential and macroprudential objectives by giving regulators flexibility to adjust requirements in times of stress without changing the accounting methodology. Feedback is requested on using a moving average to decrease fair value's potential to exacerbate downturns.
Credit Market Imperfection, Inequality and Capital AccumulationMahmoud Sami Nabi
1) The document discusses a theoretical model that examines the relationship between credit market imperfections, inequality, and capital accumulation. It incorporates judicial inefficiency as an additional credit market imperfection beyond moral hazard.
2) The model finds that wealth inequality initially widens between high- and low-wealth agents, as high-wealth agents can undertake larger projects due to credit constraints. However, inequality either remains constant or widens over time, depending on interest rate policies.
3) Numerical simulations show that increasing judicial efficiency reduces the speed of convergence to the long-run inequality level and decreases the long-run level of wealth inequality.
Mercer Capital's Investment Management Industry Newsletter | Q1 2021 | Focus:...Mercer Capital
Mercer Capital’s Investment Management Industry newsletter is a quarterly publication providing perspective on valuation issues pertinent to asset managers, trust companies, and investment consultants.
Deloitte Comments on Discussion Draft on Risk Recharacterization and Special ...Philippe Penelle
This document is a letter from Deloitte Tax LLP and Deloitte LLP submitting comments to the OECD regarding proposed revisions to Chapter I of the OECD Transfer Pricing Guidelines. The letter includes:
1) An executive summary highlighting key concerns with the discussion draft, including that some proposals move away from the arm's length principle and do not align with economic analysis of risk and returns.
2) A response to specific questions from the OECD regarding the risk-return tradeoff and the ability of associated enterprises to have different risk preferences.
3) A restatement of the principles of the arm's length standard and how it relies on the concept of equal risk equaling equal
1. The document proposes new weighting schemes to improve yield curve estimation in less liquid markets like Poland. It develops heuristics to assign weights based on bond liquidity measures like outstanding amounts and turnover.
2. It analyzes the results of estimating the Polish government yield curve under 28 different weighting systems. Systems that incorporate liquidity measures into weights produced smoother curves with smaller errors than traditional equal weighting.
3. The best performing systems gave the highest weight to the short end of the curve and excluded bonds eligible for switching. Weights based on outstanding amounts worked particularly well. While the pure expectations hypothesis did not hold universally, it could not be ruled out for horizons around 12 months and maturities around 36 months.
The document discusses CDO rating methodologies used by rating agencies. It compares two main approaches: [1] Moody's binomial expansion technique (BET) which uses a diversity score to simplify a portfolio, and [2] Monte Carlo simulation which models random defaults. The BET is faster but less accurate while Monte Carlo simulation provides more accurate loss distributions but takes longer to run. The document explores how differences in methodology, such as correlation assumptions, can impact ratings of senior CDO tranches and discusses potential model risk for investors.
The document summarizes a proposal from the Basel Committee on Banking Supervision called "Basel III" which aims to establish new capital and liquidity requirements for European banks. Key points:
1) The proposal estimates a capital shortfall of around €700 billion for European banks and requires them to raise between €3.5-5.5 trillion in additional long-term funding.
2) It proposes stricter capital quality rules, higher capital ratios, a leverage ratio, and new liquidity standards around net stable funding and liquidity coverage ratios.
3) Banks may respond by revising corporate structures, raising capital, reducing assets, and shifting assets, but the proposals could lower return on equity
This document provides an introduction to corporate finance and the financial system. It discusses how the financial system transfers funds from lenders to borrowers through both direct and indirect financing. Direct financing involves a direct transfer of funds from lender to borrower, while indirect financing involves financial institutions that borrow from savers and lend to borrowers. The document also describes different types of financial markets, how interest rates are determined, and the roles of various financial institutions.
An Analysis of the Limitations of Utilizing the Development Method for Projec...kylemrotek
Abstract: The rise and fall of subprime mortgage securitizations contributed in part to the ensuing credit crisis
and financial crisis of 2008. Some participants in the subprime-mortgage-backed securities market relied at least
in part on analyses grounded in the loss development factor (LDF) method, and many did not conduct their own
credit analyses, relying instead on the work of others such as securities brokers and rating agencies. In some
cases, the parties providing these analyses may have lacked the independence, or at least the appearance of it, that
would have likely better served the market.
