Determinants of required rate of return, Finance Basics

Assignment Help:

Determinants of Required Rate of Return

1.Risk free rate - This is the interest rate such would exist on default free securities like Treasury bills and bonds.

Risk free rate is made up of two components like:

  1. Real rate of return -if there was no inflation, interest rate
  2. Inflation premium

Therefore risk free rate (RF) = Real rate of return + Inflation premium.

If risk premium is added to risk free rate, necessary rate of return is derived. Hence required rate of return = real rate + inflation + premium + risk premium = Risk free rate + Risk premium.

2. Inflation premium - Investors are compensated for reduction in purchasing power of money.  From point (1) the higher such the inflation premium, the higher the market interest rate.

3. Default risk premium (DRP) - This is the rate further added to risk free rate for possibility of default in such payment of loans.  Generally, it's added if two securities have equal marketability and maturity.

4. Liquidity premium - This is premium that is added to equilibrium interest rate on a security if such type of security cannot be transformed to cash on short notice and close to the original cost.

5. Maturity Risk Premium - a premium reflecting interest rate risk that is risk of capital losses that investors are exposed to due to hanging interest rate over time.


Related Discussions:- Determinants of required rate of return

Evaluating financial statements, WHat are the expected rates of reimburseme...

WHat are the expected rates of reimbursement for this time frame for each player ?

Project apparisal, challenges your likely to face when apparising a project...

challenges your likely to face when apparising a project on the implemtation stage

APR, Determine how much of a total loan payment applies towards principal a...

Determine how much of a total loan payment applies towards principal and how much applies towards interest for a home mortgage of $177,219 with a fixed APR of 7.5% of 20 years

Investment analysis, Investment Analysis Any type of company will inve...

Investment Analysis Any type of company will invest finance for the sake of deriving a return that is useful for four main purposes as: 1. To reward the owners or shareholder

Investment bank, Investment Bank A lending entity is engaged in all the...

Investment Bank A lending entity is engaged in all the phases of privacy offerings the including managing, underwriting, trading, and the distributing new security issues.

Example of accounting rate of return method, Example of Accounting Rate of ...

Example of Accounting Rate of Return Method                                    Shs. Project X cost              500,000 Scrap value                 100,000 Stream of

Liquidity preference theory, Liquidity Preference Theory This theory s...

Liquidity Preference Theory This theory states that short term bonds are extremely favorable than long term bonds for two (2) purposes. 1. Investors usually prefer short te

WACC., The following is the existing capital structure of Company XYZ Ltd. ...

The following is the existing capital structure of Company XYZ Ltd. Ordinary shares at Shs.10 par 1,000,000 Retained 800,000 12% preference shares Shs.10 par 400,000 16% loan Shs.1

Determine tax cash flows & irr, An industrial engineer proposed the purchas...

An industrial engineer proposed the purchase of a RFID Fixed Asset Tracking System for the company's warehouse and weave rooms.  The engineer though that the system would provide a

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