Question

When using the CAPM to estimate the cost of equity for evaluation of investment proposals, the appropriate substitute for the risk free rate of interest is:

		The yield on ten year government bonds.
		The yield on a government security whose term to maturity matches the life of the proposed project.
		The yield on a 30-year government bond.
		The yield on three year government bonds.
		The yield on 90 day treasury notes.

Please explain your answer. Thanks

Answer 1

When using the CAPM to estimate the cost of equity for evaluation of investment proposals, the appropriate substitute for the risk free rate of interest is:

The yield on a government security whose term to maturity matches the life of the proposed project.

• The risk-free rate of return refers to the theoretical rate of return of an investment with zero risk.
• In practice, the risk-free rate of return does not truly exist, as every investment carries at least a small amount of risk.