Expected return vs required return

Is expected return and required return the same? in CAPM, sometimes it is called Expected returns an other time it is callled Required return. so confused.

please add comments.


From my undestanding , in the scope of PM, yes, they are the same. That is the rate you require, or you expected the security would gain based on the level of risks (systematic and unsystematic.

I m nt currently taking help of book to answer ur quest. but what i understood is that there may be a circumstances when Expected Return = Req. Return, therefore whether Expected Return or Required Return is used, it does’nt matter.

Now, Expected Return is the Return that Investor is expecting to receive by holding a particular Assets whereas Req. Return is the minimum Return that an investor demand for holding a particular assets instead of holding other assets with similar risk.

As we know that Price & Returns are inversly related means to say that if Return is higher, price of the assets must be low enough to compensate for higher return. For e.g. An asset has price = 80 and an investor expects the price to be 100 in one year assuming no other cash flows like dividends…etc.

Therefore Expected Return = (100-80)/80 = 25%.

while from the data, you calculated required return with the help of CAPM = 20%

Now Minimum Return Required by an Investor for holding the asset is only 20% in the market but he expects that the same asset will pay off 25%, its his ( Investor ) expectation, so it seems to be a good deal bcz asset is undervalued .i.e price is low, Expected Return is higher, buy it. Therefore we may say that Expected Return = Req. Return + some extra return ( you may view this as alpha ).

If Calculated Required return with the help of CAPM is 25% in that case whether it is Req. Return or Expectd Return is used, it does not matter.

This is what I understood, if something more or I am missing something please comment on the same so that i can also enhance my skill on Return Concepts. Thanks in Advance.

Pretty much the same thing in the CFA context. It’s just what investor’s expect to get from holding the stock. Usually you see expected return when you use CAPM or Beta. You’re calculating what you think the return should be with ur little formulas.

Required return is usually use when you talk about position in the company. Your required return from holding or investing in this company due to X,Y,Z factors is 15%.

Expected return could be leverage (using WACC, Leverage Beta), but usually required returns are not/

It depends on the model you are using and the corresponding assumptions. When using CAPM to estimate expected returns, the RRR and ERR are the same as you are assuming capital markets are in equilibrium. Same thing for APT and other multifactor models/proxy models. In realty, due to estimation errors and market anomalies ERR and RRR usually differ as markets are not in equilibrium and not anymore efficient. Evidence regarding this behavior is provided (Fama and French, Shiller, Campbell and so on).

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