On page 55, the point being made is that the expected return can be viewed as the sum of a) the required rate of return and b) a return from the convergence for price to underlying value.
If I understand this right, the required return is the return from the next best investment of similar risk (opportunity cost) and if the price reflects intrinsic value only the required return can be earned. If there is a mispricing between market price and intrinsic value there is an an opportunity to gain from the convergence of price to value as well.
Its followed by a short example with required return of 7.6% and an expected alpha of 12.4%, together these comprise the expected return of 20%.
In the following blue box example, they do not add the required return of 9.5% to the holding period return calculated (14.7%) yet the two examples appear identical.
Can someone explain what is going on with this example and how it relates to the concept of expected return being the sum of required return and expected alpha? It seems they are just calculating the expected holding period return.
I’m pretty confused.
Thanks for the help.