when one to use for required return,when you are given both short-term government bill yield or long-term government bond yield?

CFA Level II Equities
#1

when one to use for required return,when you are given both short-term government bill yield or long-term government bond yield?

I can see, for risk premium calculation, answers are based in long-term government bond yield but when it comes to calculating required return, answers are based on short-term government bill yield.

What’s the rule here?

#2

Long term for CAPM BYPRP, short term for all else.

#3

^+1

#4

Just to be clear, the BYPRP is using the company’s YTM on long term debt, not the government’s. Right?

#5

Long-term government bond yield is ALSO used for Gordon Growth Equity Risk Premium

current dividend yield + long-term consensus growth - long term government bond yield

You guys gotta be careful posting inaccurate stuff.

#6

Yeah, this is suddenly a concern for me. I just got a Fama French question wrong because I used the LT bond instead of the short term bill. Bah.

#7

I’m combing through the Return Concepts chapter and there doesn’t even seem to be any hardfast rule, just that: “the risk-free return should correspond to the time horizon for the investment.”

Serenity now.

#8

Ideally it should be long-term…considering you value on a going concern basis (perpetuity) unless question specifically ask for a particular investment horizon.

#9

Ok I see it in the CFAI curriculum now for Fama French at least. They very explicitly state T-bill rate, that wasn’t clarified in Schweser from what I can tell.

#10

I hate these inconsistencies!

#11

yeah…it’s very inconsistent.

#12

Fama French use the T-bill rate in all their papers.

Only CAPM uses long term T-Bonds.

#13

I had this question as well. helpful post. i’m guessing Pastor Stambaugh would use the same rule as FF, ST t-bill rate. Anybody know what would be used for Ibbotsen Chen? The LT bond yield?

#14

Ibbotsen-Chen use long turn RF.

BIRR use T-bill rate.

#15

CAPM = Long-term Govt Yield

BYPRP = Long-term firm yield

Fama = Short-term Yield

Pastor = Short-term yield

Ibbotson Chen = Supply Side = Not specified in the CFAI curriculum

BIRR = Short-term yield

GGM = Long-term yield

However, Ibbotson Chen, just like the GGM, gives a forward looking estimate of the return, so I would go with LT yield…

#16

^ Ibbotson Chen is used in the CFAI Mock PM and the applied yield is LT.

#17

thank you both for your comments. last question, this may be a dumb one, which is the BIRR? that acronym isnt ringing a bell.

#18

BIRR: required return =

  • T-bill rate

  • Sensitivity to confidence risk * Confidence risk

  • Sensitivity to time horizon risk * Time horizon risk

  • Sensitivity to inflation risk * Inflation risk

  • Sensitivity to business cycle risk * Business cycle risk

  • Sensitivity to market timing risk * Market timing risk

#19

what about Buildup Method? RF +ERP+Size+CSRP?

#20

FFM/PS using short-term and CAPM using long-term really trips me up.

Especially because the book says that “FFM… Factors are: RMRF, … the return … in excess of the one-month T-bill rate … and is the factor shared with the CAPM” (p75)

Well shit, if it’s the factor shared with the CAPM, why is FFM in excess of 1-month and CAPM is in excess of LT? And PS is just an extension of FFM.

Intuitively you’d think these 3 would be in sync.