Abstract
This chapter examines in particular the valuation of banks which can be classified into five parts. It introduces several valuation approaches to find out whether there is a superior method. This chapter starts with a description of bank regulations and their impact on bank valuations and continues with an overview of valuation approaches. The second part applies the banking sector decision Models. The third section shows banking sector valuation models. The fourth part presents the input factors that are needed to value a company. In the last part, financial statements have been used to analyze the main ratios of the Bank of America, and the calculated values were then compared over time (2014-2018) to assess the explanatory power of the bank.
TopBanking Sector Decision Models (Literature Review)
This part of the chapter examines some previous studies about the theories and their decision models in valuation of banking sector.
Although the Basel Accord regulation defines the lower limit of the Capital Adequacy Ratio, national banks may determine higher ratios for example for systemic relevant banks. The risk-weighted assets RWAs and the tier one and tier two capital are then used to calculate the capital adequacy ratio (CAR) (“Reserve Bank of New Zealand, 2007”).
Key Terms in this Chapter
Discounted Cash Flow: Is a valuation technique used to estimate the attractiveness of an investment opportunity.
Residual Income: Is the amount of income the individual has after paying all personal debts and expenses such as mortgages that have been repaid.
Return on Equity (ROE): Is the net income attributable to the equity ratio. The ROE estimates the profitability of the business by showing the amount of profits the company generates with the money invested by the shareholders.
Capital Adequacy: Is the ratio of the Bank's capital to its risk. It is a term that shows the relationship between the Bank's sources of capital and the risks surrounding the Bank's assets and any other operations.
Profitability Ratios: Is a measure of the financial metrics used to assess a company's ability to make profits that are comparable to its expenses and related costs over a given time period.
Financial Analysis: Financial analysis is a process aimed at assessing ways of investing and employing money in companies. It is a study of the financial information of a particular enterprise or project in order to understand cash flows, profits, and expenditures.
Intrinsic Value: The intrinsic value is the actual value of the business or an asset based on a basic perception of its true value including all aspects of the business in terms of both tangible and intangible factors.
Return on Assets (ROA): Is a measure of the profitability of a company relative to its total assets. The return on assets gives an idea of the management's efficiency in using its assets for profit.
Liquidity Ratios: Liquidity is defined as the ability of the Company to obtain cash and liquidity ratios measure the ability to repay obligations when they fall due.
The Capital Asset Pricing Model: (CAPM), identifies stock risk by knowing the sensitivity of the return of the security and comparing it to the change in market returns.