 Return requirements

Return requirements is the minimum acceptable return on investment sought by

individuals or companies considering an investment opportunity. Investors across the
world use the required rate of return to calculate the minimum return they would
accept on an investment, after taking into consideration all available options. When
calculating the required rate of return, investors look at overall market returns, risk-
free rate of return, volatility of the stock and overall project cost. The required rate of
return drives the type of investments that can be made. When calculating the
required rate of return, investors look at overall market returns, risk-free rate of
return, volatility of the stock and overall project cost.

 Specify the return measure such as total nominal return. A measure of

return needs to be specified. It can be specified in an absolute term or a
relative term. It can also be specified in nominal or real terms. Nominal returns
are not adjusted for inflation, whereas real returns are. One may also
distinguish pre-tax returns from post-tax returns.
 Determine the investor's stated return desire. A return desired by the
investor needs to be determined. The desired return indicates how much
return is expected by the investor. E.g. higher or lower than average returns.
 Determine the investor's required rate of return. A return required by the
investor also needs to be determined. A required return indicates the return
which needs to be achieved at the minimum for the investor.
 Specify an objective in terms of the return measure in the first step
above. The investor’s specific return objectives also need to be determined
so that they are consistent with his risk objectives. An investor having a high
return objective needs to have a portfolio with a high level of expected risk.

 Risk Tolerance.

Risk tolerance can be defined as the degree of variability in investment returns that
an investor is willing to withstand in their financial planning. When there is
consistency between risk willingness and ability, the investment task is made easier.
Where the two are in conflict, the advisor should seek to explain the conflict and its
implications but should not aim to try and change the client’s willingness to take on
risk that is not as a result of misperception. The prudent approach is to reach a
conclusion about risk tolerance that is the lower of the two factors – ability and
willingness.

 Liquidity Requirements.

Liquidity in the investment sense is the ability to quickly convert investments into
cash at a price close to their market value. Such constraints are associated with
cash outflows expected and required at a specific time in future and are generally in
excess of income available. Moreover, prudent investors will want to keep aside
some money for unexpected cash requirements. The financial advisor needs to keep
liquidity constraints in mind while considering an asset’s ability to be converted into
cash without impacting the portfolio value significantly.