Required Rate of Return
Required Rate of Return
The required rate of return is the minimum rate of return that an investor requires before investing capital. The degree of risk associated with an investment is reflected in the required rate of return. The Capital Asset Pricing Model (CAPM) is a method used in determining the required rate of return associated with an investment. Required rate of return is the bare minimum returns that an investor needs from an investment to feel comfortable with it. Because of this, the required rate of return is up to the investor's discretion and varies depending on the investor's priorities. CAPM considers the risk involved in a particular investment and whether or not the investment's potential returns justify this risk.
This includes –
Determine the market return. The market return is the average return that the market provides as a whole. The most commonly used index to determine market return is the DSEGEN index.
The risk-free return is the rate of return that can be obtained by investing in financial instruments considered to have no default risk. This is most commonly considered to be the discount rate by the Bangladesh Bank.
A beta value is an expression of how volatile your investment is relative to the rest of the market.
Work with the Rate –
Less the required rate better for the investment.
Apply the rate on the cost of acquiring the share.
The amount will then represent exit price at which the investment will fulfill its required rate.
For example – if you invest in a stock, your required return might be 10% per year and your share price is TK. 100 than your required return is TK. 10. So your exit price at least TK. 110.
Here we follow CAPM method to find out the required rate where market risk compensates the excess return.
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