Thursday, February 21, 2019
3 Factors That Influence the Rate of Return Essay
Any bondholder, or any investor for that matter, will allow leash factors to influence his or her required rate of make. The three factors are the by-line solid (pure) rate of return, largeness, and danger premium. These three factors equal the risk drop out rate which is the rate of return of an investment with no risk of pecuniary loss. This is also the rate that investors would expect from an absolutely risk- drop by the wayside investment all over a period of time.Inflation is the constant and progressive increase in the prices of goods and services. If the total rate of return was below the actual economic saki rates then this would cause the lender (investor) to pay off the borrower for use of his or her funds. So instead of creating mass chaos in our economic system, the pretension premium of invade rates results from lenders compensating for expected pomposity by button interest rates higher.An example that can derive from taking the inflation premium into acco unt is that when inflation is high, or expected to decline, look for semipermanent fixed rate bonds to lock in high market values. The genuinely rate of return and the inflation premium determine the risk let off rate of return. As an example, if the real rate of return were 2 pct and the inflation premium 3 percent, then we can say that the risk free rate of return is 5 percent.The real rate of return is described by our Corporate Finance book as the pecuniary rent the investor charges for using his or her funds for one year. For example, if you make a $10,000 investment that urinates 8% in one year, you would end the year with $10,800. So, you earn an extra $800, however, if inflation is at 3% for the year, your $10,800 is only worth $10,500. Your real rate of return is only 5%. Investors depending on dividends or interest from bonds are most affected by the costs of inflation. Stocks can be a little safer because companies can pass the higher cost of inflation to customers.La stly, the risk premium is the premium associated with the special risks of a given investment. In other words, is the risk you take on an investment worth the issue? The risk relates to a firms inability to meet its debt obligations as they come due. For example, bonds possess a contractual obligation for the firm to pay interest to bondholders they are considered less risky that common stock where no such obligation occurs. Treasury Bonds are backed by the full phase of the moon faith and credit of the U.S. government, whereas stocks are not. If you earn a risk free return from bonds at 3%, that becomes your baseline. Now, if any investment with risk moldiness return more than 5%. The amount the investment returns over 3%is known as the risk premium. For example, if you are looking at a stock with an expected return of 12%, the risk premium is 9%.