Risk Measurement And Hurdle Rates

In the last chapter, we presented the argument that the expected return on an equity investment should be a function of the market or non-diversifiable embedded in that investment. In this chapter, we turn our attention to how best to estimate the parameters of market risk in each of the models described in the previous chapter - the capital asset pricing model, the arbitrage pricing model and the mutli-factor model. We will present three alternative approaches for measuring the market risk in an investment; the first is to use historical data on market prices for the firm considering the project, the second is to use the market risk parameters estimated for other firms that are in the same business as the project being analyzed and the third is to use accounting earnings or revenues to estimate the parameters.

In addition to estimating market risk, we will also discuss how best to estimate a riskless rate and a risk premium (in the CAPM) or risk premiums (in the APM and multi-factor models) to convert the risk measures into expected returns. We will present a similar argument for converting default risk into a cost of debt, and then bring the discussion to fruition by combining both the cost of equity and debt to estimate a cost of capital, which will become the minimum acceptable hurdle rate for an investment.

Retirement Planning For The Golden Years

Retirement Planning For The Golden Years

If mutual funds seem boring to you, there are other higher risk investment opportunities in the form of stocks. I seriously recommend studying the market carefully and completely before making the leap into stock trading but this can be quite the short-term quick profit rush that you are looking for if you am willing to risk your retirement investment for the sake of increasing your net worth. If you do choose to invest in the stock market please take the time to learn the proper procedures, the risks, and the process before diving in. If you have a financial planner and you definitely should then he or she may prove to be an exceptional resource when it comes to the practice of 'playing' the stock market.

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