Prudential Regulation Authority Rulebook

9.1

A risk-adjusted yield on an asset must be calculated by:

1. (1) taking the asset together with any covering derivatives, forward transactions and quasi-derivatives;
2. (2) assuming that the factors which affect the yield will remain unchanged after the valuation date;
3. (3) valuing the asset (together with any offsetting transaction) in accordance with Insurance Company – Overall Resources and Valuation 3 to 8;
4. (4) making reasonable assumptions as to whether, and if so when, any options or other rights embedded in the asset (or in any offsetting transaction) will be exercised.

9.2

For the purpose of 9.1(2), the factors that affect yield should be ascertained as at the valuation date (that is, the date to which present values of cash flows are being calculated). All changes known to have occurred by that date must be taken into account including:

1. (1) changes in the rental income from real estate;
2. (2) changes in dividends or audited profit on equities;
3. (3) known or forecast changes in dividends which have been publicly announced by the issuer by the valuation date;
4. (4) known or forecast changes in earnings which have been publicly announced by the issuer by the valuation date;
5. (5) alterations in capital structure; and
6. (6) the value (at the most recent date at or before the valuation date for which it is known) of any determinant of the amount of any future interest or capital payment.

9.3

The risk-adjusted yield is either:

1. (1) for equities and real estate, a running yield; or
2. (2) for all other assets, the internal rate of return.

9.4

The risk-adjusted yield on a basket of assets is the arithmetic mean of the risk-adjusted yield on each asset weighted by that asset's market value.

9.5

The running yield:

1. (1) for real estate, is the ratio of:
1. (a) the rental income arising from the real estate over the previous 12 months; to
2. (b) the market value of the real estate.
2. (2) for equities, is:
1. (a) the dividend yield, if the dividend yield is more than the earnings yield;
2. (b) otherwise, the sum of the dividend yield and the earnings yield, divided by two.

9.6

For the purposes of 9.5(2):

1. (1) the dividend yield is the ratio (expressed as a percentage) of dividend income over the previous 12 months from the equities for which the running yield is being calculated ("the relevant equities") to the market value of those equities;
2. (2) the earnings yield is the ratio (expressed as a percentage) of the audited profit (including exceptional items and extraordinary items) for the preceding financial year of the issuer of the relevant equities to the market value of those equities;
3. (3) the earnings yield must be calculated in accordance with whichever is most appropriate (to the issuer of the relevant equities) of UK, US or international generally accepted accounting practice.

9.7

The internal rate of return on an asset is the annual rate of interest which, if used to calculate the present value of future income (before deduction of tax) and of repayments of capital (before deduction of tax) would result in the sum of those amounts being equal to the market value of the asset.

9.8

In both the running yield and internal rate of return the yield must be reduced to exclude that part of the yield that represents compensation for credit risk arising from the asset.

9.9

Provision for credit risk for securities that are not credit-rated must be made on principles at least as prudent as those adopted for credit-rated securities.