CAPM - long or short term RFR?

CFA Level I
#1

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

#2

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?

#3

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:

#4

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…

#5

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…

#6

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! #@$@

#7

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

#8

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…

#9

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…