Question

You have been hired as Risk Consultant at a U.S.-based bank. 

The bank is currently reporting its financials using the book value accounting method. The bank is considering an international move in which it can switch to the market value accounting method.

You have been asked to write a 3-page report for the bank`s management. The report should discuss the following:

What is the difference between book value accounting and market value accounting? 

How do interest rate changes affect the value of bank assets and liabilities under the two methods? Provide an example that supports your position on this.

What is marking to market?

Answer 1

1. Difference Between Book Value and Market Value Accounting.

Book Value Accounting means recording transactions on their Historical Cost and Showing it on its book values in coming years.

Market Value Accounting means recording transactions on the basis of its market price or it realizable value.

For Example if we purchased machine at cost of 2000/- and depretiation is 20/- its book value will be 1980/- and same shall be accounted as per Book value accounting, however if its selling price is 2040/- in market then it shall be market value of that machine.

Book Value shows actual worth of any particular assets or company, However market value shows Highest estimated value of any particular Assets or Company.

2. How Interest rate affects value of Assets and Liability?

When Interest Rate increase the liability increases because you have to pay more amount against the amount borrowed as loan or whatever, also when interest rate are much higher one start paying same because it becomes too costlier to keep loans and pay interest as a result they dispose off Assets to pay off debts and hence interest rate effects Assets and Liabilities.

3. What is marking to market?

It refers to daily checking what is the price of particular product or security and recording it on same amount and booking loss and gains based on market price.