Risk and Return Discussion: Expected and Required Return Analysis

This discussion post delves into the core concepts of risk and return within the realm of finance. It differentiates between expected and required rates of return, elucidating their significance in investment decisions. The post highlights how investors anticipate returns commensurate with the perceived level of risk, emphasizing the importance of these metrics in evaluating investment opportunities. Furthermore, it explores the calculation and interpretation of holding period returns, providing a comprehensive understanding of how investments perform over time. The discussion also touches upon the Capital Asset Pricing Model (CAPM), offering insights into how it can be used to assess whether the expected return of an asset sufficiently compensates an investor for the associated risks. Overall, the post provides a clear analysis of the fundamental principles of risk and return, offering a valuable resource for students studying finance.

Running Head: RISK AND RETURN DISCUSSION
RISK AND RETURN DISCUSSION
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1RISK AND RETURN DISCUSSION
Table of Contents
Expected and Required Rate of Return......................................................................................2
Reference....................................................................................................................................4

2RISK AND RETURN DISCUSSION
Expected and Required Rate of Return
Investments are made by organizations and individuals with the expectations to gain
highest possible return. Those investors who are able to take risks, they generally have the
expectation for receiving rate of the return, which matches with particular risk level. Both
required and the expected return shows risks levels, which is required to be gained from
doing the investments in risky projects or assets. The rate of return is the way someone loses
or gains on particular set of investment over time as the fraction of initial investment and
expected rate of the return is the total prediction regarding losses or gains that is different
from actual rate of the return (Greenwood and Shleifer 2014).
Expected rate of the return is return that is expected by investors for receiving once
investment is done. Its calculation is done by using the financial model, for instance CAPM,
in which there are uses of proxies for calculating expected return from investment. It can also
be calculated with the help of assigning the probabilities to possible set of returns, which can
be received from the investment. Moreover, expected rate of the return is the assumption and
hence, there is no such assurance that desired rate of the return would be received (Ehrhardt
and Brigham 2016). Although, there are certain instruments that have already set rate of the
return, for instance interest on the fixed deposits. In these kinds of investments, expected
return could be known with the degree of certainty. Further, required rate of the return is the
return that is required by investor for making investments in projects, investments or assets. It
helps in representing riskiness of investment. The rate of return represents compensation,
which investors receives for risk borne. It is helpful, when decisions-making are required
regarding investment of funds at best place. It differs from one organization or individual to
another (Huda and Barata 2015).

3RISK AND RETURN DISCUSSION
Sometime, there could be lower expected return, in that particular case, return will
not be enough for compensating investor for risk associated with investment. However,
sometimes, the expected return would be higher than that required for compensating investors
for riskiness of asset. Hence, expected and required rate of return are quite similar. In
addition, both evaluates return levels; which investor sets as benchmarks for investment. The
required rate of return helps in representing minimum returns, which is required to be
received for the option of investment and on other hand, in expected return, investors makes
the thought that they could generate return, if they make an investment. In case of correct
valuation of security, return expected will be equal to required return as well as NPV of
investment will become zero. However, in case, required rate of the return is greater in
comparison to expected rate, then in that case, security investment will be considered as
overvalued and when there is lower required rate of return compared to expected return then
in that situation, security investment is undervalued (Wang and Sun 2014).

4RISK AND RETURN DISCUSSION
Reference
Ehrhardt, M.C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage
learning.
Greenwood, R. and Shleifer, A., 2014. Expectations of returns and expected returns. The
Review of Financial Studies, 27(3), pp.714-746.
Huda, N. and Barata, A., 2015. Detecting The Expected Rate of Return Volatility of
Financing Instruments of Indonesian Islamic Banking through GARCH Modeling
(Generalized Autoregressive Conditional Heteroscedasticity). Tazkia Islamic Finance and
Business Review, 9(1).
Wang, X. and Sun, B., 2014. New results on the rate of return for the risk assets held
indefinitely. Int. J. Innovative Comput. Inf. Control, 10(2), pp.823-836.