BUSI 2503 Chapter Notes - Chapter 10: Risk-Free Interest Rate, Risk Premium, Operating Leverage
13 Aug 2016
School
Department
Course
Professor
Document Summary
What someone is prepared to pay for a financial asset (or security) is referred to as its market value. The market-determined required rate of return is the discount rate used for the time value calculations, and depends on the market"s perceived level of risk associated with an individual security. Historically, the real rate of return demanded by investors has been about 2 to 3 percent. The inflation premium added to the real rate of return. The size of the inflation premium is based on the investor"s expectations about future inflation. If one combines the real rate of return and the inflation premium, the risk- free rate of return is determined. This the rat that compensates the investor for the current use of his or her funds and for the loss in purchasing power due to inflation, but not for taking risks. We must now add the risk premium to the risk-free rate of return.
