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Chapter 4: Q3DQ (page 319)

What are the three factors that influence the required rate of return by investors?

Short Answer

Expert verified

Three factors affecting the required rate of return are 鈥� the real rate of return, inflation premium, and risk premium.

Step by step solution

01

Required rate of return

The required rate of return is based on the market鈥檚 perceived risk for any individual security. This perceived risk has two risk components 鈥� business risk and financial risk. This perceived risk generates the risk premium.

02

Factors affecting the required rate of return

As given, the required rate of return is the result of a risk-free rate and risk premium. The risk premium is the result of associated risk with security. The risk-free rate results from the real rate of return and inflation premium.

So the three factors affecting the required rate of return are 鈥�

i) Real rate of return

ii) Inflation premium

iii) Risk premium

The required rate of return is the summation of all these three factors.

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Most popular questions from this chapter

Question: Beverly Hills started a paper route on January 1. Every three months, she deposits $550 in her bank account, which earns 8 percent annually but is compounded quarterly. Four years later, she used the entire balance in her bank account to invest in an investment at 7 percent annually. How much will she have after three more years?

Larry Davis borrows $80,000 at 14 percent interest toward the purchase of a home. His mortgage is for 25 years.

a.How much will his annual payments be? (Although home payments are usually on a monthly basis, we shall do our analysis on an annual basis for ease of computation. We will get a reasonably accurate answer.)

b.How much interest will he pay over the life of the loan?

c.How much should he be willing to pay to get out of a 14 percent mortgage and into a 10 percent mortgage with 25 years remaining on the mortgage?

Assume current interest rates are 10 percent. Carefully consider the timeb value of money. Disregard taxes.

How much would you have to invest today to receive

d. $50,000 each year for 50 years at 7 percent?

Does inflation have anything to do with making a dollar today worth more than a dollar tomorrow?

You invest \(3,000 for three years at 12 percent.Combine these steps using the formula FV 5 PV 3 (1 1 i) n to find the future value of \)3,000 in 3 years at 12 percent interest.
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