Question
In: Finance
Whether using the current government bond yield for the risk free rate is a good suggestion....
Whether using the current government bond yield for the risk free rate is a good suggestion. Discuss why using this is better/worse than using average historical returns?
Solutions
Expert Solution
Current government bond yield for the risk-free rate is not a good suggestion because current government bond yield is factoring into a recession into the economy as there has been a risk of yield curve inversion and there has been a futuristic discounting of recession in the economy so use of risk free rate in order to determine the longer term perspective will not be adequate by using the current interest rate because it will not properly reflect the incoming cycles so it is better to use average historical return as they will be factoring into various economic cycle and then they will be deciding upon the risk free rate so it can be said that the current government bond yield is not a good suggestion for risk free rate.
If we are using the historical average return, then it is providing up with the scope for discounting of the various economic cycles and since investment is not made just for short period of time, this average historical rate of return in order to calculate the risk free rate will be a better reflection of risk free rate at these times when there is high economic volatility, it is better to use the average historical risk free rate.
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answer in $ not in percentage
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