Hi In one of the CFAI mock exam questions, they provided both the rate of return on 3-month Treasury bills (3.0%) and the rate of return on 10-year Treasury bonds (3.5%), and asked to calculate the cost of equity. I initially used the 3.0% since I recall RFR is based on T-Bills. But the answer key shows that 3.5% for T-Bonds is used. Is there a reason for this? Thanks a lot.
Since you are using the risk free rate in CAPM to find the cost of equity you have to consider that equity is a long term investment. Therefore, the best risk free rate for an equity investment would be 10yrs instead of 90days. However, if they only gave you the 90day t-bill rate than it would be the best option.
That’s a rather odd question because the 10-year bond has term risk. I always assumed that the RFR should be stripped of all possible known risks.
^ yeah i thought the same way, but apparently i was wrong on my selection of RFR too.
Thought the same, but it says clearly in the CFAI text to use the 10-year as this better matches the typical holding period of equity
wikipedia said RFR is t-bonds as well.
When no other information is given, T-bill should work. However, since equity is assumed to be held infinitely, long-term T-note should better match the risk-free rate