Question

Explain what is meant by the required rate of return and include an example.

Answer 1

Required rate of return is the minimum rate you want from your investment . It is the minimum rate which you expect from the risk you are taking to invest.

For ex . Amol, an Engineer who earns $ 3000 / month and he wants to invest in some stocks. Since stock market is a risky investment . he knows the money he invest can either go in losses or in profits . The risk is higher , so he expects the return from investment (Required rate of return) to be higher.

If he invests 100 $ He expects the return of at least 20% . so after one year he wants =100 * (1+0.2)^ 2 =144 $

He expects the investment amount to become 144$

Similarly , when you invest in some goverment Fixed deposits . The risk is lower that is why banks provide you with lower rate of return as the investor know the risk is lower so is the reward.

Hope it helps, :)