A new appreciation for the value of independent analysis is clearly a silver lining and an important lesson to be
taken from the crisis. Actuaries are well positioned to lend assistance to the endeavor.
Mortgages are long-duration assets and, similarly, mortgage credit losses are relatively long-tailed. As casualty
actuaries are aware, the LDF method has inherent limitations associated with immature development. The
authors in this paper will cite examples of parties relying on the LDF or similar methods for projecting subprime
mortgage credit losses, highlight the limitations of relying exclusively on such methods for projecting subprime
mortgage credit performance, and conclude by offering general enhancements for an improved approach that
considers the underwriting characteristics of the underlying loans as well as economic factors.
Traditionally, quantitative finance practitioners are divided into two populations: those who seek fair values, i.e. means of price distributions, and those who seek risk measures, i.e. quantiles of price distributions. Fair value people and risk people typically live in separate lands, and worship different gods: the profit and loss balance sheet, and regulatory capital, respectively.
Prudent Valuation is a rather unexplored midland which has recently emerged somewhere in between the well known mainlands of Pricing and Risk Management. In fact, the Capital Requirements Regulation (CRR), requires financial institutions to apply prudent valuation to all fair value positions. The difference between the prudent value and the fair value, called Additional Valuation Adjustment (AVA), is directly deducted from the Core Equity Tier 1 (CET1) capital. The Regulatory Technical Standards (RTS) for prudent valuation proposed by the EBA have been adopted by the EU (reg. 2016/101) on 28th Jan. 2016.
The 90% confidence level required by regulators for prudent valuation links quantiles of price distributions (exit prices) to capital, thus bridging the gap between the Pricing and Risk Management mainlands, and forcing the crossbreeding of the fair value and risk populations above.
In this seminar, we will explore the Prudent Valuation land.
Mercer Capital | Best Practices: Fair Value ManagementMercer Capital
Topics include: Best Practices for Valuing Illiquid Portfolio Assets, Fair Value Measurement, Valuation Methods, Valuing Fund Interests, Mezzanine Loans, GIPS Valuation Hierarchy, International Private Equity and Venture Capital Valuation Guidelines (December 2012), CFA Institute Global Investment Performance Standards (2010)
Understand the Value of Your InsurTech CompanyMercer Capital
Valuing an InsurTech company can be complicated and difficult, but carries important significance for employees, investors, and stakeholders for the company. While all InsurTech companies have differences, including what niche (distribution, claims, benefits, etc.) they operate in or what stage of development the company is in, understanding the value of the business is critically important.
This document summarizes a staff memo from Norges Bank that proposes a method for assessing credit risk on bank lending to corporations based on bankruptcy prediction modeling. The method estimates bankruptcy models for different industries using real-time economic indicators, credit ratings, and financial accounts data. It then assigns a risk weight to each firm's debt equal to its bankruptcy probability to estimate the share of debt that may end up in bankruptcy accounts. Comparing estimated risk-weighted debt to actual debt in bankruptcy accounts and bank losses historically shows good correspondence, indicating the model fits well.
The document summarizes SEC comments on fair value measurements for financial reporting. It provides examples of comments on topics such as:
1) Purchase price allocations where little value was assigned to intangible assets other than goodwill.
2) Goodwill impairment testing when indicators of impairment exist but no impairment was recorded.
3) Use of market prices for common stock versus other valuation methods to determine fair value.
4) Identification and valuation of embedded derivatives in contracts.
The SEC encourages companies to consult valuation specialists if they lack expertise to properly measure fair values.
Factors Affecting Investment Decisions in the Stock ExchangeAyman Sadiq
The document discusses factors affecting investment decisions in the stock exchange. It begins with definitions and an introduction to the topic. The broad objective is to identify factors influencing investment decisions. Specific objectives are to determine the impact of company profile, financial performance, market conditions, financial facilities, types of information, and regulatory bodies. Hypotheses are presented related to each objective. The methodology section outlines data collection through surveys and analysis using t-tests and factor analysis. Key findings indicate company reputation, size, and past financial performance most influence decisions, while market factors and financial services have less impact. Insider information and analyst recommendations also hold sway.
This document summarizes a research paper that develops a model of how "growth options" in a firm's technology can generate value above and beyond the present value of current cash flows. The model shows how variation in a technological frontier can lead to fluctuations in firm value unrelated to current performance. Simulations of the model produce results consistent with empirical findings, such as small coefficients on Tobin's Q and larger coefficients on cash flow in investment regressions. The model also demonstrates how growth options can cause excess volatility in firm valuation relative to cash flows.
