# CAPM - long or short term RFR?

Are we supposed to use the long term RFR i.e. a 10 yr t-bond or short term i.e. 3 month t-bill? I came across a question in one of the samples and for the answer they used the 10 year t-bond without any specified reason. Question was something like this: Rate of return on 3-month Treasury bills 3.0% Rate of return on 10-year Treasury bonds 3.5% Market equity risk premium 6.0 Estimated beta 1.6

I asked this yesterday and the response I got was that you should match the length of the project to the length of the rfr. So if the project is a 10 year project, use 10 yaer t-bond. I dont recall what they said about the project in that problem–do you?

There was no mention of the durationof the project in the question, which threw me off as well Question was something along these lines: XYZ wants to determine the cost of equity that can be used in the calculation of the weighted average cost of capital. Following information is present: Rate of return on 3-month Treasury bills 3.0% Rate of return on 10-year Treasury bonds 3.5% Market equity risk premium 6.0% estimated beta 1.6 Using the capital asset pricing model (CAPM) approach the cost of equity is:

I remember coming across this some time ago. The answer was to use the T-Bill rate because it represents a better estimate of the risk free rate - althought both are technically ‘risk-free’ the T-Bill is slighty more liquid, etc…

so its either 3 + 1.6(6) or 3.5 + 1.6(6). Were both answers options in the result? If only one was, that would probably solve it…

Both answers were present in the options. Only the 3.5 (long term) one is right. I went with the short term and got it wrong! and corp finance is supposed to be my forte! guess not! #@\$@

Use the T-Bond: my rational- the 3 month t-bill is too volatile and a relatively “new” product in the history of Treasuries, NOTE: the 10 yr t-bond is a benchmark for large corporations and the Treasury will never stop issuing these long term bonds

In corporate finance, how many 3 month projects are there? Not very many…10 year is better in this instance… For analyzing a stock using the CAPM, then the 3 mo Tbill makes sense, as you could only hold the stock for 3 months…

You are also generally looking at a firm’s long-term cost of capital… bonds, preferred, equity… all long-term… so the long-term risk free rate makes sense… that is my understanding anyway…