Risk free rate

CFA Level I
#1

Rate of return on 3-month Treasury bills 3.0% Rate of return on 10-year Treasury bonds 3.5% Want to confirm that when the above are given, the risk free rate to use to calculate cost of equity is 3%, correct? Thanks.

#2

i think the longer the better so 3.5% is the correct Risk free rate. the reason is:

1- When using CAPM you’d need a representative risk free rate for the period.

2- Using DDM, you are assuming that company will stay for a long period and you are discounting dividends accordingly.

so to get CAPM and DDM to have more or less matching results you’d need a longer risk free rate.

#3

You have to choose the most appropriate rate. For a company issuing debt it is appropriate to assume they will last longer than 3 months in business (hopefully) so the 10 year rate is the more accurate choice.

#4

Thanks.

#5

Kelly, are you based in Montreal ?