Required return

Definition

Required return is the minimum annual percentage earned by an investment that will induce individuals or companies to put money into a particular security or project. It is a critical component in stock valuation and investment decision-making processes.

5 Must Know Facts For Your Next Test

1. Required return is influenced by the risk-free rate, market risk premium, and the specific risk associated with the investment.
2. It serves as a benchmark for evaluating whether an investment meets or exceeds investor expectations.
3. In Dividend Discount Models (DDMs), required return is used to discount future dividends to their present value.
4. A higher required return typically indicates a higher level of perceived risk associated with the investment.
5. The Capital Asset Pricing Model (CAPM) is often used to calculate the required return based on systematic risk.

Review Questions

• What factors influence the required return for an investment?
• How does required return impact stock valuation in Dividend Discount Models?
• Why might an investor demand a higher required return for certain investments?

Related terms

Risk-Free Rate: The theoretical rate of return of an investment with zero risk, often represented by government bonds.

Market Risk Premium: The additional return expected from holding a risky market portfolio instead of risk-free assets.

Capital Asset Pricing Model (CAPM): A model used to determine the required return on an asset based on its systematic risk relative to the market.