Required return
The minimum return investors demand for holding an asset, given its risk. It is the discount rate in a valuation, so every value rests on this estimate.
Where you will meet it
Required return appears in 44 learning outcomes on the CFA syllabus. A few of them:
- Outline the main families of equity valuation model and what each gains or gives up
“Present value models, such as dividend discount and free cash flow models, estimate intrinsic value from forecast cash flows discounted at a required return.”
- Explain required returns, the risk-free rate and risk premiums
“A required rate of return is the minimum return an investor demands for holding an asset, and it can be built up from its parts.”
- Apply the security market line to spot assets that are mispriced
“The security market line plots required return against beta, and under the CAPM every correctly priced asset lies on it.”
- Contrast what lenders and shareholders are entitled to and what drives each group
“That asymmetry creates conflict: shareholders of a leveraged firm may favour riskier projects that shift value from lenders to themselves, which is why lenders protect themselves with covenants, collateral and higher required returns.”
See also
Learn it properly
- CAPM and the security market line: required return explained
- NPV vs IRR: which capital budgeting rule to trust
Practise it
Practise required return until it is automatic: questions that explain every wrong option.
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