- Required returns
When making an investment it is crucial to consider what else you could have bought. For example, pick stocks instead of, say, risk-free government bonds, and you are giving up a safe return of, say, 3%. That's your minimum required return for buying stocks. But that's too low because stocks are riskier.
The UK government has never failed to repay the capital or any coupons on its debt whereas companies go bust and even skip dividend payments when times are tough. Quantifying a required return for a share can be done using the capital asset pricing model (CAPM).
It says that if government bonds offer 3%, the average gap between the return on stocks and bonds is 5%, and a stock is 20% riskier than the wider market, you should demand 9% (3% + (5% x 1.2)) for buying it.