Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Solution to Stage Two

1:

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 plus a closing dividend of 110 at the end of three years. Compute the market value and value creation for the cases when the market discounts are at 12%, 10% and 8%.   Year 1 Year 2 Year 3 Cash flow accruing to investors 10 10 110 Managerial lesson To create value, the ROE must exceed the market discount rate, the cost of equity.