The Daily Technical #122: If the Fed wants to increase rates, what can it do?

Good morning. Welcome to the 122nd edition of The Daily Technical.

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OVERVIEW OF YESTERDAY’S QUESTION
If the share price of a company increases by 10%, what is the balance sheet impact?

There would be no change on the balance sheet as shareholders’ equity reflects the book value of equity.

Equity value, also known as the "market capitalization," represents the value of a company’s equity based on supply and demand in the open market. In contrast, the book value of equity is the initial historical amount shown on the balance sheet for accounting purposes.

This represents the company's residual value belonging to equity shareholders once all of its assets are liquidated and liabilities are paid off.

Book Value of Equity = Total Assets – Total Liabilities

The equity value recorded on the books will be significantly understated from the market value in most cases.

Common Mistakes

1. Assuming market fluctuations impact the balance sheet directly. Remember, market value represents live trading prices and doesn't alter the reported book value of equity on the balance sheet. Clearly differentiate between market and book values to avoid this confusion.

2. Mistaking shareholder’s equity changes when share prices increase. Equity is recorded at its historical cost, not its current market value. Always connect shareholder’s equity to the company's original investment values.

3. Ignoring that balance sheets are static at a point in time. They don't instantly adjust to live market conditions. Emphasize that a balance sheet snapshot represents specific historical points.

TL;DR

• Balance sheet remains unchanged with a 10% share price increase.

• Balance sheet shows book value of equity, reflecting historical values.

• Market capitalization, not reflected on the balance sheet, fluctuates with market conditions.

• Book value is Total Assets minus Total Liabilities, typically lower than market cap.

TODAY’S QUESTION
If the Fed wants to increase rates, what can it do?

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