Monday, October 19, 2009

Valuing securities

The FT talks about the effect of a re-valuation of 'toxic assets' on on the profits of US banks in Q3.

“There were some assets that had lost too much value six months ago and investors are recognising that,” said Robert Smith, chief executive of Rangemark, which specialises in structured products. “Yet despite the rally, much of the collateral is broken and banks and investors are still holding a lot of securities that even now may not have been sufficiently marked down. Valuation methods are still oversimplified, which means risks may not be property assessed.”

It raises an important point about the valuation of assets. This is not just an issue for accounting (historic cost accounting against latest market price) but also one for valuation in general. Is it possible to fix one valuation on a financial asset. Even if we take a simple bond, the valuation will depend on the rate at which future cash flow is discounted and this rate is subject to uncertainty about inflation, liquidity and, particularly, risk. As the perception of risk changes, the value of the asset changes.

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