Economic value added and Liquidity Coverage Ratio: Difference between pages

From ACT Wiki
(Difference between pages)
Jump to navigationJump to search
imported>Administrator
(CSV import)
 
imported>Doug Williamson
(Amend link.)
 
Line 1: Line 1:
(EVA).
''Bank regulation''.
1.
The periodic addition to shareholder value resulting from the efficient management and allocation of a firm's resources.


EVA can be quantified at a whole-firm level as:
(LCR).
EVA = [Return on book capital LESS Market cost of capital] x Book capital.


Taking a simplified example, for an all-equity financed firm with a market capitalisation (P<sub>0</sub>) of $130m, book value of equity $100m, and annual after tax returns of $13m.
The LCR is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its net cash requirements over 30 days.  


[To keep the illustration simple, we will assume no growth, in other words the whole of the annual after tax returns of $13m are paid out as dividends (D<sub>1</sub>).]
It applies throughout the European Union.


Return on book capital = 13/100 = 13%.
The LCR has been implemented in stages from 2015, to reach the 100% requirement by January 2019.  
Market cost of capital = 13/130 = 10%
(Using Ke = D<sub>1</sub>/P<sub>0</sub>).
EVA = [13% - 10% = 3%] x $100m = $3m.


''In practice a number of adjustments would be made both to the market values and to the book values used in the calculation of the EVA. So the application of EVA analysis is both more complicated, and arguably more subjective, than the simple calculation illustrated above.''


Turning back for now to our simple example, EVA is also closely related to Market value added (MVA).  MVA is the total present value of the expected EVA in the current and future periods.
It reduces the value to a bank of cash deposits of less than 30 days tenor because they are only worth the income on the HQLAs if a bank forecasts no short term cash receipts to cover repayment.  


For example in this case it is a simple fixed perpetuity of $3m, which is evaluated using the simple fixed perpetuity formula 1/r at the market cost of capital 10%:
The purpose of this requirement is to ensure that banks can manage stressed market conditions, under which the bank is assumed to suffer substantial outflows of the cash previously deposited with it.
MVA = $3m/0.10 = $30m.


2.
It is also possible to calculate and analyse EVA at the individual project level.
In simple terms, EVA is positive when the project Internal rate of return exceeds the (appropriately risk-adjusted) Weighted average cost of capital.
A simple decision rule when using EVA at the project level is to reject all negative EVA projects.
Positive EVA projects would be considered further.
The important insight from EVA analysis is that a project or division is <u>destructive</u> of shareholder value when its returns are inferior to the relevant economic cost of capital, even if it appears to be profitable when measured on an accounting basis (for example on an Earnings per share basis).


== See also ==
== See also ==
* [[Book value]]
* [[Basel III]]
* [[Cost of capital]]
* [[European Union]]
* [[Earnings per share]]
* [[Net Stable Funding Ratio]]
* [[Excess Return]]
* [[Cash investing in a new world]]
* [[Market value added]]
* [[HQLA]]
* [[Return on capital employed]]
* [[Level 1 liquid assets]]
* [[Shareholder value]]
* [[Level 2 liquid assets]]
* [[Wealth Added Index]]
* [[Leverage Ratio]]
* [[Liquidity buffer]]
* [[Liquidity risk]]
* [[LR]]
* [[OLAR]]
* [[Pillar 1]]
* [[Required Stable Funding]]
* [[Survival period]]


[[Category:Compliance_and_audit]]
[[Category:Liquidity_management]]

Revision as of 11:55, 17 November 2016

Bank regulation.

(LCR).

The LCR is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its net cash requirements over 30 days.

It applies throughout the European Union.

The LCR has been implemented in stages from 2015, to reach the 100% requirement by January 2019.


It reduces the value to a bank of cash deposits of less than 30 days tenor because they are only worth the income on the HQLAs if a bank forecasts no short term cash receipts to cover repayment.

The purpose of this requirement is to ensure that banks can manage stressed market conditions, under which the bank is assumed to suffer substantial outflows of the cash previously deposited with it.


See also