The UK Value Premium - An Assessment of Possible Explanations - AbstractEdoardo Marangon
The document is a master's thesis that investigates the value premium in the UK stock market between 1982-2014. It finds that a value premium does exist, with strategies based on low price-to-book and low price-to-earnings ratios being the most profitable. A risk-based explanation from standard finance theory is not sufficient to explain the anomaly. Behavioral finance offers a more plausible alternative by incorporating the psychology of individual investors.
Understanding greek government bond spreadsIlias Lekkos
The aim of our research is to enhance our understanding on the fundamental behavior of the Greek Government Bond Spreads both before and after the Greek economic crisis. We do that by trying to address the following issues:
Which are the fundamental drivers of GGB spreads?
Is this set of driving factors constant or it varies relative to the situation in the Greek bond market and the size of the spreads?
Even for factors that are significant across the spreads distribution do they maintain a constant influence (constant betas) on the spreads or this varies as well?
Are Greek Government Bonds fairly valued given the levels of their fundamentals?
Are the risks around their fair value always symmetric or can we identify periods of positive (i.e. increased probability for narrower spreads) and negative (i.e. increased probability for wider spreads) risks?
Can we use the enhanced flexibility of the model for risk management purposes? That is, can we produce more accurate Value-at-Risk analysis for GGB spreads?
Finally, can we employ our model to explore the behavior of GGB spreads under various macroeconomic scenarios?
This paper presents a model to value cash holdings for all-equity financed firms with growth opportunities. The model considers the tradeoff between agency costs of free cash flow and costs of external financing. It derives the optimal dynamic cash retention policy and shows that firms optimally retain only a fraction of cash flows. The model implies that high cash flow volatility decreases the value of cash and that optimal cash retention can delay investment timing. Empirical tests on US firm data from 1980-2010 confirm these implications, finding a negative relationship between cash value and volatility in the context of growth options.
This document proposes adjustments to fair value accounting to reduce procyclicality. It suggests using a historical moving average over four quarters to calculate asset values for capital requirements, rather than quarterly mark-to-market valuations. This would dampen the impact of short-term market volatility on capital while still providing transparency through footnote disclosures. It aims to balance microprudential and macroprudential objectives by giving regulators flexibility to adjust requirements in times of stress without changing the accounting methodology. Feedback is requested on using a moving average to decrease fair value's potential to exacerbate downturns.
Credit Market Imperfection, Inequality and Capital AccumulationMahmoud Sami Nabi
1) The document discusses a theoretical model that examines the relationship between credit market imperfections, inequality, and capital accumulation. It incorporates judicial inefficiency as an additional credit market imperfection beyond moral hazard.
2) The model finds that wealth inequality initially widens between high- and low-wealth agents, as high-wealth agents can undertake larger projects due to credit constraints. However, inequality either remains constant or widens over time, depending on interest rate policies.
3) Numerical simulations show that increasing judicial efficiency reduces the speed of convergence to the long-run inequality level and decreases the long-run level of wealth inequality.
Mercer Capital's Investment Management Industry Newsletter | Q1 2021 | Focus:...Mercer Capital
Mercer Capital’s Investment Management Industry newsletter is a quarterly publication providing perspective on valuation issues pertinent to asset managers, trust companies, and investment consultants.
Deloitte Comments on Discussion Draft on Risk Recharacterization and Special ...Philippe Penelle
This document is a letter from Deloitte Tax LLP and Deloitte LLP submitting comments to the OECD regarding proposed revisions to Chapter I of the OECD Transfer Pricing Guidelines. The letter includes:
1) An executive summary highlighting key concerns with the discussion draft, including that some proposals move away from the arm's length principle and do not align with economic analysis of risk and returns.
2) A response to specific questions from the OECD regarding the risk-return tradeoff and the ability of associated enterprises to have different risk preferences.
3) A restatement of the principles of the arm's length standard and how it relies on the concept of equal risk equaling equal
1. The document proposes new weighting schemes to improve yield curve estimation in less liquid markets like Poland. It develops heuristics to assign weights based on bond liquidity measures like outstanding amounts and turnover.
