Chapter 4: Q3DQ (page 319)
What are the three factors that influence the required rate of return by investors?
Short Answer
Three factors affecting the required rate of return are – 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’s perceived risk for any individual security. This perceived risk has two risk components – 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 –
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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