Risk free rate of return explained | FIN-Ed
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Risk-free rate of return explained | FIN-Ed
Hi, in this video, we will discuss the real risk-free rate and how it is measured using a hypothetical example.
The real risk-free rate of interest, which is usually denoted as r*, is the interest rate that would exist on riskless security if no inflation were expected. In other words, the rate of interest on short-term default-free U.S. Treasury security in an inflation-free world is the real risk-free rate. Because there is no such economy as inflation-free, it isn't easy to measure the real rate precisely. Generally speaking, a 3-months US treasury bill is used as the risk-free rate. However, the use of a 10-year US treasury bond as the risk-free rate is not uncommon. It all depends on what purpose it is used for and who the analyst is. The equation that is used to measure interest rate is:
Quoted interest rate = r = r*+IP+DRP+LP+MRP
Example:
You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.8%. Your friend, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:
• Inflation premium = 3.25%
• Liquidity premium = 0.6%
• Maturity risk premium = 1.85%
• Default risk premium = 2.15%
On the basis of these data, what is the real risk-free rate of return?
Source: Fundamentals of Financial Management (Concise Edition) Brigham and Houston
Chapter 6: Interest Rates
Problem: 6-2
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Risk-free rate of return explained | FIN-Ed
Hi, in this video, we will discuss the real risk-free rate and how it is measured using a hypothetical example.
The real risk-free rate of interest, which is usually denoted as r*, is the interest rate that would exist on riskless security if no inflation were expected. In other words, the rate of interest on short-term default-free U.S. Treasury security in an inflation-free world is the real risk-free rate. Because there is no such economy as inflation-free, it isn't easy to measure the real rate precisely. Generally speaking, a 3-months US treasury bill is used as the risk-free rate. However, the use of a 10-year US treasury bond as the risk-free rate is not uncommon. It all depends on what purpose it is used for and who the analyst is. The equation that is used to measure interest rate is:
Quoted interest rate = r = r*+IP+DRP+LP+MRP
Example:
You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.8%. Your friend, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:
• Inflation premium = 3.25%
• Liquidity premium = 0.6%
• Maturity risk premium = 1.85%
• Default risk premium = 2.15%
On the basis of these data, what is the real risk-free rate of return?
Source: Fundamentals of Financial Management (Concise Edition) Brigham and Houston
Chapter 6: Interest Rates
Problem: 6-2
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Pure Expectations Theory: Pure Expectations Theory of the Term ...
Default risk premium: Default risk premium explained | FIN-Ed
Expected interest rate: Expected interest rate calculation- T...
========================================
Thanks for watching.....!!!
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