2. It analyzes the results of estimating the Polish government yield curve under 28 different weighting systems. Systems that incorporate liquidity measures into weights produced smoother curves with smaller errors than traditional equal weighting.
3. The best performing systems gave the highest weight to the short end of the curve and excluded bonds eligible for switching. Weights based on outstanding amounts worked particularly well. While the pure expectations hypothesis did not hold universally, it could not be ruled out for horizons around 12 months and maturities around 36 months.
The document discusses CDO rating methodologies used by rating agencies. It compares two main approaches: [1] Moody's binomial expansion technique (BET) which uses a diversity score to simplify a portfolio, and [2] Monte Carlo simulation which models random defaults. The BET is faster but less accurate while Monte Carlo simulation provides more accurate loss distributions but takes longer to run. The document explores how differences in methodology, such as correlation assumptions, can impact ratings of senior CDO tranches and discusses potential model risk for investors.
The document summarizes a proposal from the Basel Committee on Banking Supervision called "Basel III" which aims to establish new capital and liquidity requirements for European banks. Key points:
1) The proposal estimates a capital shortfall of around €700 billion for European banks and requires them to raise between €3.5-5.5 trillion in additional long-term funding.
2) It proposes stricter capital quality rules, higher capital ratios, a leverage ratio, and new liquidity standards around net stable funding and liquidity coverage ratios.
3) Banks may respond by revising corporate structures, raising capital, reducing assets, and shifting assets, but the proposals could lower return on equity
This document provides an introduction to corporate finance and the financial system. It discusses how the financial system transfers funds from lenders to borrowers through both direct and indirect financing. Direct financing involves a direct transfer of funds from lender to borrower, while indirect financing involves financial institutions that borrow from savers and lend to borrowers. The document also describes different types of financial markets, how interest rates are determined, and the roles of various financial institutions.
An Analysis of the Limitations of Utilizing the Development Method for Projec...kylemrotek
Abstract: The rise and fall of subprime mortgage securitizations contributed in part to the ensuing credit crisis
and financial crisis of 2008. Some participants in the subprime-mortgage-backed securities market relied at least
in part on analyses grounded in the loss development factor (LDF) method, and many did not conduct their own
credit analyses, relying instead on the work of others such as securities brokers and rating agencies. In some
cases, the parties providing these analyses may have lacked the independence, or at least the appearance of it, that
would have likely better served the market.
A new appreciation for the value of independent analysis is clearly a silver lining and an important lesson to be
taken from the crisis. Actuaries are well positioned to lend assistance to the endeavor.
Mortgages are long-duration assets and, similarly, mortgage credit losses are relatively long-tailed. As casualty
actuaries are aware, the LDF method has inherent limitations associated with immature development. The
authors in this paper will cite examples of parties relying on the LDF or similar methods for projecting subprime
mortgage credit losses, highlight the limitations of relying exclusively on such methods for projecting subprime
mortgage credit performance, and conclude by offering general enhancements for an improved approach that
considers the underwriting characteristics of the underlying loans as well as economic factors.
Traditionally, quantitative finance practitioners are divided into two populations: those who seek fair values, i.e. means of price distributions, and those who seek risk measures, i.e. quantiles of price distributions. Fair value people and risk people typically live in separate lands, and worship different gods: the profit and loss balance sheet, and regulatory capital, respectively.
Prudent Valuation is a rather unexplored midland which has recently emerged somewhere in between the well known mainlands of Pricing and Risk Management. In fact, the Capital Requirements Regulation (CRR), requires financial institutions to apply prudent valuation to all fair value positions. The difference between the prudent value and the fair value, called Additional Valuation Adjustment (AVA), is directly deducted from the Core Equity Tier 1 (CET1) capital. The Regulatory Technical Standards (RTS) for prudent valuation proposed by the EBA have been adopted by the EU (reg. 2016/101) on 28th Jan. 2016.
The 90% confidence level required by regulators for prudent valuation links quantiles of price distributions (exit prices) to capital, thus bridging the gap between the Pricing and Risk Management mainlands, and forcing the crossbreeding of the fair value and risk populations above.
In this seminar, we will explore the Prudent Valuation land.
