Required rate of return , Financial Management

Assignment Help:

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.


Related Discussions:- Required rate of return

Blade inc case study, what are the advantages blades could gain from import...

what are the advantages blades could gain from importing or exporting to a foreign country such azs thailand?

Define how forecast the exchange rate, As of November 1, 1999, the exchange...

As of November 1, 1999, the exchange rate in between the Brazilian real and U.S. dollar is R$1.95/$. The agreement forecast for the U.S. and Brazil inflation rates for the next 1-y

Operating cycle, discuss the applicability of operating cycle in poultry in...

discuss the applicability of operating cycle in poultry industry

Difference among currency forward market and futures market, Explain the ba...

Explain the basic differences between the operation of a currency forward market and a futures market. Answer:  The forward market is an OTC market in which the forward contract

What is commercial papers, Q. What is Commercial Papers? Commercial Pap...

Q. What is Commercial Papers? Commercial Papers: Commercial papers (CPs) are short-term, unsecured securities issued by highly creditworthy large companies. They are issued wit

Explain dual currency bond, Explain Dual Currency Bond A dual currency ...

Explain Dual Currency Bond A dual currency bond is a straight fixed-rate bond that is issued in one currency and pays coupon interest in that similar currency.  At maturity, th

What is the cash flows from financing activities, Cash flows from financing...

Cash flows from financing activities: Items included in this heading are: Cash receipts Cash payments Cash  receipts  from  iss

Inventory is sometimes thought of as a necessary evil, Inventory is sometim...

Inventory is sometimes thought of as a necessary evil.  Explain. Inventory ties up funds and these funds aren't earning an unambiguous return.  Some inventory is habitually nec

Time series analysis, In Time Series Analysis, we try to identify and deter...

In Time Series Analysis, we try to identify and determine the pattern of changes in the data collected over regular intervals of time. The data collected can be at a periodical int

Trading Options, TRADING IN OPTIONS We have already seen that options a...

TRADING IN OPTIONS We have already seen that options are traded on exchanges and have already discussed how to understand published quotations. Let us now learn the trading mec

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd