The Importance Of Book Value And Market Value

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There are two main ways that a bank can be classified as insolvent. The first is if the worth of the bank 's assets and less that the worth of the bank 's liabilities. The second is if the bank cannot pay its debts, even if the bank 's assets are worth more than their liabilities, this is then a problem with the bank 's liquidity.
When analyzing the profitability or worth of a bank, book value is commonly used to understand the net worth of all the assets and liabilities that a bank holds on its balance sheet. However, there is one main issue that comes from using its book value as an accounting measure, which is the difference between book value and market value. The market value of the asset or liability is essentially what people are willing to buy that asset or liability from you in the current market, whereas the book value is the fair value, this is where differences can occur and can lead to a bank becoming economically insolvent even when the book value of its net
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Likewise, the liabilities also reflect their historic cost, so that the equity of the FI is the book value of the stockholders’ claims instead of the market value of those claims. So if a FI uses the book value concept, invariably, this value does not equal the market value of equity which is the difference between the market value of assets and liabilities. This inequality between book and market values of equity leads to false impressions of the true state of their balance sheet when examining the effects of credit and interest rate shocks on a FI and interpreting their position of being economically solvent with a positive net worth when in actuality this can be quite the

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