The top five traditions at the University of Minnesota are: Ski-U-Mah, which is a Sioux battle cry combined with "U-Mah" representing the university that was incorporated into songs in 1884; the Gopher nickname which originated from a 1857 cartoon depicting politicians as gophers; the addition of "Golden" to the Gopher nickname in the 1930s when the football team wore gold uniforms; the Pride of Minnesota marching band which performs at every home football game and hosts an annual concert; and cheerleading which began when a student organized cheers at games in response to calls for more fan enthusiasm.
El documento habla sobre cómo las empresas pueden evitar la pérdida y desperdicio de alimentos a través de la responsabilidad social empresaria. Explica que los bancos de alimentos trabajan con empresas para recuperar sus excedentes y donarlos a personas de bajos recursos. También analiza las causas de la pérdida de alimentos y la importancia de que las empresas asuman una responsabilidad social para reducir el desperdicio y ayudar a los más necesitados.
WILLIAM RANKINE POWER TRAINING CENTRE, SOLAPURmanish shukla
This document provides information about a 20-day operational aspects of thermal power plant training program offered by the William Rankine Power Training Centre (WRPTC) for mechanical engineering students. The training aims to help students understand the theoretical and practical aspects of thermal power plants to enhance their job opportunities. It will cover topics like plant components, water treatment, fuel handling, boiler, turbine, alternator, instrumentation and controls. Students will be evaluated through written and oral exams and those who pass will be awarded a certificate. The fee for the training course is 1499 INR.
This is the analysis of the existing digipaks which I have researched and analysed. The digipaks which I have chosen are: Eminem (Recovery), Kanye West (My Beautiful Dark Twisted Fantasy) and 50 Cent (The Massacre).
Art Portfolio CJ Mobley Contemporary ArtistCJ Mobley Art
This document provides information on various artworks by contemporary artist CJ Mobley. It includes the titles, medium, and dimensions of 14 paintings. It notes that two of Mobley's paintings were featured in a TV series and movie. It also mentions that Mobley's artwork has been featured in LUXE Magazine and Texas Home & Living Magazine. The document provides contact information for Mobley and information on purchasing original artwork or prints.
This study examined the contribution of common genetic variants to obesity and related traits in Mexican populations. 26 obesity-associated variants were genotyped in over 1,000 Mexican adults. 6 variants were significantly associated with obesity risk after adjusting for covariates. 12 variants showing nominal obesity associations were further analyzed for associations with BMI and waist circumference in over 3,000 Mexican children and adults, as well as Indigenous Mexicans. Variants near FAIM2/BCDIN3, TMEM18, INSIG2, GNPDA2 and SEC16B/RASAL2 were associated with BMI and/or waist circumference. The FTO variant was associated with increased BMI in Indigenous Mexicans.
Introduction to Contemporary Politics - Parties and Democracy in Britain and ...Vanessa Yasmin Schneider
This brief overview to British and American government introduces the structure, party landscape, and individual power balances of the two countries. It was created for use in a student seminar.
SPIN! Resident Marketing Research Final Report 11-14Kathleen Coleman
The document discusses the benefits of exercise for mental health. Regular physical activity can help reduce anxiety and depression and improve mood and cognitive functioning. Exercise boosts blood flow and levels of neurotransmitters and endorphins which elevate and stabilize mood.
А. Васильев "Сколько стоит создание интернет-магазина"awgua
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The Validity of Company Valuation Using Dis.docxchristalgrieg
The Validity of Company Valuation
Using Discounted Cash Flow Methods
Florian Steiger
1
Seminar Paper
Fall 2008
Abstract
This paper closely examines theoretical and practical aspects of the widely used discounted
cash flows (DCF) valuation method. It assesses its potentials as well as several weaknesses. A
special emphasize is being put on the valuation of companies using the DCF method. The
paper finds that the discounted cash flow method is a powerful tool to analyze even complex
situations. However, the DCF method is subject to massive assumption bias and even slight
changes in the underlying assumptions of an analysis can drastically alter the valuation
results. A practical example of these implications is given using a scenario analysis.
