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

Obtain the break even rate, Question 1 (a) These are merely the diffe...

Question 1 (a) These are merely the differences of the two prices. Consequently the mark to market losses are given by { Q 1 - Q 0 ,Q 2 - Q 0 ,Q 3 - Q 0

Sales of the firm, The financial ratios of a firm are given:     Current ra...

The financial ratios of a firm are given:     Current ratio    =  1.33   Acid-test ratio   =  0.80   Current liabilities  = 40,000   Inventory turnover ratio = 6    What is the

BCF103 - Fundamentals of Business Financial Management, The TERRIER program...

The TERRIER program cost estimate is in constant FY 2011 dollars, while the SPANIEL program cost estimate is in constant FY 2014 dollars. what is the most valid way of comparing th

Federal reserve system, Federal Reserve System The central banking inst...

Federal Reserve System The central banking institution in the United States responsible for determining United States monetary strategy, including the setting of interest rates

Investor’s considerations -financial market, Investor's Considerations ...

Investor's Considerations As mentioned above, every investor before taking an investment decision, must consider the following aspects: Risk: The primary consideration for t

What is non - diversifiable risk, What is nondiversifiable risk? How is it ...

What is nondiversifiable risk? How is it measured? If not the returns of one-half the assets in a portfolio are perfectly negatively correlated along with the other half-which

Exchange rate or currency risk, A bond whose payments are made in for...

A bond whose payments are made in foreign currency has unknown cash flows in domestic currency. This is because the cash flows are dependent on the exchange rate

Cost of capital, COST OF CAPITAL A project's Cost of Capital is the sm...

COST OF CAPITAL A project's Cost of Capital is the smallest amount of acceptable rate of return/required rate of return on funds committed to the project. It is a compensation

Financial audit, To begin this topic, the case of China Sky describes the a...

To begin this topic, the case of China Sky describes the appointment of a special auditor  in the organization that is also a rule in the procedures of Singapore Exchange (SGX). Th

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