If anyone has taken this version, q38 was asking for cost of equity using CAPM (in the context of WACC) and gave a 3mo T-Bill quote and a 10y T-Bond quote. The answer they had used the 10y Bond quote for the risk-free-rate assumption… Am I crazy or they are incorrect?
There was a thread a couple days ago with a problem about this. I had mentioned that you should use the bond rate instead of the tbill rate because of what I saw on the CFAI exam. Everyone disagreed, so maybe it is an error on the test.
In the context of WACC 10 Yr T-bond should be used because WACC deals with long-term projects. In the context of Sharpe calculation 3 month T-bill should be used.
There was big battle about this in June. I remember when I got that red screen I almost put my first through it!
I haven’t seen the question on test 3, but the theory is that you should use a rf rate that corresponds to your horizon. So, yeah, the 10 year would probably make more sense for a capital project (of average risk). It seems like this would be true for a sharpe calc also. We’re suppose to use a t-bill rate for that? But mwvt9 is right about the battle in June. I almost blew my lid, too. I hope I do better this time.
Hey Guys, I took CFAI Sample Exam 3 yesterday and I used the 10 year Bond RFR. I don’t understand why they used the Tbill 3 year RFR… They did not post any explanations to justify their choice… This got me really confused:( M.
One difference between a wacc calculation and a Sharpe calculation is that wacc is about forward looking financing decisions and Sharpe is about backwards looking performance evaluation. If your thinking about locking up your money for 10 years the rfr is the rate you could get for that 10 yrs, i.e., the 10-yr Treasury rate. If your looking backwards, the rfr is the rate that someone could get without worrying about holding period returns and timing issues. That’s more or less the average T-bill rate (even T-bills have holding period returns that are different than average returns though). There’s an ugly middle ground where reasonable people can disagree (CAPM). CFAI likes to use long-term interest rates for CAPM type problems with some bogus explanation about stocks are long-term so you should use long-term interest rates (this explanation has nothing to do with anything - least of all some empirical justification - so just use the concept and answer the question correctly).