____________
1
Author: Florian Steiger, European Business School, e-mail: [email protected]
Table of Contents
List of abbreviations ........................................................................................................... i
List of figures and tables ................................................................................................... ii
1 Introduction .................................................................................................................. 1
1.1 Problem Definition and Objective ...................................................................... 1
1.2 Course of the Investigation ................................................................................. 2
2 Company valuation ....................................................................................................... 2
2.1 General Goal and Use of Company Valuation ................................................... 2
2.2 Other Valuation Methods ................................................................................... 3
3 The Discounted Cash Flow Valuation Method ............................................................ 4
3.1 Approach of the Discounted Cash Flow Valuation ............................................ 4
3.2 Calculation of the Free Cash Flow ..................................................................... 5
3.2.1 Cash Flow to Firm and Cash Flow to Equity.................................................. 5
3.2.2 Building Future Scenarios .............................................................................. 6
3.3 The Weighted Average Cost of Capital ............................................................. 6
3.3.1 Cost of Equity ................................................................................................. 7
3.3.2 Cost of Debt .................................................................................................... 8
3.3.3 Summary ......................................................................................................... 9
3.4 Calculation of the Terminal Value ................................................... ...
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Bank of England's Ragveer Brar's debates prudent valuation challenges
1. 14 Autumn 2014
One lesson of the financial crisis is that the
value of financial instruments is not
necessarily what the owner states it to be,
even when it comes to relatively liquid
markets such as government bonds. In
fact, in many cases mismatches between assumed and
real value were extremely wide, and for some banks
poor valuation was a key element in their demise.
One of the first regulators to recognise the damage
caused by aggressive valuations was the UK Financial
Services Authority (FSA). In 2008 it wrote a letter to
firms outlining its concerns, which it followed up with
visits to 10 banks to assess product control functions.
In its 2011 report into the failure of RBS, the FSA uses
the word ‘valuation’ 114 times, for example saying that
the rival banks collateralised debt obligation valuations
were ‘significantly lower’ than those by RBS.
In 2012 the UK Financial Policy Committee
recommended that regulatory action be taken “to
ensure that the capital of UK banks and building
societies reflects a proper valuation of their assets, a
realistic assessment of future conduct costs and
prudent calculation of risk weights.”
Discussion paper
In the same month the European Banking Authority
(EBA) published a discussion paper on prudent
valuation, which led to a consultation and
quantitative impact study last year, and the
publication of final draft regulatory technical
standards in March of this year, under article 105 of
the Capital Requirements Regulation. Approval by
the European Parliament is expected in the coming
weeks, with implementation soon after.
“Historically the concept of prudence was central to
accounting, but what we found as regulators was that
both firms and auditors were often taking different
stances on the interpretation of accounting standards
that resulted in material valuation differences,” says
Ragveer Brar, who leads the Bank of England’s
valuation and controls team. “For example, we saw
significant variances in approach (e.g. numbers of
yield curve risk buckets used to represent the full
curve) for the calculation of the bid-offer reserves, and
New rules will set out exactly how banks must
adjust valuations of their fair valued financial
instruments, writes David Wigan.
Prudence defined
2012
In 2012 the UK Financial Policy
Committee recommended regulatory
action on banks’ valuations of their
assets.
2. PRUDENT VALUATION
Autumn 2014 15
anomalies like collateral disputes running into
hundreds of millions of dollars with signed off
accounts on both positions.”
The concept of prudent valuation relates to fair
value positions, defined by international accounting
standards, (such as IFRS 13) as “the price that would
be received to sell an asset or paid to transfer a
liability in an orderly transaction between market
participants at the measurement date.” This is
sometimes referred to as the ‘exit price’. Of course, in
the case of many illiquid securities the exit price is not
easy to guess, and in those circumstances the concept
of prudent valuation can be brought to bear.
Prudent valuation is also, in effect, the migration of
regulatory oversight into accounting and is justified in
that it aims to ensure that banks carry enough capital
to offset the risk of the fair value positions, with a
realistic level of accuracy.
“If a bank has a position valued at 50 and the
market is liquid such that the range of plausible
valuations is known to be somewhere between 49.9
and 50.1 or if the position is complex and the market
is illiquid such that the range of plausible valuations
may be somewhere between 20 and 80, then the
accounting representation of value is often largely the
same,” says Brar. “However from a risk and capital
adequacy perspective it makes an enormous
difference. Whereas accounting standards are looking
at best estimates, the regulatory perspective is much
more interested in downside risk.”
European regulation
Although UK authorities have been somewhat ahead
of their continental European counterparts on
requiring banks to consider prudent valuations, the
new European regulations are set to be meat on the
bones of the UK approach, which was subject to
complaints by UK banks over what they saw as an
uneven playing field, in some cases leading to lively
arguments with the regulator over the meaning of the
word ‘prudent’.
