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

How the export promotion trade strategy, Question 1: (i) How are educa...

Question 1: (i) How are education and economic growth connected? (ii) Explain how the export promotion trade strategy may be more growth promoting for developing economies,

Callable bonds and puttable bonds, Convertible bonds can be classified into...

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

Clearing and settlement - t- bills, Clearing and Settlement The Treasur...

Clearing and Settlement The Treasury Bills are available in physical form if an investor desires so. The market is mostly dominated by institutional players who have a facility

Aligning financial reports, Aligning Financial Reports: The primary pur...

Aligning Financial Reports: The primary purposes of financial systems are to provide information to interested parties.  Any reports produced through the financial management p

What are ratios of chromex plc, Ratios A great number of ratios might b...

Ratios A great number of ratios might be appropriate for this purpose depending on the specific kind of financial performance which is being compared. Amongst those appropriate

Effect of volatility and the arbitrage free value, The volatility ass...

The volatility assumption has a great influence on the arbitrage free value of the bond. The higher the expected volatility, the greater the value of an option. W

Define deposit loan rate spread in the eurodollar, How does the deposit-loa...

How does the deposit-loan rate spread in the Eurodollar market compare with the deposit-loan rate spread in the domestic U.S. banking system?  Why? Answer: The deposit-loan sprea

Call-put parity, Call-Put Parity P + S = C + E * [1/(1+i)] ^n     where...

Call-Put Parity P + S = C + E * [1/(1+i)] ^n     where:      P = the market price of the put    S = the market price of the stock    C = the market price of the call

Accounting or average rate of return , I need a report on Accounting or Ave...

I need a report on Accounting or Average Rate of Return. Can you please assist me for Accounting or Average Rate of Return report for about 2500 words?

What is control risk, What is Control risk That material misstatement c...

What is Control risk That material misstatement could take place and not be detected, or prevented on a timely basis, by accounting and internal control systems. All audits

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