Required Return Vs ERP

CFA Level II
#1

Afternoon folks,

I am getting a little muddled on something.

In the live schweser mock exam a question asked what the required return on equity is from a data set that requires the use of Ibbotson Chen.

What I understand is that for an ERP calculation it is necessery to subtract the risk free rate as we are looking at the premium over RF. This is fine.

In this answer, they want you to use IC to figure out the required return and have done (1+inf) x (1+EPSg) x (1+PEg) -1 + Div Yield

There is no inclusion of RF as you only want to know the required return and not the ERP.

I thought with a required return calc you ADD the RF to your calculated return (such as in Fama French) - so why has this not been done for this question above?

#2

i think that’s just the formula mate. to find ERP, we minus risk free, to find required return, we dont. so far from the mocks/tt’s seems like we just have to be able to apply the formula.

previous thread for your reference: https://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91341525

#3

ERP = required rate of return - RF

Deduct Rf if you want ERP, do not deduct Rf if you want req. return.

Fama French is different because the stuff with the 3 sensitivities gives you the ERP so you must add Rf to get req. return.

Fama French is the same as CAPM only not 1 but 3 factors will give you the risk premium.

#4

So you’re saying because the formula normally has minus RF and in theory we should be adding the RF back it cancels out to leave nothing?