Income

Август 22, 2022

Содержание

2. the determinants of required rate of return Required Rates of return are one of the key
3. the determinants of required rate of return Three Components of Required Return: Required Return is the
4. The time value of money during the time period The time value of money (TVM) is
5. The time value of money during the time period another example, say you have the option
6. How Does the Time Value of Money Relate to Opportunity Cost? Opportunity cost is key to
7. The time value of money during the time period Why Is the Time Value of Money
8. The expected rate of inflation during the period Every economy may have inflation which is alright
9. WHY ARE INFLATION EXPECTATIONS IMPORTANT? nflation expectations are simply the rate at which people—consumers, businesses, investors—expect
10. Involvement of Risk with Investment here is nothing where risk is not involved. And it is
11. Involvement of Risk with Investment Systematic Risk: Directly involved with the system which arises from the
12. Involvement of Risk with Investment The determination process is involved with complicated work because the process
13. determinants of business risk The risk premium is the excess return above the risk-free rate that
14. Business Risk Business risk is the risk associated with the uncertainty of a company's future cash
15. Financial Risk Financial risk is the risk associated with a company's ability to manage the financing
16. Liquidity Risk Liquidity risk is the risk associated with the uncertainty of exiting an investment, both
17. Exchange-Rate Risk Exchange-rate risk is the risk associated with investments denominated in a currency other than
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the determinants of required rate of return
Required Rates of return

are one of the key factors which influence an investment decision. Actually, Determinants of Required Rates of Return helps to calculate the required rates of return on investment. Sometimes the required rates of return are considered as the cost of capital/expected rates of return which basically used as a discounting or compounding factor. By using this factor, we actually calculate the present and future value of cash flows.

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the determinants of required rate of return
Three Components of Required

Return:
Required Return is the minimum rate of return that you should accept from an investment to compensate you for deferring consumption.
The required rate of return that compensates the investor for :
The time value of money during the time period
The expected rate of inflation during the period
The risk involved

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The time value of money during the time period
The time value

of money (TVM) is the concept that a sum of money is worth more now than the same sum will be at a future date due to its earnings potential in the interim.
The time value of money is also referred to as present discounted value.
Investors prefer to receive money today rather than the same amount of money in the future because a sum of money, once invested, grows over time. For example, money deposited into a savings account earns interest. Over time, the interest is added to the principal, earning more interest. That's the power of compounding interest.

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The time value of money during the time period
another example,

say you have the option of receiving $10,000 now or $10,000 two years from now. Despite the equal face value, $10,000 today has more value and utility than it will two years from now due to the opportunity costs associated with the delay.
In other words, a payment delayed is an opportunity missed.

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How Does the Time Value of Money Relate to Opportunity Cost?
Opportunity

cost is key to the concept of the time value of money. Money can grow only if it is invested over time and earns a positive return.
Money that is not invested loses value over time. Therefore, a sum of money that is expected to be paid in the future, no matter how confidently it is expected, is losing value in the meantime.

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The time value of money during the time period
Why Is the

Time Value of Money Important.
The concept of the time value of money can help guide investment decisions.
For instance, suppose an investor can choose between two projects: Project A and Project B. They are identical except that Project A promises a $1 million cash payout in year one, whereas Project B offers a $1 million cash payout in year five.

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The expected rate of inflation during the period
Every economy may have

inflation which is alright up to a considerable percent but exceeding inflation is not good for the economy. At the time of calculating expected rates of return, we must consider inflation. Higher the inflation, the higher the required rates of return. It is a central bank and government responsibility to adopt an effective economic policy by which an accepted rate of inflation can be there for an economy. The investment selection process is influenced by the required rate of inflation.

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WHY ARE INFLATION EXPECTATIONS IMPORTANT?
nflation expectations are simply the rate at

which people—consumers, businesses, investors—expect prices to rise in the future. They matter because actual inflation depends, in part, on what we expect it to be. If everyone expects prices to rise, say, 3 percent over the next year, businesses will want to raise prices by (at least) 3 percent, and workers and their unions will want similar-sized raises. All else equal, if inflation expectations rise by one percentage point, actual inflation will tend to rise by one percentage point as well.

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Involvement of Risk with Investment
here is nothing where risk is not

involved. And it is money we talk about is more sensitive towards risk. Risk can vary from industry to industry, company to company, person to person. But the common thing is higher the risk higher the rates of return person expect from an investment. Although you may find there is a variation of risk-taking behavior among the individuals which is influenced by the personal trait of an individual. Risk can be broadly categorized into two heads; one is systematic and the other is an unsystematic risk.

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Involvement of Risk with Investment
Systematic Risk: Directly involved with the system which

arises from the macroeconomic factors and it is not possible to minimize this type of risk through diversification of investment.
Unsystematic Risk: Unsystematic is a type of risk that is possible to minimize through diversification of investment. With this risk, there is a correlation between risk and diversification.

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Involvement of Risk with Investment
The determination process is involved with complicated

work because the process is depending on how market change over time and how investors behave with it.
Market change because of the following reasons:
A wide range of available investment alternatives
Return on specific assets change dramatically
Change in interest rate over the time period

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determinants of business risk
The risk premium is the excess return

above the risk-free rate that investors require as compensation for the higher uncertainty associated with risky assets. The five main risks that comprise the risk premium are business risk, financial risk, liquidity risk, exchange-rate risk, and country-specific risk. These five risk factors all have the potential to harm returns and, therefore, require that investors are adequately compensated for taking them on.

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Business Risk
Business risk is the risk associated with the uncertainty of

a company's future cash flows, which are affected by the operations of the company and the environment in which it operates. It is the variation in cash flow from one period to another that causes greater uncertainty and leads to the need for a greater risk premium for investors. For example, companies that have a long history of stable cash flow require less compensation for business risk than companies whose cash flows vary from one quarter to the next, such as technology companies. The more volatile a company's cash flow, the more it must compensate investors.

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Financial Risk
Financial risk is the risk associated with a company's ability

to manage the financing of its operations. Essentially, financial risk is the company's ability to pay its debt obligations. The more obligations a company has, the greater the financial risk and the more compensation is needed for investors. Companies that are financed with equity face no financial risk because they have no debt and, therefore, no debt obligations. Companies take on debt to increase their financial leverage; using outside money to finance operations is attractive because of its low cost.
The greater the financial leverage, the greater the chance that the company will be unable to pay off its debts, leading to financial harm for investors. The higher the financial leverage, the more compensation is required for investors in the company.

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Liquidity Risk
Liquidity risk is the risk associated with the uncertainty of

exiting an investment, both in terms of timeliness and cost. The ability to exit an investment quickly and with minimal cost greatly depends on the type of security being held. For example, it is very easy to sell off a blue-chip stock because millions of shares are traded each day and there is a minimal bid-ask spread. On the other hand,small cap stocks tend to trade only in the thousands of shares and have bid-ask spreads that can be as high as 2%.The greater the time it takes to exit a position or the higher the cost of selling out of the position, the more risk premium investors will require.

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Exchange-Rate Risk
Exchange-rate risk is the risk associated with investments denominated in

a currency other than the domestic currency of the investor. For example, an American holding an investment denominated in Canadian dollars is subject to exchange-rate, or foreign-exchange, risk. The greater the historical amount of variation between the two currencies, the greater the amount of compensation will be required by investors. Investments between currencies that are pegged to one another have little to no exchange-rate risk, while currencies that tend to fluctuate a lot require more compensation.