Business, Legal & Accounting Glossary
In financial economics, a financial institution acts as an agent that provides financial services for its clients or members. Financial institutions generally fall under financial regulation from a government authority. Common types of financial institutions include banks, building societies, credit unions, stock brokerages, asset management firms, and similar businesses.
Financial institutions provide service as intermediaries of the capital and debt markets. They are responsible for transferring funds from investors to companies, in need of those funds. The presence of financial institutions facilitates the flow of money through the economy. To do so, savings are pooled to mitigate the risk brought to provide funds for loans. Such is the primary means for depository institutions to develop revenue. Should the yield curve become inverse, firms in this arena will offer additional fee-generating services including securities underwriting, and prime brokerage.
Use Equity Multiples (as opposed to Enterprise Multiples). In order to consider how valuing a Financial Institution’s balance sheet is different from a non-Financial firm. Consider how an industrials firm wields capital machinery (asset) and the loans (liabilities) is used to finance that asset. The line is blurred in Financial Institutions, which must hold deposit accounts (liabilities) to fuel the issuance of loans (assets). The same accounts are considered loans as they are held in ownership not of the bank, but of the individual client.
Dividend Discount Model: Earnings-per-share
Discounted Cash Flow (DCF) Model: You’ll need the FCFE (Free Cash Flow for Equity), which is the amount of money that is returned to shareholders. Calculate an FCFF (Free Cash Flow to the Firm): EBIT (1-tax rate) -Capital Expenditures+ (Depreciation & Amortization) – (Net increase in working capital)= FCFF
Use the Capital Asset Pricing Model, not the Weighted Average Cost of Capital (for the same reasons one uses Equity Multiples in relative valuation) to determine the cost of equity (the return required by shareholders in order to make the decision to invest in a financial institutions)
Excess Return Model: A model where valuation is expressed as the sum of capital invested currently in the firm and the present value of dollar excess returns that the firm expects to make in the future.
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This glossary post was last updated: 1st May, 2020 | 7 Views.