After studying this chapter, you should be able to:
A few years ago, a bank reported an $87.3 million write-down on its mortgage-backed securities for the third quarter of 2008. However, the bank stated that it expected its actual losses to be only $44,000. The loss of $44,000 was equal to a modest loss on a condo foreclosure. The bank's regulator found “the accounting result absurd.” And the bank regulator was right, as the bank, in the third quarter of 2009, raised its credit-loss estimate by $263.1 million, quite a difference from its original loss estimate of $44,000.
The discussion above highlights the challenge of valuing financial assets such as loans, derivatives, and other debt investments. The fundamental question that arose out of the example above and, more significantly, the recent financial ...