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Key Topics
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Introduction
Financial institutions
Maximize the value of the shareholders wealth at an acceptable level of
risk
Must continually be on the lookout for new opportunities for revenue
growth, greater efficiency, and more effective planning and control
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Evaluating Performance
Performance must be directed toward specific objectives
A key objective is to maximize the value of the firm
The value of the financial firms stock will tend to rise in any of the
following situations
1.
2.
3.
4.
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Bank Management and Financial Services, 7/e
Example 1
An investor holds the stock of RGV Bank and expects to receive
a dividend of $4.75 per share at the end of the year. Stock
analysts recently predicted that the banks dividends will grow
at approximately 3% a year indefinitely into the future. If this is
true, and if the appropriate risk-adjusted cost of capital
(discount rate) for the bank is 14%, what should be the current
price per share of RGV Banks stock?
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Example 2
Suppose that stockbrokers have projected that RGV Bank will pay
a dividend of $2.50 per share on its common stock at the end of the
year; a dividend of $3.25 per share is expected for the next year,
and $4.00 per share in the following two years. The risk-adjusted
cost of capital for banks in RGV Banks risk class is 15%. If an
investor holding RGV Banks stock plans to hold that stock for
only 4 years and hopes to sell it at a price of $50 per share, what
should the value of the banks stock be in todays market?
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
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Bank Management and Financial Services, 7/e
Earnings Spread
Another traditional measure of earnings efficiency
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Example 3
Suppose a bank reports that its net income for the current year is
$51 million, its assets total $1,144 million, and its liabilities amount
to $926 million. What is return on assets? What is return on equity
capital?
ROA?
ROE?
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Example 4
Suppose a banker tells you that his bank in the year just completed
had total interest expenses on all borrowings of $12 million and
noninterest expenses of $5 million, while interest income from
earning assets totaled $16 million and noninterest revenues totaled
$2 million. Suppose further that assets amounted to $480 million, of
which earning assets represented 85% of that total while total
interest-bearing liabilities amounted to 75% of total assets.
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
ROE ROA
Useful Profitability Formulas for Banks and Other FinancialService Companies
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
or
where
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Bank Management and Financial Services, 7/e
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Bank Management and Financial Services, 7/e
or
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Bank Management and Financial Services, 7/e
Components of ROA
We can also divide a financial firms return on assets into its
component parts
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
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Bank Management and Financial Services, 7/e
Superior Profitability
Achieving superior profitability for a financial institution
depends upon several crucial factors:
1.
2.
3.
4.
5.
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Risk Measures
Risk to the manager of a financial institution or to a
regulator supervising financial institutions means:
The perceived uncertainty associated with a particular event
Price Risk: the probability or possibility that the value of bond portfolios and stockholders
equity may decline due to market prices movement against the financial firm.
Interest-Rate Risk: the possibility or probability that the interest rates will change, subjecting the
bank to incur a lower margin of profit or a lower value for the firms capital.
Foreign Exchange and Sovereign Risk: the uncertainty that due to fluctuation
in currency prices, assets denominated in foreign currencies may fall, forcing
the write-down of these assets on its Balance Sheet.
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Measuring Risk
1. Credit Risk
2. Liquidity Risk:
4. Price Risk:
5. Capital Risk:
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e
Example 5
A bank reports that the total amount of its net loans and leases
outstanding is $936 million, its assets total $1,324 million, its equity
capital amounts to $110 million, and it holds $1,150 million in
deposits, all expressed in book value. The estimated market values
of the bank's total assets and equity capital are $1,443 million and
$130 million, respectively. The bank's stock is currently valued at
$60 per share with annual per-share earnings of $2.50. Uninsured
deposits amount to $243 million and money-market borrowings
total $132 million, while nonperforming loans currently amount to
$43 million and the bank just charged off $21 million in loans.
Calculate as many of the risk measures as you can from the
foregoing data.
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Bank Management and Financial Services, 7/e
Other Goals
Other Goals in Banking and Financial-Services Management
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Bank Management and Financial Services, 7/e
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Bank Management and Financial Services, 7/e
Recap Q&As
What individuals or groups are likely to be interested in the banks
level of profitability and exposure to risk?
What are the principal components of ROE, and what does each of the
these components measure?
What are the most important components of ROA and what aspects of
a financial institutions performance do they reflect?
Why do the managers of financial firms often pay close attention today
to the net interest margin and noninterest margin? To the earnings
spread?
To what different kinds of risk are banks and their financial-service
competitors subjected today?
What items on a banks balance sheet and income statement can be
used to measure its risk exposure? To what other financial institutions
do these risk measures seem to apply?
McGraw-Hill/Irwin
Bank Management and Financial Services, 7/e