Required rate of return , Financial Management

Required Rate of Return (Ri

The required rate of return (Ri) is the minimum rate of return that a project must generate if it has to receive funds.  It’s thus the opportunity cost of capital or returns predictable from the second best option. In common,

Required Rate of Return = Risk-free rate + Risk premium

Risk free rate is compensation for time and is made up of the real rate of return (Rr) and the inflation premium (IRp). The risk premium is reimbursement for risk of financial actions exhibiting:

-    The riskiness of securities caused by term to maturity
-    The security liquidity and marketability
-    The consequence of exchange rate fluctuations on the security, and so on.

The requisite rate of return can hence be expressed as follows:

Rj = Rr +IRp +DRp +MRp + LRp + ERp + SRp + ORp.

Where:

1) Rr is the actual rate of return which compensates investors for giving up the utilization of their finances in inflation free and risk free market.

2) IRp is the Inflation Risk Premium that compensates the investor for the reduction in purchasing power of capital caused by inflation.

3) DRp is the Default Risk Premium that compensates the investor for the possibility that users of finances would be unable to pay back the debts.

4) MRp is the Maturity Risk Premium that compensates for the term to maturity.

5) LRp is the Liquidity Risk Premium that compensates the investor for the option that the securities given are not simply marketable (or convertible to cash).
6) ERp is the Exchange Risk Premium that compensates the investors for the fluctuation in exchange rate. This is mostly significant when the funds are denominated in foreign currencies.

7) SRp is the Sovereign Risk Premium that compensates the investors for the option of political instability in the country in which the funds have been given.

8) ORp is the Other Risk Premium example, the kind of product, the type of market, and so on.

Posted Date: 12/8/2012 6:13:34 AM | Location : United States







Related Discussions:- Required rate of return , Assignment Help, Ask Question on Required rate of return , Get Answer, Expert's Help, Required rate of return Discussions

Write discussion on Required rate of return
Your posts are moderated
Related Questions
What are the Financing and investing decision Financing and investing decisions are closely related as the company is going toraise money to invest in a project or assets. Thos

ICEQ'sgo beyond ICQ's Discover whether error or fraud is possible. Concentrates on significant frauds or errors which might be possible and so only a handful of key con

Q. Accounting Change? Accounting Change - Change in (1) an accounting principle (2) an accounting estimate or (3)the reporting entity which necessitates DISCLOSURE and explan

What are the advantages and the disadvantages of a new stock issue? A new stock issue increases funds and reduces the riskiness of the firm. It as well tends to send a negative

What is Financial Management? Anybody can describe it.

X & Y is desirous to purchase a business and has consulted you, and one point on which you are asked to advice them, is the average amount of working capital which will be required

A vailable bid capacity We saw the criterion that qualifies the bidder. Now we will learn about the bid capacity. There are chances that a bidder might acquire more contrac

who are the participants in the hedge funds industries

Q. Cost of Equity Share Capital? Cost of Equity Share Capital: - The cost of equity is the utmost rate of return that the company should earn on equity financed position of its

Explain and derive the international Fisher effect. Answer:  The international Fisher effect can be acquired by combining the Fisher effect and the relative version of purchasi