Saturday, April 4, 2009

Discussion of the Week - Financial Pricing Assumptions

This past weekend, we covered a case on pricing equities in FinMgmt. The core of the case was to highlight the various "Cost of Capital" elements and assumptions can create variability in pricing between analysts. How to determine an appropriate Risk-Free rate? How to determine the Cost of Debt?

An interesting side discussion came up from a classmate that works in the financial service industry (one of the remaining banks). He talked about how some of the banks were starting to dissect the algorithms and assumptions that are embedded in the planning software used by other banks (from IT vendors, not proprietary software). They were beginning to use that knowledge to create prediction models for how they would reacted to market conditions and use that to influence their strategy.

It creates an interesting dilemma for financial services. Do you incur the costs to develop your own software and models but give up the time-to-market, or use 3rd-party tools and software in exchange for faster availability? Where can the competitive advantage be gained, or lost?

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