Question: Datas can be found online A) When we use the CAPM model to estimate the cost of capital for a 10-year project, ideally we would
Datas can be found online
A) When we use the CAPM model to estimate the cost of capital for a 10-year project, ideally we would like to find the "average expected short-term rates (yields) of risk-free securities (e.g 1M or 3M T-bills)" for the next 10 years and use it as the proxy for the risk-free rate in the CAPM model. However, in practice, the expected short-term rates for the next 10 years are not readily available. One way is to look at historical 3M T-bill rates, and use some sort of historical average as the estimate for the "average expected short-term risk-free rates" for the next 10 years. (i) Find the historical 3M T-bill rates for the past 40 years (1978-2017) from the Internet, and plot the historical 3M T-bill rates against time (horizontal axis: time; vertical axis: 3M T-bill rate) (ii) What is the average 3M T-bill rate in the most recent 10-years, i.e. 2008 2017? (iii) Calculate the averages of 3M T-bill rates from the 10, 20, and 30 years prior to 2008 (i.e 1998-2007,1988-2007, 1978-2007 respectively). Do these historical averages prior to 2008 provide good estimates for the actual (realized) 3M T-bill rates in the subsequent 10 years (2008-2017) as you calculated in (ii)? (iv) Based on your answers in (ii) & (ii) above, discuss the issues we may encounter when we use historical 3M T-bill rates to estimate expected future 3M T-bill rates. B)Given the issues discussed in Question above, some people look at the current yield (rate) of 10-year treasury notes instead and use it as the point estimate of current "average expected short-term risk-free rates" for the next 10 years. (i)(a) What is the current yield of 10-year treasury notes? (b) How about current 3M T-bill rate? (c) Which rate is higher? (ii) Are 10-year treasury notes really "risk-free"? Compared to 3M T-bills, what are the potential risks associated with longer dated treasury securities? (iii)Given the issues discussed in (ii) above, what adjustments should we make when we use the 10-year treasure rate (yield) as the starting point of risk-free rate estimate
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