The areas that were the biggest contributors to
valuation uncertainty were market prices, close-out
costs, model risk and concentrated positions, and firms'
current prudent valuation adjustments are between
0.03% and 0.3% of the fair value balance sheet,
according to the Bank of England.
However, in completing their returns, some poor
practices were observed among UK banks, with for
example bid/offer spreads or historic Invoice Price
Variances used as a proxy for valuation uncertainty,
and only IFRS level 3 positions (unobservable inputs)
looked at in detail, rather than a broader range of
positions. There was also over-reliance on
consensus data, without recourse to alternative
pricing sources such as traded prices, broker quotes
and collateral information.
The European rules aim to put an end to those
doubts, setting out in detail how ‘prudent’ must be
defined and laying out specific rules on the
approaches banks must take to measure the value
of their fair valued financial instruments.
In simple terms the prudent valuation
adjustment is the amount by which available
capital would need to be adjusted if the downside
valuations were used instead of the fair values from
a firm’s financial statements.
How firms reach those additional valuation
adjustments (AVAs), however, depends on the size of
institutions, with firms whose fair value assets and
liabilities are below the €15bn threshold are permitted
to use a simplified approach, under which the
calculation of the required AVA is based on a
percentage of the aggregate absolute value of fair
valued positions held by the institution which
amounts to 0.1%.
Larger firms meanwhile must determine AVAs under
a core approach, with the following key features:
l Each AVA shall be calculated as the excess of
valuation adjustments required to achieve the
identified prudent value over any adjustments
applied in the institution’s fair value adjustment
that can be identified as addressing the same source
of valuation uncertainty as the AVA.
l Where possible, the prudent value of a position is
linked to a range of plausible values and a specified
target level of certainty of 90%. In practical terms,
this means that for market price uncertainty, close-out
costs and unearned credit spreads, institutions
are required to calculate the prudent value using
market data and the 90% certainty level.
l In all other cases, an expert-based approach is
specified, together with the key factors required to
be included in that approach. In these cases the
The prudent valuation requirements
pose considerable challenges to credit
institutions.
3. 16 Autumn 2014
90% target level of certainty is set for the calibration of the AVAs.
Valuation uncertainty
The EBA notes that for the majority of positions where there is valuation uncertainty, it is not possible to statistically achieve a specified level of certainty, but it says that specifying a target level is the most appropriate way to achieve greater consistency in the interpretation of a ‘prudent’ value.
Article 34 of the Capital Requirements Regulation requires institutions to deduct from Common Equity Tier 1 capital the aggregate AVA made for fair value assets and liabilities following the application of Article 105. A Quantitative Impact Study made in June 2013 by the EBA showed that on average the expected AVA would be equivalent to 1.5% of the Core Equity Tier 1 of institutions in absolute terms (on average €227m per institution), which is on average 0.07% of the value of fair valued positions on banks' balance sheets.
Perhaps not surprisingly the mood music emanating from the banking community in respect of prudent valuation has been less than enthusiastic, implying as it does lower valuations (and hence lower capital resources) through the requirement to explicitly include early termination costs, investing and funding costs and administrative expenses. Also implied is increased operational complexity and potentially a revaluation of fair value assets held in both the banking book and the trading book, both of which are covered by the rules.
Need for implementation
Banks approached for the purposes of this article declined to comment. However, with the European rules set to come into force in the coming months the time for debate has elapsed, and firms must now get on with the serious business of implementation.
One of the key differences between prudent valuation and other regulatory requirements is its often subjective nature. While market risk can be calculated using a model, valuation is often a matter of judgement within a prescribed framework, and that judgement can change from one month to the next.
“The prudent valuation requirements pose considerable challenges to credit institutions,” says Dr Andreas Werner, a partner at Frankfurt based consultancy d-fine, in a note. “The implementation is challenging as new measurement methods and business processes have to be developed and new market data sources have to be identified. Additionally, prudent valuation adjustments are pro- cyclical and may be significant with respect to tier one capital, thus posing challenges to risk management.”
Less liquid markets
One of the biggest challenges for market participants will be less liquid markets, and where firms are unable to present a specific level of price uncertainty there is a work out enabling them to explain to the regulator the approach they have adopted.
“Banks now have a quantitative definition of prudent at the 90th percentile, with an element of qualitative assessment because we recognise that in some cases there will be insufficient data,” says the Bank’s Brar.
