Question

1. We have two kind of figures such as estimated returns and required returns. There are classification for undervalued and overvalued assets. Please explain these concept and under these conditions what is the investors behavior.

Answer 1

Estimated return is the profit or loss an investor expects on an investment that has known or anticipated rates of return(ROR). It is calculated by multiplying potential outcome by chance of them occuring. For example if an investment has 70% chance of gaining $10 and 30% chance of losing $5 then the estimated return will be $5.50 [10*70% + 30%*(5)].

The required return is the minimum return an investor expects to acheive by investing in the project for takinh the risk in the project. The higher the risk higher is the expected return on the investment and vice-versa.

INVESTOR BEHAVIOUR: If the Estimated return is greater than the required return than investor would invest in that project and if expected return is lower than required return than investor would not purchase it.

If an value of an asset is trading at a value greater than its expected value then it is called overvalued asset.

If an value of an asset is trading at a value lower than its expected value then it is called undervalued asset.

INVESTOR BEHAVIOUR: If the investor predicts that the value of asset is undervalued then he will purchase such asset and sell it when the price reaches its actual value. And where asset is overvalued then he will sell such asset at higher price because in the future the price will decline.