Value Financial Firms Essay

14744 Words Aug 2nd, 2012 59 Pages
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CHAPTER 21 VALUING FINANCIAL SERVICE FIRMS
Banks, insurance companies and other financial service firms pose particular challenges for an analyst attempting to value them for two reasons. The first is the nature of their businesses makes it difficult to define both debt and reinvestment, making the estimation of cash flows much more difficult. The other is that they tend to be heavily regulated and the effects of regulatory requirements on value have to be considered. In this chapter, we begin by considering what makes financial service firms unique and ways of dealing with the differences. We then look at how best we can adapt discounted cash flow models to value financial service firms and look at three alternatives – a traditional
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An investment bank provides advice and supporting products for other firms to raise capital from financial markets or to consummate deals such as acquisitions or divestitures. Investment firms provide investment advice or manage portfolios for clients.

2 Their income comes from advisory fees for the advice and management and sales fees for investment portfolios. With the consolidation in the financial services sector, an increasing number of firms operate in more than one of these businesses. For example, Citigroup, created by the merger of Travelers and Citicorp operates in all four businesses. At the same time, however, there remain a large number of small banks, boutique investment banks and specialized insurance firms that still derive the bulk of their income from one source. How big is the financial services sector in the United States? Figure 21.1 summarizes the number of publicly traded banks, insurance companies, brokerage houses, investment firms and thrifts in the United States at the end of 2000.
Figure 21.1: Financial Service Firms 250

200

Number of firms

150

100

50

0 Banks Insurance Companies Investment Companies Category Investment banks & Security Brokers Thrift

Even more striking than the sheer number of financial service firms is their diversity in terms of size and growth. Table 21.1 provides a measure of the range on each measure across different sectors.

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