Hi, In Q&A Bank 7.1 (iii) as part of the valuation of a company there is an adjustment for capital calculation. This refers to capital tied up within the company (e.g. MCR, prudence in the reserves). Can you explain how and why this adjustment is made? (We have already calculated the realistic NAV which should already adjust for any margins in the reserves) Also: how is it possible to have a different risk discount rate to the interest earned? In Q&A Bank 7.2 (i) the same question only mentions cat reserves, claims equalisation reserves and asset mismatch reserves. Again, how and why is this adjustment made? Many thanks!
The adjustment for capital calculation can be included if it's thought that the company is going to need extra cash to cope with other things (in question 1, it mentions this may be for statutory purposes, but in question 2, more specific examples are given, such as cats and equalisation reserves - but any suitable examples would do). The adjustment is made because you'd be less willing to pay as much for a company that needs a lot of 'extra' financial help to run its business (unless you're happy to allow for this as part of higher expected returns). The risk discount rate is not the same as the interest earned. Interest earned is that expected to be earned on those assets backing reserves. Risk discount rates are used to discount future cashflows (often for pricing purposes, for example), and will reflect risk and shareholder expectations. The two are related (by the economy), but not necessarily the same. Hope this helps!
Could well be, but given Solvency II is far from finalised, I'd be tempted to talk in generalities in the exam.
