Calculation of the expected return and risk premium is an essential aspect of our investment policy. To ensure a comprehensive assessment, we follow a step-by-step approach:
- Determining the risk-free rate: We consider the prevailing risk-free rate, typically established by a government institution/bank.
- Assessing the market risk premium: We evaluate the additional return investors expect for assuming the risk of investing in the stock market compared to a risk-free investment.
- Calculating the required rate of return: By combining the risk-free rate and the market risk premium, we determine the minimum return expected from our investments, considering the associated risks.
- Adjusting for industry-specific risks: Recognizing that each industry carries its own set of risks, we incorporate an industry-specific risk premium to account for factors such as market competition, technological advancements, and economic conditions.
- Determining the total required return: Total Required Return = Required Rate of Return (Risk free return + Return on Stock) + Industry-Specific Risk Premium
Based on these calculations, our investment policy mandates that we seek an expected return of at least the determined total required return to adequately address the risks associated with specific investment opportunities.
To determine the real rate of return, our investment policy suggest to adjust it against inflation.
Formula
- ROI = Rf + Rs + Risk Premium