Determinants of required rate of return

 The determinants of required rates of return are as follows:::::::::::::::

1. Real risk-free Rate::::::::::::::::: The risk free rate is the rate of interest an investor should earn without taking any risks. Generally the interest paid by bonds issued by governments is known as the real risk free rate. This is because there is high chances that it would be paid in the future.

2. Business Risk:::::::::::::::::::::This is the uncertainty of income flows in the business. Thus the higher the uncertainty, the higher is the risk associated with the investment. For this reason the investor can demand some extra returns and the required rate of return of business will be higher. The less the business Risk, the less an investor can demand as a premium return. Thus it is one of the determinant of required rate of Return.

3. Financial Risk::::::::::::::::::::This is the risk posed by the nature of financial investments.  If the investment is on highly risky projects, it can create problem for return. Thus the expected return can be higher. In addition, if the company has used some debt financing to invest, it can create uncertainty on good profits. Thus on taking this part into account, required rate of return can be determined.

4. Liquidity Risk::::::::::::::::::::::::This is the risk associated with liquefying the assets in the shorter term. If the investment is done on assets which can be exchanged in the terms of cash in less time, then the investment has low liquidity risk. But if the investment is done on assets which cannot be exchanged in terms of cash in less time, then it has high liquidity risk. Thus if the liquidity risk is low, lower can be the required rate of return. But if the liquidity rate is high, higher can be the required rate of return.

5. Exchange Rate Risk:::::::::::::::::::::::::This is the risk associated with the exchange rate of currency while dealing with international business. Higher exchange rate risk means there is higher chance that you may not get the expected amount while converting a currency to another. Thus an investor can increase his/her expected rate of return in this case.But if there is lower exchange rate risk, an investor can expect to get the desired amount and he/she can decide to maintain a lower required rate of return. 

6. Country Risk::::::::::::::::::::::::::::::::::Country risk is also called political risk. The more political risk, the more an investor can demand to return. And the less the political risk, the less the premium on expected return an investor can demand to gain.

Thus these factors are the required rate of return determinants.  For more Finance Concepts, be in touch with this blog.

Individual investor life cycle

There are four phases in the life cycle of an Investor and it helps them to reap benefits over time equally. These four phases of individual investor life Cycle can be defined as follows.

1. Accumulation phase:::::::::::::::: Individuals who are in their early careers are in the accumulation phase. These careers can be early to middle years. Thus they should focus on investing as little money as they have. This is because the same amount of money will give them better return in the future. For this reason, an investor in this phase should focus on investing as little as they have. 

This is because it will accumulate to more money on the future. For example, if an investor invests $500 per year for 20 years, it can accumulate to $50,000 in the future. But if he decides to invest early, it can easily accumulate to more than thatand that can be a total of $150,000 if they have 40 years time.

2. Consolidation Phase:::::::::::In this phase of investment, an investors earning exceeds their investment. This is because in this phase it is assumed that main investor has already paid off his/her outstanding debts and much of their college bills. Thus they have extra income which they can use to invest in higher risks product. But they still needs funds and because of this they may not invest in high risk products that may put themselves in a loss. It is one of the Major phase of Individual Investor Life Cycle.

3. Spending phase::::::::::::::::::This phase shows up when an individual retire and their expenses is covered by their pensions of some savings fund. Thus in this phase an individual can take decision to invest in high risk projects.

4. Gifting phase::::::::::::::: In this phase an investor can gift from their earnings to others because they are already rich and settled.

There are four phases in the life cycle of an Investor and it helps them to reap benefits over time equally. These four phases can be defined as follows.

1. Accumulation phase:::::::::::::::: Individuals who are in their early careers are in the accumulation phase. These careers can be early to middle years. Thus they should focus on investing as little money as they have. This is because the same amount of money will give them better return in the future. For this reason, an investor in this phase should focuss on investing as little as they have. 

This is because it will accumulate to more money on the future. For example, if an investor invests $500 per year for 20 years, it can accumulate to $50,000min the future. But if he decides to invest early, it can easily accumulate tomore than that mand that can be a total of $150,000 if they have 40 years time.

2. Consolidation Phase:::::::::::In this phase of investment, an investors earning exceeds their investment. This is because in this phase it is assumed that main investor has already paid off his/her outstanding debts and much of their college bills. Thus they have extra income which they can use to invest in higher risks product. But they still needs funds and because of this they may not invest in high risk products that may put themselves in a loss.

 

Required rate of Return

 Required rate of return is the rate of return that an organization should achieve such that it compensates the time value of money, the expected rate of inflation and the risk involved. The concept is that each unit of money you invest has a time value. This means the value of the same unit of money is higher in the present time than compared to the future time. Thus one unit of money today has higher purchasing power yesterday and the one unit of money in the future has more purchasing power today. There are formulas to calculate the time value of money. It can be found from any books in future.

Additionally the expected rate of inflation should also be adjusted so that we can manage our earnings. If the expected inflation rate is not adjusted, then the company may lose income or they may run at a loss. This is because the price of goods and commodities increases over time and it's very unlikely that it decreases. Thus if it is expected to earn $100,000 which can be spent to purchase machinery, inflation may mcause the price of machinery to be $150,000. Thus the operation of the company can be affected. For this reason the expected inflation rate of $50,000 should be adjusted to the machinery product and the required rate of return should be calculated.

Further the required rate of return should adjust the risk involved. This means if man organization is undergoing a risky project which can give them a huge loss then they must only accept the project if it gives them huge profit also. On the opposite hand, if an organization is planning to take a project on hand which gives them minimal loss, then they can also accept to take minimal profit. This simply means that the required rate of return should be decided on the basis of the risks amount the company is willing to take while choosing a project.

Thus,

Required rate of return= The time value of money+ Expected rate of inflation + Risk Involved.

 

 For more Finance Concepts, be in touch with this blog.

Investment

 Introduction to Investment

Investment is spending your savings in such a way that it increases over time. The present trend in Countries is to invest money in such a way that it provides maximum return over time.

                                               

Risk

Risk is defined as the chances actual return deviates from the expected return. Thus higher deviation from expected return means higher risk and lower deviation means lower risk.

For Example::::::::::For example if an organization is expecting to earn $10,000, $20,000 and $30,000 per quarter but can earn only $5000, $6000 and $ 7000 in these three quarters. In this case the deviation from expected return is very high, and thus the company seems to have higher risk.

Additional an organisation is expecting to earn $10,000, $20,000 and $30,000 per quarter and earns an equivalent of $9000, $20,000 and $29,000 in three quarters. Then in this case, the deviation from expected return is very low. Thus the company has lower risk.

Microsoft company is a leading oganization in the world. Its net income for the year 2017 was 20,539 Million, for 2018 was 16, 571 Million. This shows there could have been a sharp decline from the expected profit and thus there can be higher risk. Thus the Concept of Investment is Highly Important.

 

 For more Finance Concepts, be in touch with this blog.