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hello sir. A big revision going on and questions for deeper Comprehending arising more and more in my head.
RRR=Rf+be(Rm-Rf)
can we use it when finding the MV of both MV of Debt and MV of share as Required Rate of Return (Cost of Equity, Cost of Debt). or it only for share? ( what’s for formula with beta for debt then if we assuming In CAPM that Gearing=0 and Debt beta=0 ?)
and from the latter, the 2nd question arises:
2)How is the Return for lenders is calculatedand 3rd one:
3)Formula RRR=Rf +b (Rm-Rf)In lectures it says b (beta) in formula=systematic risk, so b (equity beta) = all systematic risk? so, Equity beta is Systematic risk= Business risk + Gearing Risk only or +Economic (Market Risk) including inflation, economic risk and risks of all the market inefficiencies?
Please help.
1. In real life, debt is never complete risk free and therefore has a beta (although you would expect it to be small). Just as with equity, the beta of the debt would give the lenders required rate of return. However in F9 you have never been given a beta for debt and therefore the cost of debt is always calculated in the ways I go through in the lectures (usually the IRR because it is usually redeemable).
2. Beta measures the systematic risk, which is the risk due to general economic factors (such as inflation etc..). When there is gearing, the effect of gearing is to increase that risk for the shareholders and so the beta of equity takes both factors into account.
Market inefficiencies are not relevant in regard to betas.I think it will help you to watch the lectures again. Both as to why we are only interested in the systematic risk (which is in the CAPM lectures) and has to how and why gearing makes equity more risky (which is in the lectures on gearing).
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