T-Bills or Bonds for Risk-free CAPM

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SHoot85

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I was kind of upset when I came across a mock question I got wrong because I used the 3 month T-Bill rate (3%) instead of the 10-year T-bond rate (3.5%). I was upset b/c in all the reading and notes I’ve done on this stuff I don’t recall anything about one being preferred to the other, and if these are the types of questions CFA will be asking on the exam, I’d be a bit disappointed. So can someone direct me to where this is specified in the curriculum? Maybe it’s everywhere and I’m just blind, I’m mentally drained!
Either way, seems like such a trivial type of distinction for them to be penalizing people b/c they used T-Bill for risk free instead of T-bond.
 
It’s not specified in the curriculum.
On the real exam if you need to choose, it will be clear what to use. No guessing.
 
S2000magician wrote:
It’s not specified in the curriculum.
On the real exam if you need to choose, it will be clear what to use. No guessing.
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ok well that’s a relief. this was a CFAI mock from 2010, so I assume this was in the curriculum in years past, otherwise not sure why they would put a question in there like that. Very tricky.
 
They had this question in the mock they gave out. It was a cost of equity question and they said something to the extent of the 10 year being appropriate due to the long-term duration of cash flows for the project.
I missed the same question. They never metnioned anything about project haha.
 
In general, the risk free rate you use for discounting cash flows should match the period of the cash recieved starting from the time you lock up your investment. The practical way of doing this is to just use the treasury security with maturities matching the typical holding period, operating cycle, or the time-line of the underlying security (all three are commonly used). In the case of equities, the RFR used to build on the cost of equity is typically the 10-year treasury, although this might not be the most correct discount rate to use, it’s more correct than the 1-year RFR.
 
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