An example of the challenges facing banks is the measurement of accounting for credit value adjustments, for which some firms currently value
Banks now have a quantitative definition of prudent at the 90th percentile.
March
The European Banking Authority published final draft regulatory technical standards on prudent valuation in March 2014.
4. PRUDENT VALUATION
17
Autumn 2014
counterparty risk based on historic data and others use market implied numbers from credit default swaps. Whereas this may be acceptable for accounting standards, it also generates uncertainty, which is anathema to the regulator. However, it’s not only complex assets and liabilities that represent challenges – finding firm prices can be just as challenging for vanilla securities such as bonds, particularly those that are less liquid, e.g. emerging market bonds.
Where models are used for valuation purposes, institutions are required to estimate a model risk adjustment for each model.
“It’s incumbent on banks to demonstrate their appreciation of the range of approaches available, so when it comes to modelling if there are 10 models in the market then the theoretical ideal may be to build each of the models and put your valuation through each and then reach the 90th percentile of certainty,” says Brar. “However, in drafting regulatory policy we have ensured sufficient balance in order to avoid an unduly burdensome approach that may place too much pressure on resources. Therefore we have pragmatically left open the option for an alternative approach based on an expert risk assessment of the valuation models that firms use, including an assessment of factors such as liquidity, level of standardisation and size of position to determine an appropriate prudent valuation adjustment.”
Standards vary
Currently valuation standards vary considerably between and within banks, Brar says. Examples of poor practice include firms relying unquestioningly on the same broker prices over a prolonged period, whereas at the other end of the spectrum some firms have developed systems that capture each market data point and reflect a hierarchy of sources. For the firms that have more work to do, operational changes may need to be accompanied by a change of culture, particularly in respect of the relationship between the front office and support functions.
“It is well known there have been concerns over front office dominance, and the ability at some banks of the control functions to challenge front office valuations. Now with firms having to report and justify their valuations to the regulator it is likely that the control functions will become more empowered to question the numbers coming from the front office and it is incumbent on firms to ensure that their control functions have the capacity and confidence to do that.”
US experience
As European banks ponder the implications of the new prudent valuation rules, other financial institutions may be forgiven for looking on with a smile, having been spared similar rules in their own jurisdictions. There is, for example, no equivalent to prudent valuation for fair value in the US.
However, there are rumours that some large US banks are voluntarily producing prudent valuation assessments for their global entities because they realise the advantage of having a better understanding of their valuation processes and the degree of valuation risk the firm is exposed to.
Global regulators are watching the European example closely. “There have been discussions with global regulators and some will be bringing in these rules,” Brar says. “Two years ago it was the UK, and shortly it will be across Europe, so there is a trend. There are clearly concerns at the highest levels around valuation issues, and it would not be a surprise if prudent valuation is adopted globally in due course.”
Measurement challenges
Compliance with prudential valuation obligations presents implementation challenges for banks that require new measurement methods, business processes and market data sources for hard to value and illiquid instruments.
“Over the past year we met with over 40 banks and regulators in Europe and initially everyone seemed focused on the most complex assets on the balance sheet,” says Leon Sinclair, director of evaluated pricing at Markit. “However, many underestimated the challenges and capital impact to their institutions when undergoing additional valuation adjustment (AVA) analysis for more liquid assets.
“We saw a sea change during the quantitative impact study in November, when anecdotally banks took between six and 10 weeks to complete the core approach. This was primarily due to the task of collecting data sets that hadn’t previously been part of Independent Price Verification/ Risk workflows.”
Banks must obtain all of the data they can access, both internal and external to satisfy the quantitative requirements of prudential valuation. For example, by acquiring the underlying raw data driving bond prices, customers can streamline the data collection process into their in-house methodologies while gaining access to statistics from institutional market markers.
Banks will need to demonstrate full transparency in their methodologies and range of inputs fuelling the underlying pricing data, as well as liquidity metrics.
Since the publication of the European Banking Authority Regulatory Technical Standards on prudential valuation in March some large European banks have lobbied over correlation and offset criteria, which they see as too punitive. The banks argue they could result in an uneven playing field between institutions subject to the rules and those outside the jurisdiction of the European regulators, says Sinclair.
Ragveer Brar, head of valuation and controls team, Bank of England