Understanding Return , How much Return is Adequate?

Understanding Return

Section: 8 How much Return is Adequate?

Risk and return are positively correlated. Higher level of risk should be compensated with a higher than normal return. Higher the risk of investment, greater should be the return. This risk and return relationship needs to be kept in mind when undertaking investments.

Risk Free Return
Government bonds are normally treated as a risk free investment (as the default risk is zero). The interest rate of these government bonds is considered to be the risk free investment return in a country. As such, investors can use this rate as the lowest benchmark for their investment decision-making. Any investment other than government bonds would carry a higher investment risk and thus should provide higher return.

Risk Premium
The yield over and above the risk free rate is defined as risk premium. The investors would expect an additional return over and above the government bond rate to compensate for the additional risk inherent in a particular investment.

Market Return

The overall yield offered by the market as a whole to the investors is referred to as market return. When deciding how much return one should expect, market return is a useful benchmark to figure out the range of required return.

So, to decide the required rate of return, one must consider all three factors i.e. risk free return, risk premium and market return. The expected return by the investor will be risk free return plus a premium for the additional risk he is prepared to undertake.

Market return offered by the Saudi Arabian Stock Market in 2002 and 2003:

	Market Index at 31.12.2001	Market Index at 31.12.2002	Market Index at 31.12.2003	Market Return % - 2002	Market Return % - 2003
Saudi Arabia	2430.11	2518.08	4437.58	3.62%	76.23%

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