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
Determine the amounts to be recognised in profit or loss and in other comprehensive income in respect of the property for the year ended 31 December 2010.   Evaluate the compliance

The Federal Minister for the Environment is worried about the Greenhouse Effect, one outcome of which would be that Adelaide would have a subtropical climate by the year 2015. This

Q. Show objections against profit maximization? 1) Profit cannot be ascertained well in advance to express the. Probability of return as future is Uncertain. It is not at all p

SUGGESTION REGARDING CREDIT LIMIT. SHOULD IT BE APPROVED OR NOT, WHAT SHOULD BE THE AMOUNT OF CREDIT LIMIT THAT ELECTRONICS GIVE TO BOOTH PLASTICS

Determine the method of Credit Rating It is obligatory for the issuing companies to get credit rating done on debt securities issues. Credit ratings are also required for Comme

You have $21 to spend on prawns and potatoes. Prawns cost $20 per kilo and potatoes cost $2 per kilo.   (a) Supposing you can buy as much or as little as you want of prawns and

Non-traditional mortgages also referred to as Alternative Mortgage Instruments (AMIs), do not have level monthly payments, but employ some other structure of payment.

Net Income approach says that a raise in the proportion of debt financing in capital structure results in an increase in the proportion of a cheaper source of funds. This in turn r

The effective maturity of a callable bond can be anywhere between the first call date and its maturity date due to the presence of the call feat

Convertible bonds can be classified into different types such as callable bonds and puttable bonds. These bonds are discussed as follows: Basics of Callable Bonds A callabl