Liabilities and Equity ppt

[...]... on equity of e-Bank: ROE = profit after tax /equity For simplicity, we can visualize profit after tax and equity as two pies (Figure 4.1) The pies are divided into pieces which represent the allocated amount of profit or equity to a particular business unit For instance, the profit after tax allocated to business A is 2, while the amount of equity allocated to business A is 10 With these profit and equity. .. interbank deposits and shareholders’ equity ➨ Banks invest in five major assets: reserves with the central bank, loans, interbank loans, bonds and fixed assets ➨ The asset liability committee (ALCO) controls profit and risks It includes the president and the heads of business units, such as retail, corporate and treasury 4 > 2 stage VA L U E C R E AT I O N F O R S HAR E HOLDE RS 2 1 5 ASSET AND LIABILITY... value is created when the market value of shares exceeds the equity invested ➨ The cost of equity is the minimum return demanded by shareholders ➨ Cost of equity = risk-free rate on bonds + risk premium ➨ Value is created when ROE > cost of equity E X E R C I S E S TAG E T WO Consider a bank with an initial equity of 100, an ROE of 10%, and a life of three years The profit is paid every year as a dividend... 500 300 230 30 ––––– 1100 Liabilities and shareholders’ equity Deposits 800 Interbank deposits 200 Equity Total 100 ––––– 1100 You will notice that the equity of a commercial bank is a small part of the sources of funds, while the fixed assets (buildings and equipment, computers) are a small part of total assets A large part of the funds are deposits collected from customers and/ or money borrowed from... unit and its cost of equity: EVA = allocated profit after tax – cost of allocated equity = allocated profit after tax – (allocated equity × cost of equity) For instance, the EVA of profit centre A is: EVA = 2 – (15% × 10) = 0.5 Economic profit or EVA simply reminds managers that the creation of value does not only require a positive profit It also demands a profit exceeding the cost of allocated equity, ... very low equity allocation in order to improve your RAROC or EVA The fair allocation of profit and equity to a particular profit centre is a major issue, which will be discussed in the following stages KEY POI NTS ➨ ➨ RAROC = allocated profit after tax/allocated equity ➨ Golden rule for value creation: RAROC > cost of equity ➨ EVA = allocated profit after tax – (allocated equity ¥ cost of equity) ➨... rate, the cost of equity 10 > 3 stage ROE B R EAKDOWN 3 2 1 11 ASSET AND LIABILITY MANAGEMENT As we noticed in Stage 2, the value of shares will be affected by the future profitability and return on equity of e-Bank A large ROE is likely to lead to a higher valuation As the chief financial officer of e-Bank, you want to understand what are the major economic drivers of the return on equity To analyze... management and action committee) Although the tasks involved – profit and risk control – are not new, the allocation of information, responsibility and accountability to the very senior management is a more recent phenomenon, imposed by the central bank in some countries As deregulation and competition are reducing margins around the world, the need for more precise information and a complete asset and liability... after tax of the corporate banking division is $4 million An equity of $20 million has been allocated to this profit centre Compute the RAROC, the cost of equity and the EVA knowing that the risk-free rate on government bonds is 10% and that the market demands a risk premium of 5% on bank shares Please calculate: RAROC = ––––– = Cost of equity = + = EVA = – ( × ) = Golden... annual profit after tax of $10.8 million, paid every year as a dividend The return on equity (ROE = profit /equity = 10.8/100) of e-Bank is 10.8% To simplify the example and avoid unnecessary mathematics, imagine that the bank is closed after three years, and that investors, your sister included, recover their initial equity investment of $100 million The timing of the dividends accruing to investors . Alexandre, Augustin and Juliette > To Hoda and Joanna v > ABOUT THE AUTHORS Jean Dermine is Professor of Banking and Finance at INSEAD, Fontainebleau. With more than 20 years of research and. sources of funds (liabilities and shareholders’ equity) and the uses of funds (assets). The simplified balance sheet presented here will be the one used throughout the book. ASSET AND LIABILITY MANAGEMENT 2 Balance. banking research and training of bankers in Europe, the Americas, Africa and Asia. As deregulation and competition are reducing margins around the world, the need for knowledge on Asset and Liability